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NJ settles SEC fraud charges over bond sales
YAHOO
By MARCY GORDON, AP Business Writer
18 August 2010

WASHINGTON – The state of New Jersey has settled federal civil fraud charges of failing to inform bond investors that it had not met obligations to its largest pension plans, federal regulators said Wednesday.

In announcing the settlement, the Securities and Exchange Commission said New Jersey did not give municipal bond investors enough information to fully assess the state's financial picture.

New Jersey was the first state ever charged for violations of the securities laws. New Jersey neither admitted nor denied the allegations. It did agree to refrain from future violations of the securities laws.

No financial penalty was levied against the state. The SEC said it took into account state authorities' cooperation in its investigation and action taken by the state to correct the situation.

The case marked the latest action by the SEC touching on the $2.7 trillion bond market, used to finance schools, roads and hospitals around the country. Retail investors increasingly participate in the market, seeking safe investments with reliable returns. At the same time, crises in several municipalities have underscored the importance of the municipal bond market.

The SEC had charged that New Jersey sold more than $26 billion in municipal bonds between 2001 and 2007 to raise money for economic development projects, such as roads and power lines. But the bond sale documents didn't disclose that the state had failed to meet its financial obligations to two state employee pension funds. New Jersey likely couldn't contribute to the pension funds without raising taxes or cutting services, the SEC said.

As a result, investors in New Jersey's bonds lacked sufficient information to assess the state's financial status, the SEC said.

"All issuers of municipal securities, including states, are obligated to provide investors with the information necessary to evaluate material risks," Robert Khuzami, the SEC's enforcement director, said in a statement. "The state of New Jersey didn't give its municipal investors a fair shake, withholding and misrepresenting pertinent information about its financial situation."

The SEC last year proposed requiring brokers in municipal bonds to make fuller and more timely disclosures to investors.

Many states around the country have been unable to fully fund their public employee pension plans in the financial crisis.

"It is an area of concern," Elaine Greenberg, chief of the SEC's municipal securities and public pensions unit, said in a telephone interview. "We want to make sure that states and municipalities are adequately disclosing" their pension fund liabilities, she said.

State budget gaps to total $84 billion for fiscal 2011: study
As revenues improve, states struggle with less federal support for medical aid
By Deborah Levine, MarketWatch
July 27, 2010, 12:03 a.m. EDT

NEW YORK (MarketWatch) -- State budget gaps are now expected to total $83.9 billion for fiscal 2011, with shortfalls anticipated for the next couple of years, according to a study released Tuesday by the National Conference of State Legislatures.

That bleak assessment contains one ray of good news: The total is slightly less than the estimate in March for an $89 billion gap.

The biggest shortfall to make up may be the reduction in federal aid for medical programs. Congress hasn't approved extending this aid after increasing support as part of last year's stimulus package.

Officials in many states told NCSL that revenues have started to improve, or at least the rate of decline has slowed. But they still worry stabilizing revenues won't be enough to replace the loss of federal stimulus funds, and several states project deficits through 2013.

"For the first time in a long time we're seeing some slight improvement in the state revenue situation," said Corina Eckl, NCSL's fiscal program director. "But glimmers of improvement are tarnished by looming problems."

Almost half of all states said fiscal 2011 gaps would be 10% or more of their general fund. The largest was Nevada, with its budget deficit amounting to 45% of its general fund, NCSL said.

New Jersey, Arizona, Maine, North Carolina and three others had gaps of at least 20%.

Five states that previously said they didn't have a deficit reported one had developed.

Of the 44 states that provided 2011 tax forecasts, half said they expect revenue growth between 1% and 4.9%.

Three states see revenue growing at least 10% -- Oregon, Washington and Colorado -- all because of various tax increases.

Fiscal 2010

As of now, seven states project deficits at the end of fiscal 2010, which for some doesn't end until later this calendar year.

The biggest is Illinois, followed by Oregon, Michigan, Kansas, Washington, Pennsylvania and South Carolina.

Many did cut spending to bring the budget into balance, with 45 states saying fiscal 2010 general fund spending fell 4.6% percent below 2009 expenditures.

Economists have noted that public budget cuts would limit the recovery of the national economy, though municipal bond investors generally have little to fear. See story on municipal budgets, bonds.

NCSL notes that the report includes complete or partial information on 49 states. Only partial information was available from California, Florida and New York.

2012 and 2013

Two-thirds of the states already forecast another round of double-digit budget gaps in FY 2012. The deficit tally so far is $72.1 billion.

Eighteen states expect the gap to be at least 10% of their general fund.

Of states that have budget forecasts extending to fiscal 2013, 23 project budget gaps, which mostly can be traced in part to the end of federal stimulus funds, NCSL analysts said.


Link to the full collection of NYTIMES' series of articles...

States making employees work longer for retirement benefits
Keith M. Phaneuf, CT MIRROR
August 3, 2010

When it comes to pushing back the retirement age for state employees, Connecticut is testing waters that many states have plunged into over the past year.  A new report from the National Conference of State Legislatures found 10 states have passed laws this year to keep public-sector employees working longer.

"I think it's clear other states are doing this because they recognize the benefits are becoming unaffordable," Michael J. Cicchetti, Gov. M. Jodi Rell's deputy budget secretary and chairman of her Post Employment Benefits Commission, said Monday.

The administration, which created the commission in February to propose solutions to the huge funding gaps facing state retirement benefit programs, has suggested raising the normal retirement age for new state employees from 62 to 65 for workers with at least 10 years of experience.  According to its last, full actuarial valuation, the pension fund had $19.2 billion worth of obligations, or liabilities, and held just under $10 billion, an amount equal to 52 percent of its liability. Actuaries typically cite a funded ratio of about 80 percent as healthy.

"It's something you just can't ignore," Cicchetti added.

According to the NCSL, it's a problem shared by many other states.  Missouri Gov. Jay Nixon called his state's legislature into special session in late June to reform the pension system, securing bipartisan support for a law that - among other actions - raises the retirement age for workers hired after Jan. 1 from 62 to 67.

"We believe that these changes bring Missouri's retirement system more in line with the private sector," Nixon spokesman Scott Holste said Monday.

Illinois Gov. Pat Quinn also made pension reform a priority this year, signing legislation to raise the retirement age for new workers starting next year from 60 to 67, according to spokeswoman Annie Thompson. That change was part of a larger package of retirement reforms Quinn projected would stabilize the pension system and save over $200 billion over 35 years.

Other states that increased their retirement age for state workers this year, according to the NCSL report, are Iowa, Michigan and Vermont.  Some states base eligibility for retirement benefits on a combination of age and years of service. The 2009 concession agreement negotiated by Gov. M. Jodi Rell and Connecticut's state employee unions codified the so-called "rule of 75," which requires worker's age and years of service to total 75 before retirement health benefits can be accessed.

The minimum combination for all retirement benefits in Arizona was raised from 80 to 85, and in Colorado from 85 to 88, according to the NCSL report. Virginia increased the minimum combination for new state and municipal employees from 80 to 90.

Changes such as those enacted in Virginia effectively require eligible retirees not only to spend several decades in government service, but in most cases to retire at a later age.

Utah allows anyone with 30 years of state service, regardless of age to retire. But according to the NCSL report, the limit for new workers was raised this year to 35.

In Minnesota, lawmakers tried a different approach to keep workers on the job longer, doubling the pension reduction for state police and correction officers who seek to take advantage of early retirement rules.

Connecticut's pension fund has been plagued by two problems: decades of legislatures and governors authorizing annual contributions less than the level needed both to cover current costs and save for future payments; and periodic retirement incentive programs that trim salary expenses in the short-term while prematurely stripping the pension fund of assets that would have earned more in interest.

According to June report from an actuary and health care consultant on the effects of the 2009 incentive program on the Connecticut pension fund, the state's annual contribution to the pension fund would have to rise next year by $217 million, from $844 million to $1.06 billion.

But that report didn't assess the fund's overall investment earnings over the past two years, or the impact of $314.5 million in pension fund payments that Rell and the legislature have deferred - with union approval - since 2009.

Matt O'Connor, spokesman for the State Employees Bargaining Agent Coalition, said state government doesn't have to be at odds with its unions as it tries to strengthen its pension fund.

SEBAC, which negotiates benefits for about 45,000 unionized state employees, 42,000 retirees and roughly 100,000 dependents, offered a plan last spring to undo damage caused by early retirement programs.

Union leaders suggested reversing the process, offering incentives to workers willing to defer retirement - and thereby spend more years contributing to the pension fund rather than drawing benefits from it.

That idea was rejected by the Rell administration this year as it asked the unions to consider a second round of wage and benefit concessions. SEBAC rejected that request.

"We might be able to find some common ground if they would take a closer look at this," O'Connor said, adding the coalition believes it would interest enough workers to provide savings both the state government and employees.

"We really do believe it would be popular," he said. "We may be in a so-called recovery, but we are still facing unemployment close to 10 percent. We think a lot of people would see the advantage of staying on for another few years."

Facing Pension Woes, Maine Looks to Social Security
NYTIMES
By MARY WILLIAMS WALSH
July 20, 2010

Lawmakers in Maine have found an unusual tool for tackling their state’s pension woes: Social Security.

Just as workers in the private sector participate in Social Security in addition to any pension plan at their companies, most states put their workers in the federal program along with providing a state pension.

Maine and a handful of others, however, have long been holdouts, relying solely on their state pension plans. In addition, most states have excluded some workers — often teachers, firefighters and police — from the national retirement system and its associated costs, 6.2 percent of payroll for the employer and an equal amount for the worker.

Now, Maine legislators have prepared a detailed plan for shifting state employees into Social Security and are considering whether to adopt it. They acknowledge it will not solve their problem in the short term but see long-term advantages.

Some variation on this idea could ultimately appeal to other states grappling with their own exploding pension costs and, in extreme cases, quietly looking for help from Washington. In troubled states, some employees have wondered whether they might be allowed to begin paying in and collecting from the federal system even before they have contributed a career’s worth of taxes.

The potential effect on the Social Security program is hard to estimate. Maine’s proposal would mean new members and a small additional source of payroll tax revenue for the federal system.

Even if it fully embraces the proposal, Maine will have to come up with a considerable sum to sustain its existing pension plan, presumably through some combination of taxes and service cuts. After a phase-in period, Social Security would cover part of state retirees’ benefits, with the state pension as the remainder. Many pension plans in corporate America coordinate their benefits in this way.

The proposal has the advantage of not reducing promised benefits, guaranteed by the constitution in many states. The change would not be cheap, but it would reduce the role of Maine’s pension fund and thus the risk of having to suddenly cover giant losses down the road.

A Social Security spokesman said the agency did not expect many of the holdout states to join, citing the cost of participation. The only other state known to have talked recently about adding Social Security is Louisiana.

More than six million public employees work outside the Social Security system, including roughly 1.7 million teachers in California, Illinois and Texas, and nearly two million employees of all types in Alaska, Colorado, Massachusetts, Nevada and Ohio, as well as Louisiana and Maine. For years, these and other states have insisted they could provide richer pensions at a lower cost, both to workers and taxpayers, because of investments.

Some of those states’ pension plans now have shortfalls so large that they need outsize contributions. Virtually all state pension funds have had big losses in the last two years, but the go-it-alone states appear especially vulnerable.

Not only are these states trying to provide richer benefits with smaller contributions than the payroll tax for Social Security, but they have promised to do it for workers who can retire 10 and sometimes 20 years younger.

With pension costs ballooning and taxpayers lashing out, many workers in states with deeply underfunded plans fear their benefits will be cut. Those being asked to put more into their pension funds complain they feel caught up in Ponzi schemes. Some wish they had been part of Social Security after all.

“Had I known back then, I would not have stayed in Illinois,” said John Gebhardt, a university employee in that state, which keeps teachers and university personnel out of Social Security. He has even offered to pay both his own and his employer’s payroll tax to join Social Security, but was told no.

Maine lawmakers who support shifting state workers into Social Security say they believe it would be fairer. Social Security may not be sexy, but it is portable.

A recent study in Maine underscored the penalty paid by the mobile work force. Only one in five state employees stays around long enough to get a full pension. The majority leave, taking neither a pension nor any Social Security credits with them. This practice, not investment gains, has sustained the state’s pension system.

“The current system is immoral,” said Peter Mills, who, as a state senator, started the push to join Social Security. “It takes younger people and feeds off of them. You can withdraw from teaching at age 40 and realize you’ve got nothing to look ahead to for your old age.”

Dallas L. Salisbury, president of the Employee Benefit Research Institute, said he was surprised by how few public workers ever got pensions in Maine, where he provided advice on a pension overhaul. He said he checked and found similar turnover in other states.

Whether Maine joins Social Security or not, painful choices must be made. The state pension fund lost $2.25 billion in 2008, and taxpayers will have to replace the lost money. But they have less time to do so than most states, thanks to tough financing rules in the constitution. Projections show that Maine will not have enough money to do much else in the coming years if it adheres to those rules.

“It’s going to rip the guts out of our budget,” said Mr. Mills. “I don’t think you can find a budgetary parallel in my lifetime, and I’m 67.”

Unlike laggard states, including Illinois and New Jersey, Maine had in recent years been making its required pension contributions annually, and it avoided the common mistake of sweetening benefits when markets were strong.

Its looming fiscal crisis stems primarily from investment losses, points out Sandy Matheson, executive director of the state plan. “Maine is almost like a petri dish,” she said, showing how things can go awry even if a state is responsible.

Mr. Mills, a Republican, initially envisioned shifting workers into Social Security and a 401(k) plan. But he now views Social Security combined with a traditional pension as a safer option. That puts him on common ground with Democrats in the statehouse.

The proposal may meet resistance, however, because it does not fill the gaping hole in the state’s pension fund.

A shift into the federal program is also hard to plan because Social Security has a financial imbalance — one that will worsen as the population ages. At some point, Congress is expected to either raise taxes or cut benefits.

Still, Social Security’s future is easier to predict than that of a state pension fund, because its pressure stems from broad demographic trends, not the vagaries of the stock market. Social Security keeps its reserves in conservative Treasury securities.

“You’ve got reviews taking place all over the country,” said Mr. Salisbury. Most places are asking painful questions about their investment strategies. But what Maine has discovered, he said, is just how expensive it really is to provide a guaranteed retirement benefit.

Debt commission leaders paint gloomy picture
YAHOO
By GLEN JOHNSON, Associated Press Writer
11 July 2010

BOSTON – The heads of President Barack Obama's national debt commission painted a gloomy picture Sunday as the United States struggles to get its spending under control.

Republican Alan Simpson and Democrat Erskine Bowles told a meeting of the National Governors Association that everything needs to be considered — including curtailing popular tax breaks, such as the home mortgage deduction, and instituting a financial trigger mechanism for gaining Medicare coverage.  The nation's total federal debt next year is expected to exceed $14 trillion — about $47,000 for every U.S. resident.

"This debt is like a cancer," Bowles said in a sober presentation nonetheless lightened by humorous asides between him and Simpson. "It is truly going to destroy the country from within."

Simpson said the entirety of the nation's current discretionary spending is consumed by the Medicare, Medicaid and Social Security programs.

"The rest of the federal government, including fighting two wars, homeland security, education, art, culture, you name it, veterans, the whole rest of the discretionary budget, is being financed by China and other countries," said Simpson. China alone currently holds $920 billion in U.S. IOUs.

Bowles said if the U.S. makes no changes it will be spending $2 trillion by 2020 just for interest on the national debt.

"Just think about that: All that money, going somewhere else, to create jobs and opportunity somewhere else," he said.

Simpson, the former Republican senator from Wyoming, and Bowles, the former White House chief of staff under Democratic President Bill Clinton, head an 18-member commission. It's charged with coming up with a plan by Dec. 1 to reduce the government's annual deficits to 3 percent of the national economy by 2015.  Bowles led successful 1997 talks with Republicans on a balanced budget bill that produced government surpluses the last three years Clinton was in office and the first year of Republican George W. Bush's presidency. Simpson, as the Senate's GOP whip in 1990, helped round up votes for a budget bill in which President George H.W. Bush broke his "read my lips" pledge not to raise taxes.

Despite their backgrounds, both Simpson and Bowles said they were not 100 percent confident of success this time around.  Simpson labeled the commission members "good people of deep, deep difference, knowing the possibility of the odds of success are rather harrowing to say the least."

Bowles also said Congress had to be ready to accept the commission's findings.

"What we do is not so hard to figure out; it's the political consequences of doing it that makes it really tough," he said.

Arkansas Gov. Mike Beebe was one of those leaders who sat in rapt attention during the presentation, one of the first in public by the commission leaders.

"I don't know that I ever heard a gloomier picture painted that created more hope for me," said Beebe, commending its frankness.


Debtors’ Prism: Who Has Europe’s Loans?
NYTIMES
By JACK EWING
June 4, 2010

FRANKFURT

IT’S a $2.6 trillion mystery.

That’s the amount that foreign banks and other financial companies have lent to public and private institutions in Greece, Spain and Portugal, three countries so mired in economic troubles that analysts and investors assume that a significant portion of that mountain of debt may never be repaid.

The problem is, alas, that no one — not investors, not regulators, not even bankers themselves — knows exactly which banks are sitting on the biggest stockpiles of rotting loans within that pile. And doubt, as it always does during economic crises, has made Europe’s already vulnerable financial system occasionally appear to seize up. Early last month, in an indication of just how dangerous the situation had become, European banks — which appear to hold more than half of that $2.6 trillion in debt — nearly stopped lending money to one another.

Now, with government resources strained and confidence in European economies eroding, some analysts say the Continent’s banks have to come clean with a transparent and rigorous accounting of their woes. Until then, they say, nobody will be able to wrestle effectively with Europe’s mounting problems.

“The marketplace knows very little about where the real risks are parked,” says Nicolas Véron, an economist at Bruegel, a research organization in Brussels. “That is exactly the problem. As long as there is no semblance of clarity, trust will not return to the banking system.”

Limited disclosure and possibly spotty accounting have been long-voiced concerns of analysts who follow European banks. Though most large publicly listed banks have offered information about their exposure — Deutsche Bank in Frankfurt says it holds 500 million euros in Greek government bonds and no Spanish or Portuguese sovereign debt — there has been little disclosure from the hundreds of smaller mortgage lenders, state-owned banks and thrift institutions that dominate banking in countries like Germany and Spain.

Depfa, a German bank that is now based in Dublin, is one of the few second-tier European banking institutions that have offered detailed disclosures about their financial wherewithal, and its stark troubles may be emblematic of those still hidden on other banks’ books.

Despite boasting as recently as two years ago of its “very conservative lending practices,” Depfa, which caters primarily to governments, has flirted with disaster. It narrowly avoided collapsing in late 2008 until the German government bailed it out, and today its books are still laden with risk.

DEPFA and its parent, Hypo Real Estate Holding, a property lender outside Munich, have 80.4 billion euros in public-sector debt from Greece, Spain, Portugal, Ireland and Italy. The amount was first disclosed in March but did not draw much attention outside Germany until last month, when investors decided to finally try to tally how much cross-border lending had gone on in Europe.

Before Greece’s problems spilled into the open this year, investors paid little heed to how much lending European banks had done outside their own countries — so it came as a surprise how vulnerable they were to economies as weak as those of Greece and Portugal.

“Everybody knew there was a lot of debt out there,” said Nick Matthews, senior European economist at Royal Bank of Scotland and one of the authors of the report that tallied up Greek, Spanish and Portuguese debt. “But I think the extent of the exposure was a lot higher than most people had originally thought.”

Concern has quickly spread beyond just the sovereign bonds issued by the three countries as well as by Italy and Ireland, which are also seriously indebted. Private-sector debt in the troubled countries is also becoming an issue, because when governments pay more for financing, so do their domestic companies. Recession, along with higher interest payments, could lead to a surge in corporate defaults, the European Central Bank warned in a report on May 31.

Hypo Real Estate has hundreds of millions in shaky real estate loans on its books, as well as toxic assets linked to the subprime crisis in the United States. In the first quarter, it set aside an additional 260 million euros to cover potential loan losses, bringing the total to 3.9 billion euros. But that amount is a drop in the bucket, a mere 1.6 percent of Hypo’s total loan portfolio. Hypo has not yet set aside anything for money lent to governments in Greece and other troubled countries, arguing that the European Union rescue plan makes defaults unlikely.

The European Central Bank estimates that the Continent’s largest banks will book 123 billion euros ($150 billion) for bad loans this year, and an additional 105 billion euros next year, though the sums will be partly offset by gains in other holdings.

Analysts at the Royal Bank of Scotland estimate that of the 2.2 trillion euros that European banks and other institutions outside Greece, Spain and Portugal may have lent to those countries, about 567 billion euros is government debt, about 534 billion euros are loans to nonbanking companies in the private sector, and about 1 trillion euros are loans to other banks. While the crisis originated in Greece, much more was borrowed by Spain and its private sector — 1.5 trillion euros, compared with Greece’s 338 billion.

Beyond such sweeping estimates, however, little other detailed information is publicly known about those loans, which are equivalent to 22 percent of European G.D.P. And the inscrutability of the problem, as serious as it is, is spawning spoofs, at least outside the euro zone. A pair of popular Australian comedians, John Clarke and Bryan Dawe, who have created a series of sketches about various aspects of the financial crisis, recently turned their attention to the bad-debt problem in Europe. After grilling Mr. Clarke about the debt crisis in a mock quiz show, Mr. Dawe tells Mr. Clarke that his prize is that he has lost a million dollars. “Well done,” says Mr. Dawe. “That’s an extraordinary performance.”

On a more serious front, Timothy F. Geithner, the United States Treasury secretary, visited Europe at the end of May and called on European leaders to review their banks’ portfolios, as American regulators did last year, to separate healthy banks from those that need intensive care.

Others say that if such reviews do not occur, the banking sector in Europe could be crippled and the broader economy — dependent on loans for business expansions and job growth — could stall. And if that happens, says Edward Yardeni, president of Yardeni Research, the Continent’s banks could find themselves sinking even further because “European governments won’t be in a position to help them again.”

LENDING practices at Depfa may have seemed conservative before its 2008 meltdown, but its business model had always been based on a precarious assumption: borrowing at short-term rates to finance long-term lending, often for huge infrastructure projects.

From its base in Dublin, where it moved from Germany in 2002 for tax reasons, Depfa helped raise money for the Millau Viaduct, the huge bridge in France; for refinancing the Eurotunnel between France and Britain; and for an expansion of the Capital Beltway in suburban Virginia. Depfa was also a big player in the United States in other ways, like lending to the Metropolitan Transportation Authority in New York and to schools in Wisconsin.

Before the current crisis, Depfa was proud of its engagement in Mediterranean Europe. In its 2007 annual report, the company boasted of helping to raise 200 million euros for Portugal’s public water supplier and 100 million euros for public transit in the city of Porto. In Spain, it helped cities such as Jerez refinance their debt and helped raise money for public television stations in Valencia and Catalonia as well as raise 90 million euros for a toll road in Galicia. And in Greece, Depfa raised 265 million euros for the government-owned railway and in 2007 told shareholders of a newly won mandate: providing credit advice to the city of Athens.

Depfa said it performed a rigorous analysis of the creditworthiness of its customers, including a 22-grade internal rating system in addition to outside ratings. More than a third of its buyers earned the top AAA rating, the bank said in 2008, while more than 90 percent were A or better.

The public infrastructure projects in which Depfa specialized were considered low-risk, and typically generated low interest payments. Yet because long-term interest rates were typically higher than short-term rates, Depfa could collect the difference, however modest, in profit.

To outsiders, Depfa still looked like a growth story even after the subprime crisis began in the United States. Hypo Real Estate, which focused on real estate lending, acquired Depfa in 2007. After the acquisition, Depfa kept its name and its base in Dublin.

But when the United States economy reached the precipice in September 2008, banks suddenly refused to make short-term loans to one another, blowing a hole in Depfa’s financing and leaving it with a loss for the year of 5.5 billion euros and dependent on the German government for a bailout.

As Hypo’s 2008 annual report said of Depfa: “The business model has proved not to be robust in a crisis.”

Even with Depfa’s myriad travails, most investors weren’t aware of the extent of its cross-border problems until it disclosed them this year.

The question now hanging over Europe is how many other banks have problems similar to Depfa’s, but haven’t disclosed them.

On May 7, the cost of insuring against credit losses on European banks reached levels higher than in the aftermath of the Lehman Brothers collapse in the United States. Officials at the European Central Bank warned that risk premiums were soaring to levels that threatened their ability to carry out their fundamental role of controlling interest rates.

Three days later, European Union governments joined with the International Monetary Fund to offer nearly $1 trillion in loan guarantees to Europe’s banks. At the same time, the European Central Bank began buying government bonds for the first time ever to prevent a sell-off of Greek, Spanish and other sovereign debt.

The measures, widely regarded as a de facto bank rescue, restored some calm to the markets, but critics said that the aid merely bought time without reducing overall debt load. Europe’s major stock indexes and the euro have continued to fall as investors remain dubious about the ability of Greece and perhaps other countries to repay their debts.

Even so, figuring out which banks may be most exposed to those countries largely remains a guessing game.

Regulators in each country know what assets their domestic banks hold, but have been reluctant to share that information across borders. Lucas D. Papademos, vice president of the European Central Bank, which gets an indication of banks’ health based on which ones draw heavily on its emergency credit lines, said at a news conference Monday that a small number of banks were “overreliant” on that funding.

But Mr. Papademos, who retired last Tuesday at the end of his term, wouldn’t be more specific. He said European banks would undertake a vigorous round of stress tests by July.

It’s obvious that Greek and Spanish banks hold large amounts of their own government’s bonds. Spanish banks hold 120 billion euros in sovereign debt, according to the Spanish central bank. But a central bank spokesman said that those holdings were not a problem because, thanks to the European Union’s rescue plan, the prices of Spanish bonds have recovered.

Guessing also falls heavily on public and quasipublic institutions like the German Landesbanks, which are owned by German states sometimes in conjunction with local savings banks. Five of Germany’s nine Landesbanks required federal or state government support after they loaded up on assets that later turned radioactive, ranging from subprime loans in the United States to investments in Icelandic banks that failed.

According to the Royal Bank of Scotland study, banks in France have the largest exposure to debt from Greece, Spain and Portugal, with 229 billion euros; German banks are second, with 226 billion euros. British and Dutch banks are next, at about 100 billion euros each, with American banks at 54 billion euros and Italian banks at 31 billion euros.

“Banks continue to not trust each other,” says Jörg Rocholl, a professor at the European School of Management and Technology in Berlin. “They know other banks are sick, but they don’t know which ones.”

DEPFA and Hypo Real Estate, meanwhile, face continued setbacks as they try to steer back to health. Hypo reported a pretax loss for the group of 324 million euros in the first quarter, down from 406 million euros a year earlier.

At the end of May, the German government raised its guarantees for Hypo to 103.5 billion euros from 93.4 billion. Some analysts say they think the bank may need more aid in the future.

“I don’t think it’s over yet,” says Robert Mazzuoli, an analyst at Landesbank Baden-Württemberg in Stuttgart.

Raphael Minder contributed reporting from Madrid.

State Debt Woes Grow Too Big to Camouflage
NYTIMES
By MARY WILLIAMS WALSH
March 29, 2010

California, New York and other states are showing many of the same signs of debt overload that recently took Greece to the brink — budgets that will not balance, accounting that masks debt, the use of derivatives to plug holes, and armies of retired public workers who are counting on benefits that are proving harder and harder to pay.

And states are responding in sometimes desperate ways, raising concerns that they, too, could face a debt crisis.

New Hampshire was recently ordered by its State Supreme Court to put back $110 million that it took from a medical malpractice insurance pool to balance its budget. Colorado tried, so far unsuccessfully, to grab a $500 million surplus from Pinnacol Assurance, a state workers’ compensation insurer that was privatized in 2002. It wanted the money for its university system and seems likely to get a lesser amount, perhaps $200 million.

Connecticut has tried to issue its own accounting rules. Hawaii has inaugurated a four-day school week. California accelerated its corporate income tax this year, making companies pay 70 percent of their 2010 taxes by June 15. And many states have balanced their budgets with federal health care dollars that Congress has not yet appropriated.

Some economists fear the states have a potentially bigger problem than their recession-induced budget woes. If investors become reluctant to buy the states’ debt, the result could be a credit squeeze, not entirely different from the financial strains in Europe, where markets were reluctant to refinance billions in Greek debt.

“If we ran into a situation where one state got into trouble, they’d be bailed out six ways from Tuesday,” said Kenneth S. Rogoff, an economics professor at Harvard and a former research director of the International Monetary Fund. “But if we have a situation where there’s slow growth, and a bunch of cities and states are on the edge, like in Europe, we will have trouble.”

California’s stated debt — the value of all its bonds outstanding — looks manageable, at just 8 percent of its total economy. But California has big unstated debts, too. If the fair value of the shortfall in California’s big pension fund is counted, for instance, the state’s debt burden more than quadruples, to 37 percent of its economic output, according to one calculation.

The state’s economy will also be weighed down by the ballooning federal debt, though California does not have to worry about those payments as much as its taxpaying citizens and businesses do.

Unstated debts pose a bigger problem to states with smaller economies. If Rhode Island were a country, the fair value of its pension debt would push it outside the maximum permitted by the euro zone, which tries to limit government debt to 60 percent of gross domestic product, according to Andrew Biggs, an economist with the American Enterprise Institute who has been analyzing state debt. Alaska would not qualify either.

State officials say a Greece-style financial crisis is a complete nonissue for them, and the bond markets so far seem to agree. All 50 states have investment-grade credit ratings, with California the lowest, and even California is still considered “average,” according to Moody’s Investors Service. The last state that defaulted on its bonds, Arkansas, did so during the Great Depression.

Goldman Sachs, in a research report last week, acknowledged the pension issue but concluded the states were very unlikely to default on their debt and noted the states had 30 years to close pension shortfalls.

Even though about $5 billion of municipal bonds are in default today, the vast majority were issued by small local authorities in boom-and-bust locations like Florida, said Matt Fabian, managing director of Municipal Market Advisors, an independent consulting firm. The issuers raised money to pay for projects like sewer connections and new roads in subdivisions that collapsed in the subprime mortgage disaster.

The states, he said, are different. They learned a lesson from New York City, which got into trouble in the 1970s by financing its operations with short-term debt that had to be rolled over again and again. When investors suddenly lost confidence, New York was left empty-handed. To keep that from happening again, Mr. Fabian said, most states require short-term debt to be fully repaid the same year it is issued.

Some states have taken even more forceful measures to build creditor confidence. New York State has a trustee that intercepts tax revenues and makes some bond payments before the state can get to the money. California has a “continuous appropriation” for debt payments, so bondholders know they will get their interest even when the budget is hamstrung.

The states can also take refuge in America’s federalist system. Thus, if California were to get into hot water, it could seek assistance in Washington, and probably come away with some funds. Already, the federal government is spending hundreds of millions helping the states issue their bonds.

Professor Rogoff, who has spent most of his career studying global debt crises, has combed through several centuries’ worth of records with a fellow economist, Carmen M. Reinhart of the University of Maryland, looking for signs that a country was about to default.

One finding was that countries “can default on stunningly small amounts of debt,” he said, perhaps just one-fourth of what stopped Greece in its tracks. “The fact that the states’ debts aren’t as big as Greece’s doesn’t mean it can’t happen.”

Also, officials and their lenders often refused to admit they had a debt problem until too late.

“When an accident is waiting to happen, it eventually does,” the two economists wrote in their book, titled “This Time Is Different” — the words often on the lips of policy makers just before a debt bomb exploded. “But the exact timing can be very difficult to guess, and a crisis that seems imminent can sometimes take years to ignite.”

In Greece, a newly elected prime minister may have struck the match last fall, when he announced that his predecessor had left a budget deficit three times as big as disclosed.

Greece’s creditors might have taken the news in stride, but in their weakened condition, they did not want to shoulder any more risk from Greece. They refused to refinance its maturing $54 billion euros ($72 billion) of debt this year unless it adopted painful austerity measures.

Could that happen here?

In January, incoming Gov. Chris Christie of New Jersey announced that his predecessor, Jon S. Corzine, had concealed a much bigger deficit than anyone knew. Mr. Corzine denied it.

So far, the bond markets have been unfazed.

Moody’s currently rates New Jersey’s debt “very strong,” though a notch below the median for states. Moody’s has also given the state a negative outlook, meaning its rating is likely to decline over the medium term. Merrill Lynch said on Monday that New Jersey’s debt should be downgraded to reflect the cost of paying its retiree pensions and health care.

In fact, New Jersey and other states have used a whole bagful of tricks and gimmicks to make their budgets look balanced and to push debts into the future.

One ploy reminiscent of Greece has been the use of derivatives. While Greece used a type of foreign-exchange trade to hide debt, the derivatives popular with states and cities have been interest-rate swaps, contracts to hedge against changing rates.

The states issued variable-rate bonds and used the swaps in an attempt to lock in the low rates associated with variable-rate debt. The swaps would indeed have saved money had interest rates gone up. But to get this protection, the states had to agree to pay extra if interest rates went down. And in the years since these swaps came into vogue, interest rates have mostly fallen.

Swaps were often pitched to governments with some form of upfront cash payment — perhaps an amount just big enough to close a budget deficit. That gave the illusion that the house was in order, but in fact, such deals just added hidden debt, which has to be paid back over the life of the swaps, often 30 years.

Some economists think the last straw for states and cities will be debt hidden in their pension obligations.

Pensions are debts, too, after all, paid over time just like bonds. But states do not disclose how much they owe retirees when they disclose their bonded debt, and state officials steadfastly oppose valuing their pensions at market rates.

Joshua Rauh, an economist at Northwestern University, and Robert Novy-Marx of the University of Chicago, recently recalculated the value of the 50 states’ pension obligations the way the bond markets value debt. They put the number at $5.17 trillion.

After the $1.94 trillion set aside in state pension funds was subtracted, there was a gap of $3.23 trillion — more than three times the amount the states owe their bondholders.

“When you see that, you recognize that states are in trouble even more than we recognize,” Mr. Rauh said.

With bond payments and pension contributions consuming big chunks of state budgets, Mr. Rauh said, some states were already falling behind on unsecured debts, like bills from vendors. “Those are debts, too,” he said.

In Illinois, the state comptroller recently said the state was nearly $9 billion behind on its bills to vendors, which he called an “ongoing fiscal disaster.” On Monday, Fitch Ratings downgraded several categories of Illinois’s debt, citing the state’s accounts payable backlog. California had to pay its vendors with i.o.u.’s last year.

“These are the things that can precipitate a crisis,” Mr. Rauh said.


Back to Business: Wall Street Pursues Profit in Bundles of Life Insurance
NYTIMES
By JENNY ANDERSON
September 6, 2009

After the mortgage business imploded last year, Wall Street investment banks began searching for another big idea to make money. They think they may have found one.

The bankers plan to buy “life settlements,” life insurance policies that ill and elderly people sell for cash — $400,000 for a $1 million policy, say, depending on the life expectancy of the insured person. Then they plan to “securitize” these policies, in Wall Street jargon, by packaging hundreds or thousands together into bonds. They will then resell those bonds to investors, like big pension funds, who will receive the payouts when people with the insurance die.

The earlier the policyholder dies, the bigger the return — though if people live longer than expected, investors could get poor returns or even lose money.

Either way, Wall Street would profit by pocketing sizable fees for creating the bonds, reselling them and subsequently trading them. But some who have studied life settlements warn that insurers might have to raise premiums in the short term if they end up having to pay out more death claims than they had anticipated.

The idea is still in the planning stages. But already “our phones have been ringing off the hook with inquiries,” says Kathleen Tillwitz, a senior vice president at DBRS, which gives risk ratings to investments and is reviewing nine proposals for life-insurance securitizations from private investors and financial firms, including Credit Suisse.

“We’re hoping to get a herd stampeding after the first offering,” said one investment banker not authorized to speak to the news media.

In the aftermath of the financial meltdown, exotic investments dreamed up by Wall Street got much of the blame. It was not just subprime mortgage securities but an array of products — credit-default swaps, structured investment vehicles, collateralized debt obligations — that proved far riskier than anticipated.

The debacle gave financial wizardry a bad name generally, but not on Wall Street. Even as Washington debates increased financial regulation, bankers are scurrying to concoct new products.

In addition to securitizing life settlements, for example, some banks are repackaging their money-losing securities into higher-rated ones, called re-remics (re-securitization of real estate mortgage investment conduits). Morgan Stanley says at least $30 billion in residential re-remics have been done this year.

Financial innovation can be good, of course, by lowering the cost of borrowing for everyone, giving consumers more investment choices and, more broadly, by helping the economy to grow. And the proponents of securitizing life settlements say it would benefit people who want to cash out their policies while they are alive.

But some are dismayed by Wall Street’s quick return to its old ways, chasing profits with complicated new products.

“It’s bittersweet,” said James D. Cox, a professor of corporate and securities law at Duke University. “The sweet part is there are investors interested in exotic products created by underwriters who make large fees and rating agencies who then get paid to confer ratings. The bitter part is it’s a return to the good old days.”

Indeed, what is good for Wall Street could be bad for the insurance industry, and perhaps for customers, too. That is because policyholders often let their life insurance lapse before they die, for a variety of reasons — their children grow up and no longer need the financial protection, or the premiums become too expensive. When that happens, the insurer does not have to make a payout.

But if a policy is purchased and packaged into a security, investors will keep paying the premiums that might have been abandoned; as a result, more policies will stay in force, ensuring more payouts over time and less money for the insurance companies.

“When they set their premiums they were basing them on assumptions that were wrong,” said Neil A. Doherty, a professor at Wharton who has studied life settlements.

Indeed, Mr. Doherty says that in reaction to widespread securitization, insurers most likely would have to raise the premiums on new life policies.

Critics of life settlements believe “this defeats the idea of what life insurance is supposed to be,” said Steven Weisbart, senior vice president and chief economist for the Insurance Information Institute, a trade group. “It’s not an investment product, a gambling product.”

After Mortgages

Undeterred, Wall Street is racing ahead for a simple reason: With $26 trillion of life insurance policies in force in the United States, the market could be huge.

Not all policyholders would be interested in selling their policies, of course. And investors are not interested in healthy people’s policies because they would have to pay those premiums for too long, reducing profits on the investment.

But even if a small fraction of policy holders do sell them, some in the industry predict the market could reach $500 billion. That would help Wall Street offset the loss of revenue from the collapse of the United States residential mortgage securities market, to $169 billion so far this year from a peak of $941 billion in 2005, according to Dealogic, a firm that tracks financial data.

Some financial firms are moving to outpace their rivals. Credit Suisse, for example, is in effect building a financial assembly line to buy large numbers of life insurance policies, package and resell them — just as Wall Street firms did with subprime securities.

The bank bought a company that originates life settlements, and it has set up a group dedicated to structuring deals and one to sell the products.

Goldman Sachs has developed a tradable index of life settlements, enabling investors to bet on whether people will live longer than expected or die sooner than planned. The index is similar to tradable stock market indices that allow investors to bet on the overall direction of the market without buying stocks.

Spokesmen for Credit Suisse and Goldman Sachs declined to comment.

If Wall Street succeeds in securitizing life insurance policies, it would take a controversial business — the buying and selling of policies — that has been around on a smaller scale for a couple of decades and potentially increase it drastically.

Defenders of life settlements argue that creating a market to allow the ill or elderly to sell their policies for cash is a public service. Insurance companies, they note, offer only a “cash surrender value,” typically at a small fraction of the death benefit, when a policyholder wants to cash out, even after paying large premiums for many years.

Enter life settlement companies. Depending on various factors, they will pay 20 to 200 percent more than the surrender value an insurer would pay.

But the industry has been plagued by fraud complaints. State insurance regulators, hamstrung by a patchwork of laws and regulations, have criticized life settlement brokers for coercing the ill and elderly to take out policies with the sole purpose of selling them back to the brokers, called “stranger-owned life insurance.”

In 2006, while he was New York attorney general, Eliot Spitzer sued Coventry, one of the largest life settlement companies, accusing it of engaging in bid-rigging with rivals to keep down prices offered to people who wanted to sell their policies. The case is continuing.

“Predators in the life settlement market have the motive, means and, if left unchecked by legislators and regulators and by their own community, the opportunity to take advantage of seniors,” Stephan Leimberg, co-author of a book on life settlements, testified at a Senate Special Committee on Aging last April.

Tricky Predictions

In addition to fraud, there is another potential risk for investors: that some people could live far longer than expected.

It is not just a hypothetical risk. That is what happened in the 1980s, when new treatments prolonged the life of AIDS patients. Investors who bought their policies on the expectation that the most victims would die within two years ended up losing money.

It happened again last fall when companies that calculate life expectancy determined that people were living longer.

The challenge for Wall Street is to make securitized life insurance policies more predictable — and, ideally, safer — investments. And for any securitized bond to interest big investors, a seal of approval is needed from a credit rating agency that measures the level of risk.

In many ways, banks are seeking to replicate the model of subprime mortgage securities, which became popular after ratings agencies bestowed on them the comfort of a top-tier, triple-A rating. An individual mortgage to a home buyer with poor credit might have been considered risky, because of the possibility of default; but packaging lots of mortgages together limited risk, the theory went, because it was unlikely many would default at the same time.

While that idea was, in retrospect, badly flawed, Wall Street is convinced that it can solve the risk riddle with securitized life settlement policies.

That is why bankers from Credit Suisse and Goldman Sachs have been visiting DBRS, a little known rating agency in lower Manhattan.

In early 2008, the firm published criteria for ways to securitize a life settlements portfolio so that the risks were minimized.

Interest poured in. Hedge funds that have acquired life settlements, for example, are keen to buy and sell policies more easily, so they can cash out both on investments that are losing money and on ones that are profitable. Wall Street banks, beaten down by the financial crisis, are looking to get their securitization machines humming again.

Ms. Tillwitz, an executive overseeing the project for DBRS, said the firm spent nine months getting comfortable with the myriad risks associated with rating a pool of life settlements.

Could a way be found to protect against possible fraud by agents buying insurance policies and reselling them — to avoid problems like those in the subprime mortgage market, where some brokers made fraudulent loans that ended up in packages of securities sold to investors? How could investors be assured that the policies were legitimately acquired, so that the payouts would not be disputed when the original policyholder died?

And how could they make sure that policies being bought were legally sellable, given that some states prohibit the sale of policies until they have been in force two to five years?

Spreading the Risk

To help understand how to manage these risks, Ms. Tillwitz and her colleague Jan Buckler — a mathematics whiz with a Ph.D. in nuclear engineering — traveled the world visiting firms that handle life settlements. “We do not want to rate a deal that blows up,” Ms. Tillwitz said.

The solution? A bond made up of life settlements would ideally have policies from people with a range of diseases — leukemia, lung cancer, heart disease, breast cancer, diabetes, Alzheimer’s. That is because if too many people with leukemia are in the securitization portfolio, and a cure is developed, the value of the bond would plummet.

As an added precaution, DBRS would run background checks on all issuers. Also, a range of quality of life insurers would have to be included.

To test how different mixes of policies would perform, Mr. Buckler has run computer simulations to show what would happen to returns if people lived significantly longer than expected.

But even with a math whiz calculating every possibility, some risks may not be apparent until after the fact. How can a computer accurately predict what would happen if health reform passed, for example, and better care for a large number of Americans meant that people generally started living longer? Or if a magic-bullet cure for all types of cancer was developed?

If the computer models were wrong, investors could lose a lot of money.

As unlikely as those assumptions may seem, that is effectively what happened with many securitized subprime loans that were given triple-A ratings.

Investment banks that sold these securities sought to lower the risks by, among other things, packaging mortgages from different regions and with differing credit levels of the borrowers. They thought that if house prices dropped in one region — say Florida, causing widespread defaults in that part of the portfolio — it was highly unlikely that they would fall at the same time in, say, California.

Indeed, economists noted that historically, housing prices had fallen regionally but never nationwide. When they did fall nationwide, investors lost hundreds of billions of dollars.

Both Standard & Poor’s and Moody’s, which gave out many triple-A ratings and were burned by that experience, are approaching life settlements with greater caution.

Standard & Poor’s, which rated a similar deal called Dignity Partners in the 1990s, declined to comment on its plans. Moody’s said it has been approached by financial firms interested in securitizing life settlements, but has not yet seen a portfolio of policies that meets its standards.

Investor Appetite

Despite the mortgage debacle, investors like Andrew Terrell are intrigued.

Mr. Terrell was the co-head of Bear Stearns’s longevity and mortality desk — which traded unrated portfolios of life settlements — and later worked at Goldman Sachs’s Institutional Life Companies, a venture that was introducing a trading platform for life settlements. He thinks securitized life policies have big potential, explaining that investors who want to spread their risks are constantly looking for new investments that do not move in tandem with their other investments.

“It’s an interesting asset class because it’s less correlated to the rest of the market than other asset classes,” Mr. Terrell said.

Some academics who have studied life settlement securitization agree it is a good idea. One difference, they concur, is that death is not correlated to the rise and fall of stocks.

“These assets do not have risks that are difficult to estimate and they are not, for the most part, exposed to broader economic risks,” said Joshua Coval, a professor of finance at the Harvard Business School. “By pooling and tranching, you are not amplifying systemic risks in the underlying assets.”

The insurance industry is girding for a fight. “Just as all mortgage providers have been tarred by subprime mortgages, so too is the concern that all life insurance companies would be tarred with the brush of subprime life insurance settlements,” said Michael Lovendusky, vice president and associate general counsel of the American Council of Life Insurers, a trade group that represents life insurance companies.

And the industry may find allies in government. Among those expressing concern about life settlements at the Senate committee hearing in April were insurance regulators from Florida and Illinois, who argued that regulation was inadequate.

“The securitization of life settlements adds another element of possible risk to an industry that is already in need of enhanced regulations, more transparency and consumer safeguards,” said Senator Herb Kohl, the Democrat from Wisconsin who is chairman of the Special Committee on Aging.

DBRS agrees on the need to be careful. “We want this market to flourish in a safe way,” Ms. Tillwitz said.

The Washington Times, July 23, 2010...

Roubini: "U-shaped" recovery is possible
YAHOO
Fri Sep 4, (2009) 10:27 am ET

CERNOBBIO, Italy (Reuters) – Nouriel Roubini, a leading economist who predicted the scale of global financial troubles, said a U-shaped recovery is possible, with leading economies undeperforming perhaps for 3 years.

He said there is also an increasing risk of a "double-dip" scenario, however.

"I believe that the basic scenario is going to be one of a U-shaped economic recovery where growth is going to remain below trend ... especially for the advanced economies, for at least 2 or 3 years," he said at a news conference here.

"Within that U scenario I also see a small probability, but a rising probability, that if we don't get the exit strategy right we could end up with a relapse in growth ... a double-dip recession," he added.

Roubini, a professor at New York University's Stern School of Business, said he was concerned economies which save a lot, such as China, Japan and Germany, might not boost consumption enough to compensate for any fall in demand from "overspenders" such as the United States and Britain.

"If U.S. consumers consume less, then for the global economy to grow at its potential rate, other countries that are saving too much will have to save less and consume more," he said.

"My concern is that for a number or reasons ... (it is unlikely that) countries like China, other emerging markets in Asia, Japan, Germany in Europe, will have a significant increase in the consumption rate and a reduction in the savings rate."

Roubini said he thought central banks should pay more attention to asset prices when deciding interest rate policy and encouraged U.S. Federal Reserve Chairman Ben Bernanke to follow this route.

"I think that asset prices, asset bubbles should become much more important in the setting of interest rates, in addition to concerns about inflation and growth. (Bernanke's) views until now have been different. Hopefully this crisis has taught a lesson."

Roubini's outlook remains downbeat, however.

"I think that too many people are hopeful that everything is fine and unfortunately the road ahead is going to be at best bumpy, if not worse," he said.

(Reporting by Jo Winterbottom; editing by Chris Pizzey)


Rise of the Super-Rich Hits a Sobering Wall
NYTIMES
By DAVID LEONHARDT and GERALDINE FABRIKANT
August 21, 2009

The rich have been getting richer for so long that the trend has come to seem almost permanent.

They began to pull away from everyone else in the 1970s. By 2006, income was more concentrated at the top than it had been since the late 1920s. The recent news about resurgent Wall Street pay has seemed to suggest that not even the Great Recession could reverse the rise in income inequality.

But economists say — and data is beginning to show — that a significant change may in fact be under way. The rich, as a group, are no longer getting richer. Over the last two years, they have become poorer. And many may not return to their old levels of wealth and income anytime soon.

For every investment banker whose pay has recovered to its prerecession levels, there are several who have lost their jobs — as well as many wealthy investors who have lost millions. As a result, economists and other analysts say, a 30-year period in which the super-rich became both wealthier and more numerous may now be ending.

The relative struggles of the rich may elicit little sympathy from less well-off families who are dealing with the effects of the worst recession in a generation. But the change does raise several broader economic questions. Among them is whether harder times for the rich will ultimately benefit the middle class and the poor, given that the huge recent increase in top incomes coincided with slow income growth for almost every other group. In blunter terms, the question is whether the better metaphor for the economy is a rising tide that can lift all boats — or a zero-sum game.

Just how much poorer the rich will become remains unclear. It will be determined by, among other things, whether the stock market continues its recent rally and what new laws Congress passes in the wake of the financial crisis. At the very least, though, the rich seem unlikely to return to the trajectory they were on.

Last year, the number of Americans with a net worth of at least $30 million dropped 24 percent, according to CapGemini and Merrill Lynch Wealth Management. Monthly income from stock dividends, which is concentrated among the affluent, has fallen more than 20 percent since last summer, the biggest such decline since the government began keeping records in 1959.

Bill Gates, Warren E. Buffett, the heirs to the Wal-Mart Stores fortune and the founders of Google each lost billions last year, according to Forbes magazine. In one stark example, John McAfee, an entrepreneur who founded the antivirus software company that bears his name, is now worth about $4 million, from a peak of more than $100 million. Mr. McAfee will soon auction off his last big property because he needs cash to pay his bills after having been caught off guard by the simultaneous crash in real estate and stocks.

“I had no clue,” he said, “that there would be this tandem collapse.”

Some of the clearest signs of the reversal of fortunes can be found in data on spending by the wealthy. An index that tracks the price of art, the Mei Moses index, has dropped 32 percent in the last six months. The New York Yankees failed to sell many of the most expensive tickets in their new stadium and had to drop the price. In one ZIP code in Vail, Colo., only five homes sold for more than $2 million in the first half of this year, down from 34 in the first half of 2007, according to MDA Dataquick. In Bronxville, an affluent New York suburb, the decline was to two, from 17, according to Coldwell Banker Residential Brokerage.

“We had a period of roughly 50 years, from 1929 to 1979, when the income distribution tended to flatten,” said Neal Soss, the chief economist at Credit Suisse. “Since the early ’80s, incomes have tended to get less equal. And I think we’ve entered a phase now where society will move to a more equal distribution.”

No More ’50s and ’60s

Few economists expect the country to return to the relatively flat income distribution of the 1950s and 1960s. Indeed, they say that inequality is likely to remain significantly greater than it was for most of the 20th century. The Obama administration has not proposed completely rewriting the rules for Wall Street or raising the top income-tax rate to anywhere near 70 percent, its level as recently as 1980. Market forces that have increased inequality, like globalization, are also not going away.

But economists say that the rich will probably not recover their losses immediately, as they did in the wake of the dot-com crash earlier this decade. That quick recovery came courtesy of a new bubble in stocks, which in 2007 were more expensive by some measures than they had been at any other point save the bull markets of the 1920s or 1990s. This time, analysts say, Wall Street seems unlikely to return soon to the extreme levels of borrowing that made such a bubble possible.

Any major shift in the financial status of the rich could have big implications. A drop in their income and wealth would complicate life for elite universities, museums and other institutions that received lavish donations in recent decades. Governments — federal and state — could struggle, too, because they rely heavily on the taxes paid by the affluent.

Perhaps the broadest question is what a hit to the wealthy would mean for the middle class and the poor. The best-known data on the rich comes from an analysis of Internal Revenue Service returns by Thomas Piketty and Emmanuel Saez, two economists. Their work shows that in the late 1970s, the cutoff to qualify for the highest-earning one ten-thousandth of households was roughly $2 million, in inflation-adjusted, pretax terms. By 2007, it had jumped to $11.5 million.

The gains for the merely affluent were also big, if not quite huge. The cutoff to be in the top 1 percent doubled since the late 1970s, to roughly $400,000.

By contrast, pay at the median — which was about $50,000 in 2007 — rose less than 20 percent, Census data shows. Near the bottom of the income distribution, the increase was about 12 percent.

Some economists say they believe that the contrasting trends are unrelated. If anything, these economists say, any problems the wealthy have will trickle down, in the form of less charitable giving and less consumer spending. Over the last century, the worst years for the rich were the early 1930s, the heart of the Great Depression.

Other economists say the recent explosion of incomes at the top did hurt everyone else, by concentrating economic and political power among a relatively small group.

“I think incredibly high incomes can have a pernicious effect on the polity and the economy,” said Lawrence Katz, a Harvard economist. Much of the growth of high-end incomes stemmed from market forces, like technological innovation, Mr. Katz said. But a significant amount also stemmed from the wealthy’s newfound ability to win favorable government contracts, low tax rates and weak financial regulation, he added.

The I.R.S. has not yet released its data for 2008 or 2009. But Mr. Saez, a professor at the University of California, Berkeley, said he believed that the rich had become poorer. Asked to speculate where the cutoff for the top one ten-thousandth of households was now, he said from $6 million to $8 million.

For the number to return to $11 million quickly, he said, would probably require a large financial bubble.

Making More Money

The United States economy experienced two such bubbles in recent years — one in stocks, the other in real estate — and both helped the rich become richer. Mr. McAfee, whose tattoos and tinted hair suggest an independent streak, is an extreme but telling example. For two decades, at almost every step of his career, he figured out a way to make more money.

In the late 1980s, he founded McAfee Associates, the antivirus software company. It gave away its software, unlike its rivals, but charged fees to those who wanted any kind of technical support. That decision helped make it a huge success. The company went public in 1992, in the early years of one of biggest stock market booms in history.

But Mr. McAfee is, by his own description, an atypical businessman — easily bored and given to serial obsessions. As a young man, he traveled through Mexico, India and Nepal and, more recently, he wrote a book called, “Into the Heart of Truth: The Spirit of Relational Yoga.” Two years after McAfee Associates went public, he was bored again.

So he sold his remaining stake, bringing his gains to about $100 million. In the coming years, he started new projects and made more investments. Almost inevitably, they paid off.

“History told me that you just keep working, and it is easy to make more money,” he said, sitting in the kitchen of his adobe-style house in the southwest corner of New Mexico. With low tax rates, he added, the rich could keep much of what they made.

One of the starkest patterns in the data on inequality is the extent to which the incomes of the very rich are tied to the stock market. They have risen most rapidly during the biggest bull markets: in the 1920s and the 20 years starting in 1987.

“We are coming from an abnormal period where a tremendous amount of wealth was created largely by selling assets back and forth,” said Mohamed A. El-Erian, chief executive of Pimco, one of the country’s largest bond traders, and the former manager of Harvard’s endowment.

Some of this wealth was based on real economic gains, like those from the computer revolution. But much of it was not, Mr. El-Erian said. “You had wealth creation that could not be tied to the underlying economy,” he added, “and the benefits were very skewed: they went to the assets of the rich. It was financial engineering.”

But if the rich have done well in bubbles, they have taken enormous hits to their wealth during busts. A recent study by two Northwestern University economists found that the incomes of the affluent tend to fall more, in percentage terms, in recessions than the incomes of the middle class. The incomes of the very affluent — the top one ten-thousandth — fall the most.

Over the last several years, Mr. McAfee began to put a large chunk of his fortune into real estate, often in remote locations. He bought the house in New Mexico as a playground for himself and fellow aerotrekkers, people who fly unlicensed, open-cockpit planes. On a 157-acre spread, he built a general store, a 35-seat movie theater and a cafe, and he bought vintage cars for his visitors to use.

He continued to invest in financial markets, sometimes borrowing money to increase the potential returns. He typically chose his investments based on suggestions from his financial advisers. One of their recommendations was to put millions of dollars into bonds tied to Lehman Brothers.

For a while, Mr. McAfee’s good run, like that of many of the American wealthy, seemed to continue. In the wake of the dot-com crash, stocks started rising again, while house prices just continued to rise. Outside’s Go magazine and National Geographic Adventure ran articles on his New Mexico property, leading to him to believe that “this was the hottest property on the planet,” he said.

But then things began to change.

In 2007, Mr. McAfee sold a 10,000-square-foot home in Colorado with a view of Pike’s Peak. He had spent $25 million to buy the property and build the house. He received $5.7 million for it. When Lehman collapsed last fall, its bonds became virtually worthless. Mr. McAfee’s stock investments cost him millions more.

One day, he realized, as he said, “Whoa, my cash is gone.”

His remaining net worth of about $4 million makes him vastly wealthier than most Americans, of course. But he has nonetheless found himself needing cash and desperately trying to reduce his monthly expenses.

He has sold a 10-passenger Cessna jet and now flies coach. This week his oceanfront estate in Hawaii sold for $1.5 million, with only a handful of bidders at the auction. He plans to spend much of his time in Belize, in part because of more favorable taxes there.

Next week, his New Mexico property will be the subject of a no-floor auction, meaning that Mr. McAfee has promised to accept the top bid, no matter how low it is.

“I am trying to face up to the reality here that the auction may bring next to nothing,” he said.

In the past, when his stock investments did poorly, he sold real estate and replenished his cash. This time, that has not been an option.

Stock Market Mystery

The possibility that the stock market will quickly recover from its collapse, as it did earlier this decade, is perhaps the biggest uncertainty about the financial condition of the wealthy. Since March, the Standard & Poor’s 500-stock index has risen 49 percent.

Yet Wall Street still has a long way to go before reaching its previous peaks. The S.& P. 500 remains 35 percent below its 2007 high. Aggregate compensation for the financial sector fell 14 percent from 2007 to 2008, according to the Securities Industry and Financial Markets Association — far less than profits or revenue fell, but a decline nonetheless.

“The difference this time,” predicted Byron R. Wein, a former chief investment strategist at Morgan Stanley, who started working on Wall Street in 1965, “is that the high-water mark that people reached in 2007 is not going to be exceeded for a very long time.”

Without a financial bubble, there will simply be less money available for Wall Street to pay itself or for corporate chief executives to pay themselves. Some companies — like Goldman Sachs and JPMorgan Chase, which face less competition now and have been helped by the government’s attempts to prop up credit markets — will still hand out enormous paychecks. Over all, though, there will be fewer such checks, analysts say. Roger Freeman, an analyst at Barclays Capital, said he thought that overall Wall Street compensation would, at most, increase moderately over the next couple of years.

Beyond the stock market, government policy may have the biggest effect on top incomes. Mr. Katz, the Harvard economist, argues that without policy changes, top incomes may indeed approach their old highs in the coming years. Historically, government policy, like the New Deal, has had more lasting effects on the rich than financial busts, he said.

One looming policy issue today is what steps Congress and the administration will take to re-regulate financial markets. A second issue is taxes.

In the three decades after World War II, when the incomes of the rich grew more slowly than those of the middle class, the top marginal rate ranged from 70 to 91 percent. Mr. Piketty, one of the economists who analyzed the I.R.S. data, argues that these high rates did not affect merely post-tax income. They also helped hold down the pretax incomes of the wealthy, he says, by giving them less incentive to make many millions of dollars.

Since 1980, tax rates on the affluent have fallen more than rates on any other group; this year, the top marginal rate is 35 percent. President Obama has proposed raising it to 39 percent and has said he would consider a surtax on families making more than $1 million a year, which could push the top rate above 40 percent.

What any policy changes will mean for the nonwealthy remains unclear. There have certainly been periods when the rich, the middle class and the poor all have done well (like the late 1990s), as well as periods when all have done poorly (like the last year). For much of the 1950s, ’60s and ’70s, both the middle class and the wealthy received raises that outpaced inflation.

Yet there is also a reason to think that the incomes of the wealthy could potentially have a bigger impact on others than in the past: as a share of the economy, they are vastly larger than they once were.

In 2007, the top one ten-thousandth of households took home 6 percent of the nation’s income, up from 0.9 percent in 1977. It was the highest such level since at least 1913, the first year for which the I.R.S. has data.

The top 1 percent of earners took home 23.5 percent of income, up from 9 percent three decades earlier.
Tax Hikes and the 2011 Economic Collapse:  Today's corporate profits reflect an income shift into 2010. These profits will tumble next year, preceded most likely by the stock market.
Wall Street Journal (via National Review)
By ARTHUR LAFFER
7 June 2010

People can change the volume, the location and the composition of their income, and they can do so in response to changes in government policies.

It shouldn't surprise anyone that the nine states without an income tax are growing far faster and attracting more people than are the nine states with the highest income tax rates. People and businesses change the location of income based on incentives.

Likewise, who is gobsmacked when they are told that the two wealthiest Americans—Bill Gates and Warren Buffett—hold the bulk of their wealth in the nontaxed form of unrealized capital gains? The composition of wealth also responds to incentives. And it's also simple enough for most people to understand that if the government taxes people who work and pays people not to work, fewer people will work. Incentives matter.
More

People can also change the timing of when they earn and receive their income in response to government policies. According to a 2004 U.S. Treasury report, "high income taxpayers accelerated the receipt of wages and year-end bonuses from 1993 to 1992—over $15 billion—in order to avoid the effects of the anticipated increase in the top rate from 31% to 39.6%. At the end of 1993, taxpayers shifted wages and bonuses yet again to avoid the increase in Medicare taxes that went into effect beginning 1994."

Just remember what happened to auto sales when the cash for clunkers program ended. Or how about new housing sales when the $8,000 tax credit ended? It isn't rocket surgery, as the Ivy League professor said.

On or about Jan. 1, 2011, federal, state and local tax rates are scheduled to rise quite sharply. President George W. Bush's tax cuts expire on that date, meaning that the highest federal personal income tax rate will go 39.6% from 35%, the highest federal dividend tax rate pops up to 39.6% from 15%, the capital gains tax rate to 20% from 15%, and the estate tax rate to 55% from zero. Lots and lots of other changes will also occur as a result of the sunset provision in the Bush tax cuts.

Tax rates have been and will be raised on income earned from off-shore investments. Payroll taxes are already scheduled to rise in 2013 and the Alternative Minimum Tax (AMT) will be digging deeper and deeper into middle-income taxpayers. And there's always the celebrated tax increase on Cadillac health care plans. State and local tax rates are also going up in 2011 as they did in 2010. Tax rate increases next year are everywhere.
[laffer]

Now, if people know tax rates will be higher next year than they are this year, what will those people do this year? They will shift production and income out of next year into this year to the extent possible. As a result, income this year has already been inflated above where it otherwise should be and next year, 2011, income will be lower than it otherwise should be.

Also, the prospect of rising prices, higher interest rates and more regulations next year will further entice demand and supply to be shifted from 2011 into 2010. In my view, this shift of income and demand is a major reason that the economy in 2010 has appeared as strong as it has. When we pass the tax boundary of Jan. 1, 2011, my best guess is that the train goes off the tracks and we get our worst nightmare of a severe "double dip" recession.

In 1981, Ronald Reagan—with bipartisan support—began the first phase in a series of tax cuts passed under the Economic Recovery Tax Act (ERTA), whereby the bulk of the tax cuts didn't take effect until Jan. 1, 1983. Reagan's delayed tax cuts were the mirror image of President Barack Obama's delayed tax rate increases. For 1981 and 1982 people deferred so much economic activity that real GDP was basically flat (i.e., no growth), and the unemployment rate rose to well over 10%.

But at the tax boundary of Jan. 1, 1983 the economy took off like a rocket, with average real growth reaching 7.5% in 1983 and 5.5% in 1984. It has always amazed me how tax cuts don't work until they take effect. Mr. Obama's experience with deferred tax rate increases will be the reverse. The economy will collapse in 2011.

Consider corporate profits as a share of GDP. Today, corporate profits as a share of GDP are way too high given the state of the U.S. economy. These high profits reflect the shift in income into 2010 from 2011. These profits will tumble in 2011, preceded most likely by the stock market.

In 2010, without any prepayment penalties, people can cash in their Individual Retirement Accounts (IRAs), Keough deferred income accounts and 401(k) deferred income accounts. After paying their taxes, these deferred income accounts can be rolled into Roth IRAs that provide after-tax income to their owners into the future. Given what's going to happen to tax rates, this conversion seems like a no-brainer.

The result will be a crash in tax receipts once the surge is past. If you thought deficits and unemployment have been bad lately, you ain't seen nothing yet.

Mr. Laffer is the chairman of Laffer Associates and co-author of "Return to Prosperity: How America Can Regain Its Economic Superpower Status" (Threshold, 2010).

Op-Ed Contributor
G.D.P. R.I.P.
By ERIC ZENCEY, Montpelier, Vt.
August 10, 2009

IF there’s a silver lining to our current economic downturn, it’s this: With it comes what the economist Joseph Schumpeter called “creative destruction,” the failure of outmoded economic structures and their replacement by new, more suitable structures. Downturns have often given a last, fatality-inducing nudge to dying industries and technologies. Very few buggy manufacturers made it through the Great Depression.

Creative destruction can apply to economic concepts as well. And this downturn offers an excellent opportunity to get rid of one that has long outlived its usefulness: gross domestic product. G.D.P. is one measure of national income, of how much wealth Americans make, and it’s a deeply foolish indicator of how the economy is doing. It ought to join buggy whips and VCRs on the dust-heap of history.

The first official attempt to determine our national income was made in 1934; the goal was to measure all economic production involving Americans whether they were at home or abroad. In 1991, the Bureau of Economic Analysis switched from gross national product to gross domestic product to reflect a changed economic reality — as trade increased, and as foreign companies built factories here, it became apparent that we ought to measure what gets made in the United States, no matter who makes it or where it goes after it’s made.

Since then it has become probably our most commonly cited economic indicator, the basic number that we take as a measure of how well we’re doing economically from year to year and quarter to quarter. But it is a miserable failure at representing our economic reality.

To begin with, gross domestic product excludes a great deal of production that has economic value. Neither volunteer work nor unpaid domestic services (housework, child rearing, do-it-yourself home improvement) make it into the accounts, and our standard of living, our general level of economic well-being, benefits mightily from both. Nor does it include the huge economic benefit that we get directly, outside of any market, from nature. A mundane example: If you let the sun dry your clothes, the service is free and doesn’t show up in our domestic product; if you throw your laundry in the dryer, you burn fossil fuel, increase your carbon footprint, make the economy more unsustainable — and give G.D.P. a bit of a bump.

In general, the replacement of natural-capital services (like sun-drying clothes, or the propagation of fish, or flood control and water purification) with built-capital services (like those from a clothes dryer, or an industrial fish farm, or from levees, dams and treatment plants) is a bad trade — built capital is costly, doesn’t maintain itself, and in many cases provides an inferior, less-certain service. But in gross domestic product, every instance of replacement of a natural-capital service with a built-capital service shows up as a good thing, an increase in national economic activity. Is it any wonder that we now face a global crisis in the form of a pressing scarcity of natural-capital services of all kinds?

This points to the larger, deeper flaw in using a measurement of national income as an indicator of economic well-being. In summing all economic activity in the economy, gross domestic product makes no distinction between items that are costs and items that are benefits. If you get into a fender-bender and have your car fixed, G.D.P. goes up.

A similarly counterintuitive result comes from other kinds of defensive and remedial spending, like health care, pollution abatement, flood control and costs associated with population growth and increasing urbanization — including crime prevention, highway construction, water treatment and school expansion. Expenditures on all of these increase gross domestic product, although mostly what we aim to buy isn’t an improved standard of living but the restoration or protection of the quality of life we already had.

The amounts involved are not nickel-and-dime stuff. Hurricane Katrina produced something like $82 billion in damages in New Orleans, and as the destruction there is remedied, G.D.P. goes up. Some of the remedial spending on the Gulf Coast does represent a positive change to economic well-being, as old appliances and carpets and cars are replaced by new, presumably improved, ones. But much of the expense leaves the community no better off (indeed, sometimes worse off) than before.

Consider the 50 miles of sponge-like wetlands between New Orleans and the Gulf Coast that once protected the city from storm surges. When those bayous were lost to development — sliced to death by channels to move oil rigs, mostly — gross domestic product went up, even as these “improvements” destroyed the city’s natural defenses and wiped out crucial spawning ground for the Gulf Coast shrimp fishery. The bayous were a form of natural capital, and their loss was a cost that never entered into any account — not G.D.P. or anything else.

Wise decisions depend on accurate assessments of the costs and benefits of different courses of action. If we don’t count ecosystem services as a benefit in our basic measure of well-being, their loss can’t be counted as a cost — and then economic decision-making can’t help but lead us to undesirable and perversely un-economic outcomes.

The basic problem is that gross domestic product measures activity, not benefit. If you kept your checkbook the way G.D.P. measures the national accounts, you’d record all the money deposited into your account, make entries for every check you write, and then add all the numbers together. The resulting bottom line might tell you something useful about the total cash flow of your household, but it’s not going to tell you whether you’re better off this month than last or, indeed, whether you’re solvent or going broke.

BECAUSE we use such a flawed measure of economic well-being, it’s foolish to pursue policies whose primary purpose is to raise it. Doing so is an instance of the fallacy of misplaced concreteness — mistaking the map for the terrain, or treating an instrument reading as though it were the reality rather than a representation. When you’re feeling a little chilly in your living room, you don’t hold a match to a thermometer and then claim that the room has gotten warmer. But that’s what we do when we seek to improve economic well-being by prodding G.D.P.

Several alternatives to gross domestic product have been proposed, and each tackles the central problem of placing a value on goods and services that never had a dollar price. The alternatives are controversial, because that kind of valuation creates room for subjectivity — for the expression of personal values, of ideology and political belief.

How, after all, do we judge what exactly was the value of the services provided by those bayous in Louisiana? Was it $82 billion? But what about the value of the shrimp fishery that was already lost before the hurricane? What about the insurance value of the protection the bayous offered against another $82 billion loss? What about the security and sense of continuity of life enjoyed by the thousands of people who lived and made their livelihoods in relation to those bayous before they disappeared? It’s admittedly difficult to set a dollar price on such things — but this is no reason to set that price at zero, as gross domestic product currently does.

Common sense tells us that if we want an accurate accounting of change in our level of economic well-being we need to subtract costs from benefits and count all costs, including those of ecosystem services when they are lost to development. These include storm and flood protection, water purification and delivery, maintenance of soil fertility, pollination of plants and regulation of our climate on a global and local scale. (One recent estimate puts the minimum market value of all such natural-capital services at $33 trillion per year.)

Nature has aesthetic and moral value as well; some of us experience awe, wonder and humility in our encounters with it. But we don’t have to go so far as to include such subjective intangibles in order to fix the national income accounts. As stressed ecosystems worldwide disappear, it will get easier and easier to assign a nonsubjective valuation to them; and value them we must if we are to keep them at all. No civilization can survive their loss.

Given the fundamental problems with G.D.P. as a leading economic indicator, and our habit of taking it as a measurement of economic welfare, we should drop it altogether. We could keep the actual number, but rename it to make clearer what it represents; let’s call it gross domestic transactions. Few people would mistake a measurement of gross transactions for a measurement of general welfare. And the renaming would create room for acceptance of a new measurement, one that more accurately signals changes in the level of economic well-being we enjoy.

Our use of total productivity as our main economic indicator isn’t mandated by law, which is why it would be fairly easy for President Obama to convene a panel of economists and other experts to join the Bureau of Economic Analysis in creating a new, more accurate measure. Call it net economic welfare. On the benefit side would go such nonmarket goods as unpaid domestic work and ecosystem services; on the debit side would go defensive and remedial expenditures that don’t improve our standard of living, along with the loss of ecosystem services, and the money we spend to try to replace them.

In 1934, the economist Simon Kuznets, in his very first report of national income to Congress, warned that “the welfare of a nation can ... scarcely be inferred from a measure of national income.” Just as this crisis gives us the opportunity to end the nature-be-damned, more-is-always-better economy that flourished when oil was cheap and plentiful, we can finally act on Kuznets’s wise warning. We’re in an economic hole, and as we climb out, what we need is not simply a measurement of how much money passes through our hands each quarter, but an indicator that will tell us if we are really and truly gaining ground in the perennial struggle to improve the material conditions of our lives.

Eric Zencey, a professor of historical and political studies at Empire State College, is the author of “Virgin Forest: Meditations on History, Ecology and Culture” and a novel, “Panama.”


Op-Ed Contributor
Hurrying Into the Next Panic?
NYTIMES
By PAUL WILMOTT
July 29, 2009

Istanbul

ON vacation in Turkey, I am picked up at the airport by a minibus. It’s past midnight, pitch-black, the driver is speeding around corners. Only one headlight is working. And I have my doubts about the brakes. In my head I’m planning the letter of complaint to the tour company. And then the driver’s cellphone rings, he picks it up and answers it, he has only one hand on the steering wheel. Now I’m mentally compiling the list of songs to be played at my funeral.

That’s rather how I feel when people talk about the latest fashion among investment banks and hedge funds: high-frequency algorithmic trading. On top of an already dangerously influential and morally suspect financial minefield is now being added the unthinking power of the machine.

The idea is straightforward: Computers take information — primarily “real-time” share prices — and try to predict the next twitch in the stock market. Using an algorithmic formula, the computers can buy and sell stocks within fractions of seconds, with the bank or fund making a tiny profit on the blip of price change of each share.

There’s nothing new in using all publicly available information to help you trade; what’s novel is the quantity of data available, the lightning speed at which it is analyzed and the short time that positions are held.

You will hear people talking about “latency,” which means the delay between a trading signal being given and the trade being made. Low latency — high speed — is what banks and funds are looking for. Yes, we really are talking about shaving off the milliseconds that it takes light to travel along an optical cable.

So, is trading faster than any human can react truly worrisome? The answers that come back from high-frequency proponents, also rather too quickly, are “No, we are adding liquidity to the market” or “It’s perfectly safe and it speeds up price discovery.” In other words, the traders say, the practice makes it easier for stocks to be bought and sold quickly across exchanges, and it more efficiently sets the value of shares.

Those responses disturb me. Whenever the reply to a complex question is a stock and unconsidered one, it makes me worry all the more. Leaving aside the question of whether or not liquidity is necessarily a great idea (perhaps not being able to get out of a trade might make people think twice before entering it), or whether there is such a thing as a price that must be discovered (just watch the price of unpopular goods fall in your local supermarket — that’s plenty fast enough for me), l want to address the question of whether high-frequency algorithm trading will distort the underlying markets and perhaps the economy.

It has been said that the October 1987 stock market crash was caused in part by something called dynamic portfolio insurance, another approach based on algorithms. Dynamic portfolio insurance is a way of protecting your portfolio of shares so that if the market falls you can limit your losses to an amount you stipulate in advance. As the market falls, you sell some shares. By the time the market falls by a certain amount, you will have closed all your positions so that you can lose no more money.

It’s a nice idea, and to do it properly requires some knowledge of option theory as developed by the economists Fischer Black of Goldman Sachs, Myron S. Scholes of Stanford and Robert C. Merton of Harvard. You type into some formula the current stock price, and this tells you how many shares to hold. The market falls and you type the new price into the formula, which tells you how many to sell.

By 1987, however, the problem was the sheer number of people following the strategy and the market share that they collectively controlled. If a fall in the market leads to people selling according to some formula, and if there are enough of these people following the same algorithm, then it will lead to a further fall in the market, and a further wave of selling, and so on — until the Standard & Poor’s 500 index loses over 20 percent of its value in single day: Oct. 19, Black Monday. Dynamic portfolio insurance caused the very thing it was designed to protect against.

This is the sort of feedback that occurs between a popular strategy and the underlying market, with a long-lasting effect on the broader economy. A rise in price begets a rise. (Think bubbles.) And a fall begets a fall. (Think crashes.) Volatility rises and the market is destabilized. All that’s needed is for a large number of people to be following the same type of strategy. And if we’ve learned only one lesson from the recent financial crisis it is that people do like to copy each other when they see a profitable idea.

Such feedback is not necessarily dangerous. Take for example what happens with convertible bonds — bonds that can be converted into stocks at the option of the holder. Here a hedge fund buys the bond and then hedges some market risk by selling the stock itself short. As the price of the stock rises, the relevant formula tells the fund to sell. When the stock falls the formula tells it to buy — the exact opposite of what happens with portfolio insurance. To the outside world — if not necessarily to the hedge fund with the convertible bonds — this mix is usually seen as a good thing.

Thus the problem with the sudden popularity of high-frequency trading is that it may increasingly destabilize the market. Hedge funds won’t necessarily care whether the increased volatility causes stocks to rise or fall, as long as they can get in and out quickly with a profit. But the rest of the economy will care.

Buying stocks used to be about long-term value, doing your research and finding the company that you thought had good prospects. Maybe it had a product that you liked the look of, or perhaps a solid management team. Increasingly such real value is becoming irrelevant. The contest is now between the machines — and they’re playing games with real businesses and real people.


NOTE:  Standard & Poor's 500-stock index, adjusted for inflation, using 10-year average earnings



NOTE:  Existing home resale values


NOTE:  Savings patterns


If "Reagan did it" then the Presidents since haven't reversed his policies...housing a key indicator here!

The Inflation Canard
Paul Krugman distorts Allan Meltzer.
NATIONAL REVIEW ONLINE
Stephen Spruiell
July 14, 2010 4:00 A.M.      

Where’s the inflation? The calls have come tauntingly, from the usual suspects. The Keynesian economists who warned of deflation in the aftermath of the 2008 financial crisis are trying to declare victory now, pointing to falling price levels as evidence that they were right. The most illustrative example is a recent blog post by Paul Krugman, the New York Times columnist, entitled, “What Have We Learned?” The post featured one chart showing a decline in inflation since late 2008, and another showing a decline in the rate of interest paid on ten-year Treasury notes. “The other side declared that we were in imminent danger of runaway inflation,” Krugman scoffed, “and that federal borrowing would lead to very high interest rates.”

The first link — “imminent danger of runaway inflation” — takes readers to a May 2009 op-ed by Carnegie Mellon University economist Allan Meltzer, author of the acclaimed History of the Federal Reserve. Nowhere in the op-ed did Meltzer warn that runaway inflation was “imminent”; in fact, he specifically stated:

    When will it come? Surely not right away. But sooner or later, we will see the Fed, under pressure from Congress, the administration and business, try to prevent interest rates from increasing. The proponents of lower rates will point to the unemployment numbers and the slow recovery. That's why the Fed must start to demonstrate the kind of courage and independence it has not recently shown.

I phoned Meltzer to ask him about Krugman’s distortion of his work, of which Meltzer was unaware. “I don’t read him,” he said. “And I wouldn’t attempt to convince Paul Krugman, because he has a set of beliefs that he won’t give up.” The kinds of policies Krugman has been advocating lately — e.g., more quantitative easing from a Fed that has already over-extended its balance sheet — are precisely the kinds of policies Meltzer was warning against, and Krugman is offering precisely the justification that Meltzer predicted.

The danger of an inflationary fire, as Meltzer took pains to note, was not imminent in early 2009. Rather, his point was that the Fed and the U.S. Congress had done the equivalent of laying an enormous amount of newspapers and gasoline around a house that was not exactly fireproof to begin with, making it vulnerable to two possible sparks: (1) An economic recovery could begin in earnest, leading banks to start lending out the nearly $1 trillion dollars in excess reserves the Fed had pumped into them; or (2) a big domino in the sovereign-debt markets — Japan, say — could fall, sparking a re-pricing of sovereign debt across the board and a spike in U.S. borrowing costs.

On the first point, some note that the Fed has recently started paying interest on reserves. If interest rates start to rise, tempting banks to loan out their reserves, the Fed can offer them a similar rate in order to keep them from flooding the economy with new money. But Meltzer doesn’t believe this strategy is likely to work. In an op-ed for the Wall Street Journal last January, he noted that politicians want banks to lend the money. The demand for the Fed to keep interest rates low — including the rate it pays on reserves — will be strong, as Keynesians such as Krugman encourage the Fed to put concerns about unemployment ahead of concerns about inflation.

In this context it is worth remembering that, after the tech bubble burst, Krugman cheered on the Fed’s disastrous policy of using easy money to fight the ensuing recession, even as he acknowledged that the logical endpoint of the policy was “a housing bubble to replace the Nasdaq bubble.” It is also worth noting that most measures of inflation do not include home prices, but rather use a “rent equivalent” measure to incorporate the cost of shelter into most price indices. Thus, most measures of the general price level completely missed the enormous flood of cheap money into real-estate speculation. If a sudden doubling or tripling of the price of housing doesn’t constitute a form of inflation, what does?

On the second point, the risk of inflation stems from the concern that, in the event that a crisis of confidence precipitated a sudden increase in Treasury’s borrowing costs, the Fed would print money to fund the deficit rather than allow the U.S. government to default on its debt. Such an event could have any number of triggers, but Krugman tells us not to worry about the “invisible bond vigilantes.” It would be one thing if Krugman had a better track record of appropriately evaluating the risks associated with his preferred fiscal and monetary policies. But he doesn’t (see above).

In other words, the fact that we haven’t seen inflation yet isn’t proof of anything, much less proof that critics of our current fiscal and monetary policies are wrong. Meltzer is correct that it’s pointless to try to change Krugman’s mind. But it’s important to keep pointing out how his ideology blinded him to the risks of his brand of recession-fighting before, and to note that those risks are present — and growing — today.
Op-Ed Columnist
Reagan Did It
By PAUL KRUGMAN
June 1, 2009

“This bill is the most important legislation for financial institutions in the last 50 years. It provides a long-term solution for troubled thrift institutions. ... All in all, I think we hit the jackpot.” So declared Ronald Reagan in 1982, as he signed the Garn-St. Germain Depository Institutions Act.

He was, as it happened, wrong about solving the problems of the thrifts. On the contrary, the bill turned the modest-sized troubles of savings-and-loan institutions into an utter catastrophe. But he was right about the legislation’s significance. And as for that jackpot — well, it finally came more than 25 years later, in the form of the worst economic crisis since the Great Depression.

For the more one looks into the origins of the current disaster, the clearer it becomes that the key wrong turn — the turn that made crisis inevitable — took place in the early 1980s, during the Reagan years.

Attacks on Reaganomics usually focus on rising inequality and fiscal irresponsibility. Indeed, Reagan ushered in an era in which a small minority grew vastly rich, while working families saw only meager gains. He also broke with longstanding rules of fiscal prudence.

On the latter point: traditionally, the U.S. government ran significant budget deficits only in times of war or economic emergency. Federal debt as a percentage of G.D.P. fell steadily from the end of World War II until 1980. But indebtedness began rising under Reagan; it fell again in the Clinton years, but resumed its rise under the Bush administration, leaving us ill prepared for the emergency now upon us.

The increase in public debt was, however, dwarfed by the rise in private debt, made possible by financial deregulation. The change in America’s financial rules was Reagan’s biggest legacy. And it’s the gift that keeps on taking.

The immediate effect of Garn-St. Germain, as I said, was to turn the thrifts from a problem into a catastrophe. The S.& L. crisis has been written out of the Reagan hagiography, but the fact is that deregulation in effect gave the industry — whose deposits were federally insured — a license to gamble with taxpayers’ money, at best, or simply to loot it, at worst. By the time the government closed the books on the affair, taxpayers had lost $130 billion, back when that was a lot of money.

But there was also a longer-term effect. Reagan-era legislative changes essentially ended New Deal restrictions on mortgage lending — restrictions that, in particular, limited the ability of families to buy homes without putting a significant amount of money down.

These restrictions were put in place in the 1930s by political leaders who had just experienced a terrible financial crisis, and were trying to prevent another. But by 1980 the memory of the Depression had faded. Government, declared Reagan, is the problem, not the solution; the magic of the marketplace must be set free. And so the precautionary rules were scrapped.

Together with looser lending standards for other kinds of consumer credit, this led to a radical change in American behavior.

We weren’t always a nation of big debts and low savings: in the 1970s Americans saved almost 10 percent of their income, slightly more than in the 1960s. It was only after the Reagan deregulation that thrift gradually disappeared from the American way of life, culminating in the near-zero savings rate that prevailed on the eve of the great crisis. Household debt was only 60 percent of income when Reagan took office, about the same as it was during the Kennedy administration. By 2007 it was up to 119 percent.

All this, we were assured, was a good thing: sure, Americans were piling up debt, and they weren’t putting aside any of their income, but their finances looked fine once you took into account the rising values of their houses and their stock portfolios. Oops.

Now, the proximate causes of today’s economic crisis lie in events that took place long after Reagan left office — in the global savings glut created by surpluses in China and elsewhere, and in the giant housing bubble that savings glut helped inflate.

But it was the explosion of debt over the previous quarter-century that made the U.S. economy so vulnerable. Overstretched borrowers were bound to start defaulting in large numbers once the housing bubble burst and unemployment began to rise.

These defaults in turn wreaked havoc with a financial system that — also mainly thanks to Reagan-era deregulation — took on too much risk with too little capital.

There’s plenty of blame to go around these days. But the prime villains behind the mess we’re in were Reagan and his circle of advisers — men who forgot the lessons of America’s last great financial crisis, and condemned the rest of us to repeat it.


The Return to Irrational Exuberance
NYTIMES
Floyd Norris
March 2, 2009, 11:32 am

Another stock market milestone was reached last week, when the S.&P. 500 fell under the Dec. 5, 1996, close of 744.38. The Dow, for what it is worth, is still above the 6,437.10 level it sported then.

(As I write this, the S.&P. is at 714 and the Dow at 6,880.)

That night Alan Greenspan uttered his legendary “irrational exuberance” comment. It was actually a question:

”How do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade?”

Mr. Greenspan’s comments unsettled the stock market. The Dow fell 55 points the next day, which seemed like a lot at the time. But the bull market soon continued, and Mr. Greenspan stopped worrying. By the spring of 2000, he was quoting Wall Street analysts to justify high technology stock prices.

There are five stocks now in the Dow that trade for more than twice their level when Mr. Greenspan spoke, and six that trade for less than half as much. (Prices are through about 11 a.m. today.)

The winners:

Wal-Mart, up 282%
Exxon Mobil, up 180%
United Technologies, up 136%
I.B.M., up 130%
McDonald’s, up 120%

The losers:

General Motors, down 95%
Citigroup, down 89%
Bank of America, down 86%
Alcoa, down 63%
DuPont, down 63%
General Electric, down 52%

MOUNTAIN OF DEBT: Rising Debt May Be Next Crisis
NYTIMES
By THE ASSOCIATED PRESS
Filed at 9:32 p.m. ET
July 3, 2009

WASHINGTON (AP) -- The Founding Fathers left one legacy not celebrated on Independence Day but which affects us all. It's the national debt.

The country first got into debt to help pay for the Revolutionary War. Growing ever since, the debt stands today at a staggering $11.5 trillion -- equivalent to over $37,000 for each and every American. And it's expanding by over $1 trillion a year.

The mountain of debt easily could become the next full-fledged economic crisis without firm action from Washington, economists of all stripes warn.

''Unless we demonstrate a strong commitment to fiscal sustainability in the longer term, we will have neither financial stability nor healthy economic growth,'' Federal Reserve Chairman Ben Bernanke recently told Congress.

Higher taxes, or reduced federal benefits and services -- or a combination of both -- may be the inevitable consequences.

The debt is complicating efforts by President Barack Obama and Congress to cope with the worst recession in decades as stimulus and bailout spending combine with lower tax revenues to widen the gap.

Interest payments on the debt alone cost $452 billion last year -- the largest federal spending category after Medicare-Medicaid, Social Security and defense. It's quickly crowding out all other government spending. And the Treasury is finding it harder to find new lenders.

The United States went into the red the first time in 1790 when it assumed $75 million in the war debts of the Continental Congress.

Alexander Hamilton, the first treasury secretary, said, ''A national debt, if not excessive, will be to us a national blessing.''

Some blessing.

Since then, the nation has only been free of debt once, in 1834-1835.

The national debt has expanded during times of war and usually contracted in times of peace, while staying on a generally upward trajectory. Over the past several decades, it has climbed sharply -- except for a respite from 1998 to 2000, when there were annual budget surpluses, reflecting in large part what turned out to be an overheated economy.

The debt soared with the wars in Iraq and Afghanistan and economic stimulus spending under President George W. Bush and now Obama.

The odometer-style ''debt clock'' near Times Square -- put in place in 1989 when the debt was a mere $2.7 trillion -- ran out of numbers and had to be shut down when the debt surged past $10 trillion in 2008.

The clock has since been refurbished so higher numbers fit. There are several debt clocks on Web sites maintained by public interest groups that let you watch hundreds, thousands, millions zip by in a matter of seconds.

The debt gap is ''something that keeps me awake at night,'' Obama says.

He pledged to cut the budget ''deficit'' roughly in half by the end of his first term. But ''deficit'' just means the difference between government receipts and spending in a single budget year.

This year's deficit is now estimated at about $1.85 trillion.

Deficits don't reflect holdover indebtedness from previous years. Some spending items -- such as emergency appropriations bills and receipts in the Social Security program -- aren't included, either, although they are part of the national debt.

The national debt is a broader, and more telling, way to look at the government's balance sheets than glancing at deficits.

According to the Treasury Department, which updates the number ''to the penny'' every few days, the national debt was $11,518,472,742,288 on Wednesday.

The overall debt is now slightly over 80 percent of the annual output of the entire U.S. economy, as measured by the gross domestic product.

By historical standards, it's not proportionately as high as during World War II, when it briefly rose to 120 percent of GDP. But it's still a huge liability.

Also, the United States is not the only nation struggling under a huge national debt. Among major countries, Japan, Italy, India, France, Germany and Canada have comparable debts as percentages of their GDPs.

Where does the government borrow all this money from?

The debt is largely financed by the sale of Treasury bonds and bills. Even today, amid global economic turmoil, those still are seen as one of the world's safest investments.

That's one of the rare upsides of U.S. government borrowing.

Treasury securities are suitable for individual investors and popular with other countries, especially China, Japan and the Persian Gulf oil exporters, the three top foreign holders of U.S. debt.

But as the U.S. spends trillions to stabilize the recession-wracked economy, helping to force down the value of the dollar, the securities become less attractive as investments. Some major foreign lenders are already paring back on their purchases of U.S. bonds and other securities.

And if major holders of U.S. debt were to flee, it would send shock waves through the global economy -- and sharply force up U.S. interest rates.

As time goes by, demographics suggest things will get worse before they get better, even after the recession ends, as more baby boomers retire and begin collecting Social Security and Medicare benefits.

While the president remains personally popular, polls show there is rising public concern over his handling of the economy and the government's mushrooming debt -- and what it might mean for future generations.

If things can't be turned around, including establishing a more efficient health care system, ''We are on an utterly unsustainable fiscal course,'' said the White House budget director, Peter Orszag.

Some budget-restraint activists claim even the debt understates the nation's true liabilities.

The Peter G. Peterson Foundation, established by a former commerce secretary and investment banker, argues that the $11.4 trillion debt figures does not take into account roughly $45 trillion in unlisted liabilities and unfunded retirement and health care commitments.

That would put the nation's full obligations at $56 trillion, or roughly $184,000 per American, according to this calculation.

^------

On the Net:

Treasury Department ''to the penny'' national debt breakdown: http://tinyurl.com/yrxrsh

Peter G. Peterson Foundation independent assessment of the national debt: http://www.pgpf.org/

''Deficits do Matter'' debt clock: http://tinyurl.com/l6mvjb

The American Engine Still Can
Weekly Standard
BY Irwin M. Stelzer
August 14, 2010 12:00 AM

The American economy is in serious trouble, and the remaining weapons we have available to prevent a double dip are few indeed. We will try to avoid a long period of deflation of the sort that doomed Japan to a lost decade, but are not confident we can. That’s a free translation of what the Federal Reserve Board’s monetary policy committee said after last week’s meeting. Of course, central bankers are not so blunt. The Fed’s committee actually said that “the pace of recovery in output and employment has slowed in recent months.” The economy “remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit.Housing starts remain at a depressed level. Bank lending has continued to contract.”

The Fed could have mentioned:

♦ Revised economic data that show the recent recession to have been the worst of the post-war years.

♦ The slowdown in economic activity in China.

♦ The absence of any long-term plan to rein in the deficit.

♦ The possibility of a “shock” to the world banking system if Greece defaults on its sovereign debt as seems increasingly likely, or if any one of our several states finally drown in their own red ink.

♦ The negative effect of the increase in health care, energy costs, and taxes, the latter planned by President Obama for year-end.

♦ The 2.6 percent decline in already-depressed pending home sales in June, despite record-low mortgage rates.

♦ The 1.2 percent decline in factory sales, indicating that the manufacturing recovery might be stalling.

♦ The pile up in inventories of durable goods.

♦ The widest trade deficit since October 2008.

♦ And, perhaps most important of all, the increasing number of workers unemployed for so long that their skills are atrophying, while economic growth no longer seems to produce very many jobs, causing two-thirds of Americans to believe that the economy has further to fall.

The worse news is that the bad news cited above is only the tip of the iceberg: The lethal out-of-sight 90 percent is a more dangerous threat to the good ship Robust Recovery.

Start with the state of the nation’s finances. The federal deficit remains untamed, at 10 percent of GDP, topping the decade’s pre-Obama high of 3.5 percent in 2004. Given the slowing of the recovery, a reasonable argument can be made that what is needed is continued spending, but only if combined with a medium-term plan for bringing the deficit under control. No such plan is on the horizon, in part because of the political paralysis produced by the impending congressional elections, and in part because “kicking the can down the road” – leaving every problem to the next generation of politicians – has become a durable feature of American political life.

The second longer-term problem is the Obama-created imbalance between the private sector that creates wealth and the public sector that depends on that wealth. A recent analysis by USA Today, based on government compensation data, shows that federal government employees earn, on average, twice as much as private sector workers. That’s a result of the recent stagnation in private sector compensation and a steady rise in the pay of public sector workers. This situation was exacerbated earlier this week when Congress decided to spend $26 billion to prevent lay-offs of teachers and other state employees, funded in part by higher taxes on U.S. corporations that do business overseas. Teacher lay-offs, of course, are used by politicians to attract sympathy and bail-out money, rather than fire less useful workers in their over-manned bureaucracies.

Then there is the perverse incentive created by a badly structured tax system. A small businessman in New Jersey took to the op ed pages of the Wall Street Journal to point out that it costs him $74,000 to pay an employee $59,000 per year, when taxes and benefits are factored in. But when the employee pays her taxes, she is left with only $44,000. So the gap between his cost of hiring and her incentive to work is substantial. Not a prescription for full employment.

Still, all is not lost. Most economists believe that the economy will not drop into double dip territory, but will instead rack up low growth this year and next. Corporate earnings are quite healthy, close to the record highs reached before the downturn. Corporations have a $2 trillion hoard that they will soon have to spend or continue the emerging trend of increasing dividends, something that corprocrats are always reluctant to do since that means surrendering control of unused funds to their owners – the shareholders. Businesses are already increasing spending on equipment and software to replace stuff that is at the end of its useful life. The inflation-adjusted annual increases of more than 20 percent in each of the last two quarters were the most rapid since the latter part of the 1990s and far outstripped the rate of upturn that characterized past recessions.

Moreover, the Fed has not really emptied its quiver, even with interest rates effectively at zero. Last week it decided to stop shrinking its portfolio and instead to reinvest cash coming from maturing mortgages into Treasury IOUs, keeping long-term interest rates low to encourage businesses to invest and consumers to spend. Should it decide that things are getting worse, it can resume money creation, known as quantitative easing (QE), leading pundits to joke that Fed chairman Ben Bernanke might decide to captain the QE2, and is already preparing his job application. Whether he can steer the economy into more agreeable waters is not certain, since making it cheaper for businesses to borrow is, as Keynes once noted, like pushing on a string. So far, cash-laden banks say they can’t find credit-worthy small business borrowers, and cash-strapped borrowers say the banks won’t lend even to sound small businesses.

Then there is fiscal policy. A new Congress will be in place in 2011, and is likely to have more deficit hawks than the existing bunch, many of whom won election by riding on Barack Obama’s coattails, now so frayed that these same politicians are asking him not to come into their districts. If the election returns follow the polls, the probability of the introduction of some sanity into federal fiscal policy will increase, especially if the presidential commission’s post-election report on the deficit can come up with suggestions for a politically acceptable mix of tax increases and spending cuts, perhaps using the new British government’s ratio of £4 of spending cuts for every £1 of tax increases as a guide.

All of which brings me to share prices. This week’s Fed confession that the economy was not moving along at the pace it had expected rattled markets, which sometimes affects the real economy by producing a drop in consumer confidence and spending. Take heart: After dropping about 3 percent on the day after the Fed’s announcement, the Standard & Poor’s index of 500 stocks hit 1093, the precise level that prevailed at the end of last year, and closed the week at 1079. For investors, although not for in-and-out traders, there has been much ado about very little: The tailwinds provided by good profits have been offset by the headwinds created by negative economic reports.

In the end, with the fuss created by the Fed report behind us, a longer-than-one-week look shows that jobs are indeed being created in the private sector, share prices are relatively unchanged, retail sales are sluggish but nevertheless up a bit, profits are ample, and businesses have started to reinvest. The American economy just might once again prove to be the engine that could.
The crisis when our debt goes 'pop'
NYPOST
By THOMAS SOWELL
Last Updated: 1:56 AM, August 4, 2010
Posted: 12:48 AM, August 4, 2010

Without naming names or making political charges, the Congressional Budget Office last week issued a report titled "Federal Debt and the Risk of a Fiscal Crisis." The report's dry, measured words paint a painfully bleak picture of the long-run dangers from the current runaway government deficits.

The CBO report points out that the national debt, which was 36 percent of the gross domestic product three years ago, is now projected to be 62 percent of GDP at the end of fiscal year 2010 -- and rising in future years.

Tracing the history of the national debt back to the beginning of the country, the CBO finds that the national debt did not exceed 50 percent of GDP, even when the country was fighting the Civil War, the First World War or any other war except World War II. Moreover, a graph in the CBO report shows the national debt going down sharply after World War II, as the nation began paying off its wartime debt when the war was over.

By contrast, our current national debt is still going up and may end up in "unfamiliar territory," according to the CBO, reaching "unsustainable levels." They spell out the economic consequences -- and it is not a pretty picture.

Although Barack Obama and members of his administration constantly talk about the so-called "stimulus" spending as creating a demand for goods that is in turn "creating jobs," every dime they spend comes from somewhere else, which means that there is less money to create jobs somewhere else.

White House press secretary Robert Gibbs' recent rant against Rush Limbaugh for criticizing the bailout of General Motors went on and on about how this bailout had saved "a million jobs." But where does Gibbs think the bailout money came from? The Tooth Fairy?

When you take money from the taxpayers and spend it to rescue the jobs of one set of workers -- your union political supporters, in this case -- what does that do to the demand for the jobs of other workers, whose products taxpayers would have bought with the money you took away from them? There is no net economic gain to the country from this, though there may well be political gains for the administration from having rescued their UAW supporters.

As the Congressional Budget Office puts it, if the national debt continues to grow out of control, a "growing portion of people's savings would go to purchase government debt rather than toward investments in productive capital goods such as factories and computers; that 'crowding out' of investment would lead to lower output and incomes than would otherwise occur."
The only place where there is growth in the economy...as we've been saying:
Obama Team Sees Jobs Growth In Health, Environment
NYTIMES
By REUTERS
Filed at 7:57 a.m. ET, July 13, 2009

WASHINGTON (Reuters) - Jobs in the healthcare and environmental sectors are growing at a faster rate than those of the U.S. economy as a whole, President Barack Obama's Council of Economic Advisers will say a report to be released on Monday.

The report, which looks at how the U.S. labor market is expected to develop in the next few years, says a rebound in employment in construction and some manufacturing sectors is expected as stimulus spending approved early this year invests in projects around the country.

The report is based on an analysis of recent labor market data, a White House official said. The report identifies likely changes in the U.S. labor market as economic drivers shift from sectors like financial services to the growing sectors that are transforming the economy, the official said.

The report, entitled "Preparing the Workers of Today for the Jobs of Tomorrow," will also discuss the skills and training that will likely be most relevant in growing occupations, the official said. It also will discuss the type of education and training system needed to prepare workers for those jobs.

Obama said in an opinion piece in The Washington Post published on Sunday that he would be talking this week about how to ensure workers have the skills needed to compete for the jobs of the future.

"In an economy where jobs requiring at least an associate's degree are projected to grow twice as fast as jobs requiring no college experience, it's never been more essential to continue education and training after high school," he wrote.

Obama has said he wants the United States to lead the world in college degrees by 2020.

"Part of this goal will be met by helping Americans better afford a college education. But part of it will also be strengthening our network of community colleges," he said.

"We believe it's time to reform our community colleges so that they provide Americans of all ages a chance to learn the skills and knowledge necessary to compete for the jobs of the future," Obama wrote.

Obama's chief of staff, Rahm Emanuel, told a meeting of the Democratic Leadership Council several weeks ago that the administration was planning a major education initiative dealing with community colleges.

COMINGS AND GOINGS IN GOVERNMENT FINANCIAL INSTITUTIONS...

Treasury Department's "Office of Thrift Supervision" -  just like some other government institutions - a misnomer if ever I heard one!
Freddie Mac exec killed himself - so this story below is a sign that pressure is lessining?  Remember, the housing industry can be both a critical indicator of "turnaround" as well as a lagging indicator - when the economic music stops, housing industry left holding the bag.  And mortgage ind

Embattled Thrift Agency Official Retiring July 3
NYTIMES
By THE ASSOCIATED PRESS
Filed at 10:45 a.m. ET
June 19, 2009

WASHINGTON (AP) -- The previous head of the federal thrift agency is leaving the government amid criticism of the agency's role in the run-up to the financial crisis.

The Treasury Department's Office of Thrift Supervision says Scott Polakoff, who was placed on leave in March from his position as acting OTS director, is retiring on July 3.

Polakoff, who was the agency's chief operating officer, held the acting-director position only since February following the resignation of OTS Director John Reich. John Bowman is now acting director.

The Obama administration's new plan for overhauling financial regulation calls for abolishing OTS. It oversaw insurance conglomerate American International Group Inc. -- whose near-collapse last fall led to about $180 billion in federal aid.

The case for Clinton Adminstration piling on...housingnytimes101908.pdf