May 25

Good News from Goldman Sachs?

Wind PowerGoldman Sachs, a financial behemoth once famously referred to as a giant “vampire squid” by Matt Taibbi of Rolling Stone, has long been accused, and rightfully so, of providing no real value to society generally and existing only to maximize profits by extracting wealth from the economy, oftentimes at its own clients’ expense. While Goldman certainly has no plans to alter the way in which it does business, it recently announced plans to make an investment that flies in the face of conventional conservative wisdom. The company plans to invest at least $40 billion into the alternative energy market over the next ten years, even in the face of expiring tax credits and incentives. The company exists, and will always exist, to make money. Truckloads of cold hard cash and huge numbers of gigabytes of 1′s and 0′s. So, why is Goldman Sachs investing so much into a sector that nearly each end every Republican views as expensive and impractical? Recent statistical evidence suggests that certain alternative energy sources are closing the cost gap with traditional coal and natural gas electricity generators, and it appears that Goldman, as Taibbi argued, isn’t all that interested in politics, instead it only seeks out new sources of profit. Goldman evidently wants to be out front and entrench itself as a major player in the energy sources of the 21st century.

President Obama, for all of his flaws, has consistently been a supporter of alternative energy. He has pushed for significant commercial and residential tax credits and has made use of government funds to make low-interest loans and grants to producers and researchers of green technology and power generation. However, may of the tax credits and investment programs aimed at bolstering the infant green energy sector are set to expire at the end of 2012. It is increasingly unlikely that the programs will be renewed by a Republican controlled House of Representatives. The recent up-tick in more cheaply–and dangerously–extracted natural gas has also forced serious debate of the need for renewable and alternative energy sources onto the back burner. So, while little doubt exists as to Obama’s cozy relationship with Wall Street and the financial sector, he fearlessly remains at odds with many in his own party, as well as Republicans, who are loathed to support green technology under threats of reprisal from the immensely powerful oil and natural gas lobbies. Continue reading

May 24

The Fiscal Cliff: You Must be this Intransigent to Board this Ride, Let’s Go!

DivingIf you’re like me, you love roller coasters, most notably the incarnations that retain the preliminary long steep climb accompanied by the ominous clickity clack of the chain and track below the car until the pinnacle is reached. At the apex, all is silent, and just as you can see nothing but sky before you and the tiny heads of fellow park visitors hundreds of feet below you, the car proceeds downward at a ridiculous speed sucking the breath from your lungs. It’s exhilarating fun, and generally lasts no more than a minute or two. At this very moment, the United States is scaling hill number one while frantically ensuring that the lap bar has engaged properly. On December 31, 2012, a series of economic events are scheduled to take place that many are referring to as the “fiscal cliff.”

The Bush tax cuts enacted in 2001 and 2003, and extended through 2012 by President Obama in a December 2010 agreement, are set to expire. The expiration would adjust marginal tax rates upward across all income brackets and modestly raise the tax on capital gains–income earned from investments–from 15% to 20%. The expiration will also remove qualified dividends from special tax treatment, and undo a temporary patch to the Alternative Minimum Tax, among other smaller changes. Additionally, as part of the deal to raise the debt ceiling in 2011, Democrats and Republicans agreed to automatic across the board spending cuts of $1.2 trillion over the next ten years. The cuts are part of a sequester agreed to by both parties which will go into effect because the two sides could not agree on an alternative as required by the original pact. While certain mandatory outlays are exempted from the spending reductions, the total amount will be split roughly 50/50 between discretionary and defense spending unless consensus is reached before or sometime shortly after January 1, 2013. The federal unemployment extension and temporary 2% payroll tax reduction would also expire at years end. If Republicans are not willing to move into a position of rationality and responsibility, my position is that we should all buckle up and see where the ride takes us, rather than concede to incoherent demands in order to to avert a greater short term disaster. Continue reading

May 18

The Wealthy Do Not Create Jobs

ScroogeAt the May 2012 TED conference in Long Beach, an interesting thing happened, a venture capitalist stood up before the audience and told the truth. One of the original investors in and current chief of Second Avenue Partners, an advisory group and investment company, Nick Hanauer, gave a six minute speech in which he detailed an obvious yet taboo fact, the wealthy do not create jobs. The talk was originally yanked from TED’s website, and later only released by request, which in and of itself speaks volumes. The essence of Hanauer’s confession is that the conventional wisdom that the wealthy are somehow responsible for the creation of jobs through entrepreneurship is false. The truth, he shrewdly points out, is that the economy is much more like an ecosystem, wherein each segment depends upon another segment for survival, and no one group is any more important than another. Alternatively, in a free market, it is the consumer who drives job creation, not the entrepreneur. The full text of the speech can be found here.

It should come as no surprise that the talk spawned a vitriolic response from many TED attendees, who blasted an initial decision to post the talk publicly, and from TED itself, which now treats the six minutes of truth telling as if it never happened, citing the “political” nature of the disputation. It is unclear to me when exactly basic economics became political. I would hazard a guess that it occurred somewhere between 1979 and the Republican Party’s complete assimilation by sociopathic billionaires and tax-cut hawks in 2008. What is so striking about the reaction to Hanauer’s words is that he did nothing more than lay out basic truths about supply, demand, production and employment.

That’s why I can say with confidence that rich people don’t create jobs, nor do businesses, large or small. What does lead to more employment is a “circle of life” like feedback loop between customers and businesses. And only consumers can set in motion this virtuous cycle of increasing demand and hiring. In this sense, an ordinary middle-class consumer is far more of a job creator than a capitalist like me.

So when businesspeople take credit for creating jobs, it’s a little like squirrels taking credit for creating evolution. In fact, it’s the other way around.

Anyone who’s ever run a business knows that hiring more people is a capitalists course of last resort, something we do only when increasing customer demand requires it.  In this sense, calling ourselves job creators isn’t just inaccurate, it’s disingenuous.

He also lampooned another widely accepted theory, that tax cuts for the wealthy create jobs.

If it were true that lower tax rates and more wealth for the wealthy would lead to more job creation, then today we would be drowning in jobs.  And yet unemployment and under-employment is at record highs.

Hanauer’s ideas were delivered in such a matter-of-fact and simple manner that it left little room for ambiguity or misunderstanding. The economy is much like any ecosystem, or as he refers to it, a “feedback-loop.” Without consumers, entrepreneurs and businesses do not exist, and once a business does exist, it will not create new jobs until consumer demand not only dictates it, but when the capitalist is left with no other alternative. Hiring an employee is a last resort, rather than a noble calling.  He cleverly points out that the most fundamental reason that the middle class and poor consumers drive job creation is the difference in consumption levels. For example, he and his family own three cars, not three-thousand cars. But if three thousand consumers were given jobs capable of purchasing a car, then orders to manufacture cars would increase, and car manufactures would be forced by necessity to hire more employees. No matter how wealthy Hanauer becomes, he will never need more than three cars. He can never eat out at a capitalist’s restaurant more than seven times per week. It is an empirical impossibility. However, millions of new employees will eat millions of meals at restaurants, and therefore create a far greater number of jobs. Hanauer understands that forming a business does not occur in a vacuum. Without customers, there is no capitalist, and there are no employees.

I can’t buy enough of anything to make up for the fact that millions of unemployed and underemployed Americans can’t buy any new clothes or cars or enjoy any meals out. Or to make up for the decreasing consumption of the vast majority of American families that are barely squeaking by, buried by spiraling costs and trapped by stagnant or declining wages.

Here’s an incredible fact.  If the typical American family still got today the same share of income they earned in 1980, they would earn about 25% more and have an astounding $13,000 more a year. Where would the economy be if that were the case?

Hanauer also points out that the wealthy have come to expect certain tax and other benefits in our capitalist system as a direct result of being deified as “job creators,” if even subconsciously. In other words, many rich Americans, even business owners, venture capitalists, and executives, may not be aware of how flawed the notion is that the wealth creates employment. The expectation of uncommon treatment under the law may be the by-product of an extraordinary campaign by a few motivated folks and wide acceptance of the scheme by a fawning electorate. Many wealthy individuals may actually believe that their wealth alone creates jobs, and left to their own devices, they could produce equal wealth absent consumers at all, notwithstanding the utter absurdity of the hypothesis. So-called “job creators” have been elevated to superhuman or even prophetical status, not simply by themselves, but by those of us who mistakenly believe it. The story is as old as capitalism itself. The poor father who must beg Ebenezer Scrooge for each and every penny he earns–no Scrooge, no job. When the fact of the matter is that if each of us were paid as little as the wealthy would prefer, the wealthy would lose their fortunes overnight. Without enough disposable income to purchase their products, employment would shrink, factories would close, and yachts would sit idle.

Significant privileges have come to capitalists like me for being perceived as “job creators” at the center of the economic universe, and the language and metaphors we use to defend the fairness of the current social and economic arrangements is telling. For instance, it is a small step from “job creator” to “The Creator”. We did not accidentally choose this language. It is only honest to admit that calling oneself a “job creator” is both an assertion about how economics works and the a claim on status and privileges.

The extraordinary differential between a 15% tax rate on capital gains, dividends, and carried interest for capitalists, and the 35% top marginal rate on work for ordinary Americans is a privilege that is hard to justify without just a touch of deification.

Much like a small farm pond, the economy relies upon the smallest among us to maintain the health of the whole. The water must be kept oxygenated by just the right number of plants and exposure to the air. Insects and other small animals must come to the pond in order to feed and to be fed upon by the more developed fish. The less developed fish and other animals must feed upon the waste of the plants and more developed fish in order to prevent the pond from becoming unable to sustain life. If any of the elements is removed, the pond and all within it will die. So too will the economy. Without those willing to risk capital in order to fund business ventures, consumers can not purchase goods to increase employment, but without employment and the subsequent income, those risking the capital lose everything. Because there are so far fewer capitalists required in relation to consumers in order to sustain a market economy, the consumers role is incontestably more important. As Hanauer correctly argued, try as they might, the wealthy simply can not purchase enough goods and services to drive job creation, while large numbers of consumers with disposable income can buoy an economy to unprecedented growth, and create countless jobs in the process.

The modern boycott is a striking example of Hanauer’s thesis. During an effective boycott, consumers refuse to purchase the goods and services of a particular capitalist. If a large enough number of consumers participate, the capitalist is forced to terminate employees due to decreased demand–remember, hiring employees is an absolute last resort, and also the first line of defense against falling sales–as well as to scale back payments to executives, owners, and shareholders. If the boycott continues for a long enough period of time, the resources of the capitalist no longer are able to fund the remaining liabilities, and the capitalist fails. By contrast, in a functioning market system, if a capitalist closes his or her doors, consumers are free to begin spending disposable income with a competing capitalist, who is then forced to increase employment in order to meet demand. In other words, in an efficient capitalist marketplace, the consumer is more important than that wealthy business owner.

The most striking, and in my view, the most telling passage in Hanauer’s soliloquy is also the most elemental.

It is astounding how significantly one idea can shape a society and its policies.  Consider this one.

If taxes on the rich go up, job creation will go down.

This idea is an article of faith for republicans and seldom challenged by democrats and has shaped much of today’s economic landscape

Why is it that Democrats seldom challenge this idea? Cynically, one could easily draw the conclusion that the festering tumor of our campaign financing structure render Democrats and Republicans alike unable to challenge a notion as ridiculous as this, for fear of political reprisal. An idea that has long since been debunked by economists left, right, and center. Right wing groups have made it no secret that they will actively fund primary challengers to Republican incumbents who do not walk the line of tax cuts. Could Democrats have a more surreptitious agreement with their wealthy benefactors? I prefer to think it is a combination of a sincere misunderstanding of economics, a real fear that the public has so come to believe the notion of the rich as “job creators” that to say otherwise would be politically damaging, and an outright and not so subtle relationship with wealthy donors who expect tax cuts in return for now unlimited amounts of cash.

What I will never understand is how it is that those who would most benefit from reversing the current tax policies so ardently campaign against it. Perhaps they have been deified to the degree that they are incapable of understanding the disastrous consequences of their actions. Whatever the case, it is we the consumers and the middle class who hold the key to reversing this trend, and returning Hanauer and those who agree with his understanding of sound economics to their proper place in the halls of government, and to cast out those who wish to do harm to not only us, but themselves.

It is time for the consumer to rise up against those businesses that champion the misguided notion of wealth as job creation. It is as easy as getting to know your local business owners and spending your money accordingly. The sheer thought of this frightens the wealthy so that they spend billions each year blistering the airwaves with propaganda in an effort to prevent us from learning Hanauer’s elemental truth. It is as simple as avoiding the large corporations whose money is spent reinforcing these false, hateful and misguided ideas. Hanauer is right, the economy will ultimately shift so long as consumer spending remains constant or grows. Once the tax code is altered, there will be no shortage of opportunities for the “job creators” to get back to work. In fact, times will never be better for them.

May 16

What Barack Obama and Mitt Romney’s Investments Say About Them

Obama RomneyBarack Obama and Mitt Romney both filed their Executive Branch Personnel Public Financial Disclosure Reports as required in order to seek the office of the Presidency in 2011. I have previously described the two men as Pragmatist and Opportunist, respectively, and the financial disclosures further buttress my position. Barack Obama’s investment disclosure (Schedule A) is a mere three pages in length, while Mitt Romney’s disclosure runs a staggering eight pages, with an additional four pages of detailed investments managed in tax-sheltered private accounts. Barack Obama’s investments read like the embodiment of the conservative investment strategies championed by Vanguard’s founder John C. Bogle and investment adviser and author Dan Solin, while Mitt Romney’s portfolio appears to be right at home with noted investment televangelist fraud Jim Cramer’s Lightning Round, during which the shyster offers up investment buy or sell recommendations at breakneck pace out of thin air.

Barack Obama’s largest asset is a diversified group of long term and short term treasury obligations. The bonds and notes are generally regarded as risk-free investments delivering modest returns, even more modest in the current low interest rate environment. Mr. Obama’s personal stock holdings are limited to three retirement accounts, all invested in the Vanguard 500 Index Fund. The fund is not actively managed nor speculative. It simply tracks the performance of the S&P 500 Index, nothing tricky or fancy, or creative. Mitt Romney on the other hand holds pages and pages of individual equities, individual corporate bonds, foreign securities and actively managed mutual funds, many of which are managed in so-called blind trusts. Romney does have significant assets in market tracking index funds as well, but he also has upwards of $500,000 in gold, perhaps the most speculative of all possible investments. While the two men offer very similar policies for Wall Street, the two banal baby-kissers could not be more contrasting in their handling of their own personal fortunes.

So, what does this say about the two men? It has been widely reported that President Obama harbors no adulation for Wall Street, but rather coddles and serves it out of a fear of the political consequences of not doing so. Whether Obama has made a poor political calculation in this regard is a subject for another day. However, Obama apparently views the endeavor of those who have chosen “finance” as their career as facile and uncreative, adding little of real value to society. In fact, during a meeting between Obama’s campaign director and Wall Street heavies, the executives pulled no punches, even demanding that the President apologize to Wall Street publicly.

One of the guests raised his hand; he knew how to solve the problem. The president had won plaudits for his speech on race during the last campaign, the guest noted. It was a soaring address that acknowledged white resentment and urged national unity. What if Obama gave a similarly healing speech about class and inequality? What if he urged an end to attacks on the rich? Around the table, some people shook their heads in disbelief.

“Most people in the financial world,” a top Obama donor later told me, “do not understand how most of America feels about them.” But they think they understand how the president’s inner circle feels about them. “This administration has a more contemptuous view of big money and of Wall Street than any administration in 40 years,” the donor said. “And it shows.”

Mitt Romney on the other hand embraces the myth of creative finance and wealth creation wholeheartedly. Even given his advanced age of sixty-five–by age-based investment strategies at least–he is far too heavily invested in individual equities, individual corporate bonds, and active managed mutual funds. Most responsible fee only investment advisers would counsel the GOP candidate to sell off much of his equity stake in lieu of safer fixed income investments. Mitt Romney however will apparently hear none of that. His investments evidence a heartfelt belief  in the soundness of the American financial system directly in line with his political rhetoric and hyperbole.

Most of us spend decades believing the hype surrounding individual stocks and pimply-faced mutual fund managers fresh from Harvard Business School notwithstanding the mountain of empirical data to the contrary. We call our brokers and financial advisers seeking the next hot tip. After all, they know what they’re doing, right? Study after study reports the ineffectiveness of actively managed mutual funds and investing upon the advice of brokers and commissioned advisers. It is not until we actually sit down and research the subject, or remove our head from Wall Street’s all-encompassing allegory surrounding its brilliance for long enough to pay close attention to someone who actually knows what he or she is talking about, that we adjust our strategy. President Obama, a self described pragmatist, must have undertaken this analysis years ago. He understands that no matter how rosy the claims or how flashy the public relations campaign, that those peddling financial stock-picking advice have a downright pitiful track record. He also understands that to truly reap extraordinary gains from the stock market over time, you must either risk losing your entire fortune on risky bets, or you must be privy to inside and often illegal information. Neither of the preceding two courses of action is particularly appealing to an individual aspiring to the highest office in the land, so hum drum practicality it has been for the Commander in Chief.

President Obama’s changeable challenger is the consummate opportunist. He believes that actively managed funds offer superior returns to stock index funds and bond index funds. He believes that those Wall Street boys clad in $5,000 suits while extracting 2% or more of the wealth of their clients in return for poor advice actually enjoy some level of expertise. It is not all that surprising in that Romney himself spent much of his career surrounded by folks who made their livings bilking people of onerous fees by touting “exclusive” yet utterly perfunctory “proprietary analysis” while poorly managing their investments. The crowd in which Romney moves honestly believes its own claims of brilliance. In contrast to the con-man who knows precisely how valueless his products are, the Romney’s of the world believe their advice and knowledge has some real value. They are, in a essence, delusional borderline sociopaths. Some have opined that Romney’s portfolio is overly conservative and carefully crafted to avoid any political pitfalls. This analysis only makes sense if the author continues to himself or herself subscribe to the long-since-discredited strategy of actively managing investments. Even in 2012, those who advocate for a strategy based upon empirical data and sound experiential reports continue to swim upstream. A testament to the depth and reach of the myth of the stock-picker.

I believe that the duo’s investments speak volumes concerning each man’s approach to governance. Obama almost certainly charges his staff and advisers with the responsibility of researching each and every social issue or economic policy question inside, up, out, and down, leaving no stone unturned. It is in his nature to do so. He is then presented with each and every data set and potential effect prior to his coming to a practical and pragmatic conclusion. That very conclusion is then simmered on low heat through a Bearnaise sauce of political consequences and an ultimate decision is reached. This is precisely how Obama handled the gay marriage debate. He understands that practically speaking gay marriage is of no consequence to him, his marriage, or the orderly functioning of society or government. He has no moral objections to the idea. He has said as much in the past. However, once placed upon the hot stove of electoral politics, he made a poor decision, and his statements on the issue during the 2008 campaign were overly-complicated, forced, and disingenuous. This is almost certainly how he has approached the closing of Guantanamo Bay Prison since being elected, among a whole host of other issues and questions that have but one clear and obvious practical solution.

Mr. Romney in part still believes in  making “gut” decisions. It would be unfair to cast him among the same ilk as George W. Bush and his nearly unexpurgated lack of reliance on data and practical effect, as Romney can indeed be a thoughtful and realistic man. However, having no occasion in his life to doubt the efficacy of efficient markets, Mr. Romney is almost certain to believe much of what he spews on the campaign trail. I am unquestionably confident that he believes that tax cuts spur economic growth and lead to job creation in the face of reams of data to the contrary. He almost assuredly believes that  military power can be used to solve centuries old civil and religious conflicts and restore peace. He without question holds the position that income inequality will not eventually erode society as a whole. If he is elected it is likely that Mr. Romney will make many poor decisions based upon an honest belief that he is correct notwithstanding opposing information. However, he will also make his share of practical decisions. The question is which of the two categories will be out of balance.

In 2012 we do not have to chose between an ideologue and a pragmatist, or a true believer and a statistician–assuming a vote for either of the two mega-parties. Neither of the major candidates ultimately believes in anything strongly enough to be swayed by ideology or morality alone. Each man can be swayed from a practical common sense solution by politics, so both men are inherently dangerous. One need only look to Obama’s treatment of Wall Street and Romney’s continual conversion on policy for evidence. It is ultimately irrelevant how thoughtful and pragmatic a leader may be at his or her core if practical considerations have no place at the policy table. In analyzing the two men’s investments, it is clear that one man is a practical sound decision-maker at his essence, and one man is practical yet inclined to surrender to his belief in the advantage of risk and reward. Whether it is more desirable for a leader to make poor decisions based upon an honest yet misguided belief in the anticipated results, or to make poor decisions based upon a political calculation in the face of a deep understanding of information to the contrary is a choice that each of you will have to make on your own. I however would like a third choice.

May 15

No Separation – No Peace

Jamie DimonEven if your only source of news is FOX and Friends, you must certainly have heard by now that the nation’s largest bank, JP Morgan Chase, suffered a loss of at least $2 billion–and likely much more–in a botched credit derivatives trade. The trade, which spurred an all but dog-and-pony show investigation by the FBI and renewed lip-service on Capitol Hill for strengthening Dodd-Frank‘s Volcker Rule and swaps regulations, involved a corporate bond hedging strategy gone horribly wrong. A London based trader for JP Morgan assembled a huge portfolio of derivative credit default swaps and sold them off to investors based upon the trader’s wrong-headed belief that corporate bonds owned by JP Morgan would perform well. The market believed otherwise, and the once “well-intentioned” hedging strategy blew up in the face of JP Morgan chief Jamie Dimon and the rest of the masterly minds who also carry keys to the executive washroom. Losses began to mount, and rather than accept the losses commensurate with the oft-cited free market’s value of the underlying assets and derivatives, Dimon chose instead to attempt to call off the dogs by whining to the federal government yet again. Dimon, long the golden-boy of Wall Street for his perceived risk management acumen, suffered a scathing blow to his egregious ego.

Barack Obama is fond of referring to Dimon as one of Wall Street’s best and brightest.

JP Morgan is one of the best-managed banks there is. Jamie Dimon, the head of it, is one of the smartest bankers we got and they still lost $2 billion and counting,” the president said. “We don’t know all the details. It’s going to be investigated, but this is why we passed Wall Street reform.

I don’t know which claim in this sentence is the most absurd. First, if Jamie Dimon is one of the smartest bankers we’ve got, who is the worst? Good grief. If you have a potential loss looming into the many billions of dollars on a unnecessary and risky bet that was permitted to spiral out of control on your watch, you’re not a genius. If you beg Congress to limit the rules that could potentially prevent the loss from taking place in the first place, you’re an idiot whose hubris has digested whatever tiny amount of good sense you had remaining. You are by no stretch of the imagination to be held out as some captain of finance worthy of the respect of the common man and bankers alike. If you insult those who are attempting to promulgate rules to prevent you–yes you–from destroying the economy and sending millions back to the unemployment lines and soup kitchens, you are a sociopath incapable of understanding the profound effect your actions have on other human beings. You’re just another banker Mr. Dimon, and there are hundreds of thousands of people within fifty miles of Wall Street capable of stepping into your shoes and replicating your results in an instant. I only wish Barack Obama understood that simple fact. Let me backpedal a bit. In fairness, I am sure that he does understand, he just isn’t willing to act upon this knowledge. Continue reading

May 14

Not Your Grandfather’s Government – The Public Sector Needs You

Unless you live in California, you may not have heard the announcement today that the state is currently facing a $16 billion shortfall in revenues for the next fiscal year. Tax revenues fell short of rosy politically motivated estimates, and spending has increased above expectations. The budget deadline is in June, and several of the Governor’s proposals to cut spending have been thwarted by fellow Democrats in the state legislature, while proposals to increase taxes have been lampooned by Republicans and money flowing in from right wing groups. A similar story is playing out across this great land of ours. The failure of the people to accept tax increases, corporate defiance to invest capital, government’s rejection of job training efforts, and the petulant reluctance of the Congress to step in and buoy state coffers is causing massive layoffs and reductions in public services.

Unlike the New Deal programs that followed the Great Depression, during this period of extreme economic trauma, both the federal government and the states have instead reacted to shrinking tax revenues and mass unemployment by shrinking government programs and firing workers. At the federal level, the appetite for renewed borrowing to fund programs, assist states, and help the middle class and the poor is minuscule. At the state level, due to requirements of budgetary balance, massive layoffs have accompanied drastic cuts in public services. Parks have closed. Hospitals have closed. Transportation, improvement, and infrastructure projects have been canceled altogether or have been substituted with patchwork fixes and band-aid repairs. Public sentiment is perceived by Washington to favor deep cuts and curtailments in borrowing and spending. Not only is Washington wrong on the policy, it is wrong on its taking of the pulse of Americans.

It was recently revealed that another 15,000 public sector jobs were lost in April 2012. Since the depression began in 2008, the public sector has lost–conservatively–more than 600,000 jobs. 600,000 folks who once provided you with the services that you took for granted as a birthright. People who educated your children, removed your trash, maintained your public spaces, filed your deed transfers, inspected your homes, monitored clean air and clean water standards, and on and on. Democrats and Republicans each favor varying degrees of continued austerity, with Democrats favoring small tax increases on the wealthy and corporations, and fewer cuts to government programs, and Republicans favoring huge tax cuts for the wealthy and corporations, with massive cuts to spending, defense outlays left untouched.

To listen to stump speeches and congressional soliloquies, one might come away with the impression that the public favors some mixture of the two approaches, with wide agreement that taxes should be kept in check and government spending cuts imperative. The data suggests that neither side is properly reflecting the position of the vast majority of Americans. For example, 56% of Americans believe that higher taxes and increased spending is needed to remedy our faltering economy. 68% of Americans believe that the current tax system benefits the wealthy at the expense of the rest of us, and a majority of Americans would be willing to pay more taxes to maintain Social Security and Medicare, as well as government programs that assist the poor.

As stimulus monies run dry, it is nearly impossible to open a local paper anywhere in the nation and not find a story or two concerning budget shortfalls and potential layoffs. School Board meetings far and wide have become contentious events. Property owners have been asked to pay more to support local schools, yet staff reductions and benefit give-backs remain unavoidable. Teachers are slated to be laid off, municipal services are being scaled back, and programs that offer help to young children and the poor are being eliminated altogether. State programs to offer incentives to people to install energy reducing technologies are being dispensed with, and along with the incentives, the jobs of those who install solar panels, geothermal systems, and energy efficient building materials and upgrades are lost. With each unnecessary cut, the ripple effects are felt beyond the public sector.

With budget cuts to education, we are destroying our own future. Enrollment is down at some of our most prestigious public university systems in response to higher out-of-pocket costs and staffing restrictions. At a time when technical education is becoming the very key to obtaining a good paying job, we are making it increasingly difficult to obtain, even for those who have excelled academically. This is a recipe for disaster. Last year alone, the federal government cut more than $5 billion in funding from education programs, the bulk of which was slated to pay for state programs and direct state grants. As the states struggle to balance budgets, education becomes a large juicy target. New York State alone will be eliminating more than 5,000 teaching positions, even after increasing tax levies.

As federal money fails to reach states, so too does state money fail to reach localities. These localities are forced to cut back on services such as fire and rescue, as well as police. Local government offices cut back on building inspections, shrink hours of operation, close public libraries, and even darken street lights. The Federal Reserve Bank of San Francisco, hardly an arm of the socialist movement, has predicted lasting consequences should the economy remain stagnant and federal aid to states remain damned. Because state governments are constrained by a requirement to balance their budgets, revenue shortfalls require offsetting cuts and debt offerings. Many states are already burdened by high debt loads and are loathed to increase bond offerings for fears of credit downgrades that increase borrowing costs. The states are left with the option of cutting spending and increasing taxes. Increasing taxes–while necessary–is politically unappealing during an economic recession, therefore most states opt for spending and services cuts.

The only entity available to step in and curtail the bloodletting of state and municipal jobs and cuts to public services is the federal government. Unfortunately, President Obama has not been willing to expend any political capital on efforts to assist the states, and Republicans are hell bent on ensuring that the economic emergency continue through election day. This situation creates immeasurable suffering in local communities. Taxpayers are asked to bear the burden of funding depleted schools and local services at increasingly unsustainable levels. Many people have lost their homes over an inability to meet property tax and other municipal burdens. Allowing this to continue during a period of high unemployment is particularly devastating, and sets in motion a cavalcade of events that only drags the local economy down further.

It is time for the federal government to step up and offer assistance to states and localities in order to maintain a basic level of public services and avert further layoffs of public employees. While the private sector continues to report modest job creation in 2012, the public sector continues to lose jobs. Lost in the debate over funding of government and government services is the fact that it is the public sector that allows the private sector to flourish, and it has done so since WWII. The public sector helps educate its employees, it maintains the bridges and roads on which the private sector transports its goods and personnel, it maintains the safety of air travel so that the private sector may travel to meetings and business events, it oversees the ports through which the private sector exports its goods and imports its supplies, it manages the tax boards and the IRS, it provides fire, police, and ambulance services to private sector business and its employees, it pumps clean water in and carries sewage and waste water out of private sector facilities, it has ensured efficient markets and regulation that has allowed private sector American business to attract capital from around the globe and enjoy some of the largest stock trading premiums in the modern world, it administers the courts through which the private sector settles its disputes, it handles patents, copyrights, and trademarks in order to allow private business to profit from its own creative product free of exploitation and theft. Essentially, without a robust and functional public sector, the United States of America and its business and financial dominance would not exist.

It is time to provide the public sector with the short term assistance it needs in order to ensure our collective long term survival. Teachers and public employees are not the reason that the government is broke–wage inequality, poor and dis-courageous governance, and corporate greed is. Please join us in focusing the anger, vitriol, and more importantly the constructive solutions, on those actually to blame for the current circumstances of state and municipal budgets. Those who provide us with the invaluable services that distinguish a modern functional society from one of chaos and dysfunction in return for substandard wages and a secure retirement are not the enemy. Don’t allow yourself to be convinced otherwise.

May 03

A Lost Decade or Ten . . . .

This past Wednesday, Larry Summers and Paul Krugman both spoke at different events and both warned of a lost economic decade–or decades–in the United States. While I am loathed to accept anything spewing from the frothy mouth of Larry Summers, he was uncharacteristically cogent in his remarks. Mr. Krugman continued–much to his credit–to pound the drum for decreased austerity, increased stimulus, and more proactive programs to spur employment. Mr. Krugman is widely regarded as championing policies that hang precariously the fringe of mainstream economic thinking, while Mr. Summers has long been a technocratic proponent of free markets.

“For the first time in 75 years, we are experiencing a protracted recession due to a lack of demand,” Summers said during a speech to the Center for Global Development in Washington. “It’s now been about five years since the recession began and it appears the stagnation will be with us for another long interval.”

“There is not enough demand,” Krugman said during an appearance at the Economic Policy Institute, where he gave a talk to promote his new book, End This Depression Now. “We focused a lot – too much – on the financial sector’s problems. Yet that is long since gone and we still don’t have a steady recovery. That tells us the crisis was far more about household debt.”

Summers chose to focus on fixes to income inequality through progressive taxation as medicine for the demand problems in the United States, while Krugman focused on retracing the cuts in government spending at the federal and state level in order to increase expendable income, employment, and certainty. Both men are correct. Summers is correct in that if the United States is to allow the tax system to remedy income inequality rather than to implement tight regulation and limits on executive pay and compensation, then individual–namely wealthy individuals–and corporate tax revenues must necessarily increase. He also points out, falsely I believe, that much of the job losses caused by technological innovation in the manufacturing sector are to blame for much of the income inequality, and that nothing can be done to reverse that trend. Krugman is correct in that it was wholly irresponsible to react to a short term protraction in government revenues by slashing millions of public sector jobs. By failing to recapitalize state and municipal coffers, the federal government has exacerbated the huge demand problem and contracted government tax revenues. Krugman also points out that the long slog of short term fixes to the tax code and stop-gap measures on infrastructure funding have created an uncertain contracting environment for federal and state agencies, leading to the cancellation and procrastination of major improvement and repair projects. In doing so, the government has further dragged down consumer spending, employment, and government revenues. Continue reading

May 01

Don’t Do It America

The Federal Reserve recently released its most current Senior Loan Officer Opinion Survey on Bank Lending Practices report. The report indicates that consumers are demanding increased access to credit cards as well as consumer debt, such as auto loans. In response, large and small banks alike have eased lending standards. Approximately 14% of all banks reported having made it easier for new applicants to be approved for revolving credit card accounts in the first quarter of 2012. Smaller banks and credit unions have eased standards at a slower pace, but not by an appreciable amount.

While the banks have moved significantly from tightening lending standards across the board in 2008, to a toes-in-the-water approach to easing lending standards following the crisis, it is only a matter of time before banks begin to ease standards considerably in an effort to boost profits. American households did a great job of paying down debt during the early part of the financial collapse, reducing household liabilities to $865 billion from $958 billion between 2008 and 2009, according to the most recent Federal Reserve G.19 report.

It will certainly be difficult for consumers, whose spending accounts for 70% of the American economy to resist the urge to return to the spending frenzy of the mid 2000′s, but resist it we must. First, it isn’t sustainable. A modern economy can not survive if the vast majority of its economic activity surrounds purchasing goods and services from foreign companies and eating fast food at the local hot shop. Second, it isn’t responsible. With fewer and fewer employer sponsored options available for funding retirement, and health care cost increases, over-leveraging household debt is a recipe for disaster in old age. Moreover, it isn’t fair to your fellow citizen, who will ultimately have to pick up the tab for your health care costs and basic needs.

According to the Federal Reserve G.19 report, consumer debt has risen from the low of $793 billion during the crisis to nearly $800 billion today. With banks and credit union lending standards loosening, that number is certain to rise quickly. We must not forget what it was that fueled the mess that we’re currently in and accept our measure of accountability for it. A return to credit card debt and rampant consumer spending is not the answer. Ignore the news reports you hear begging you to spend your hard earned money to support the greater economy. The American economy requires a structural change from the floor to the ceiling, and much like the fast food that the television demands that you eat, increased consumer spending will fill a short term craving but leave you hungry and sick down the road.

Apr 30

IMF Chief Calls for Mortgage Principle Forgiveness in U.S.

International Monetary Fund Chief Christine Legarde has added her voice to the growing chorus of economists not bought and and paid for by the banking sector in calling for the United States to begin to reduce the principal on underwater mortgages purchased during the fraudulent run-up in housing prices between 2002 and 2008. She recommends doing so in order to stimulate growth across the globe, but doing so would also significantly impact the economy at home.

She called upon Fannie Mae and Freddie Mac, both of which are overseen by the Federal Housing Finance Agency, to reduce the principal owed on homes, whether the homeowner is in arrears on payments or simply underwater and current in their obligations. Unfortunately, FHFA boss Edward DeMarco has steadfastly maintained that he will not support policies that allow for widespread mortgage write-downs. Mr. DeMarco was to make a decision by April 30, 2012 whether or not he would move forward on a plan under Obama’s HAMP program to allow principal reductions on properties backed by Fannie Mae and Freddie Mac where the mortgage holder is seriously delinquent. Unfortunately Mr. DeMarco recently announced that he would ignore the deadline, imposed by Congress, and continue to study the problem.

The HAMP program reductions that are under consideration by Mr. DeMarco would only affect about 10% of all underwater mortgages backed by Fannie Mae and Freddie Mac because homeowners who are underwater but continuing to make timely payments are not eligible for reductions. Mr. DeMarco has said in the past that he fears mass purposeful mortgage delinquencies if the program is permitted to move forward, a prospect that has not been supported by evidence. The likelihood of damaging ones credit rating and potentially losing a home in exchange for a principal reduction that may or may not come at all has not convinced any significant number of borrowers to stop making their mortgage payments.

The Obama administration has been reported as putting pressure on Mr. DeMarco to make a decision allowing the contemplated principal reductions to move forward, but I am dubious as to how extraordinary the insistence has truly been from the White House. The administration has offered a deluge of failed and ill-conceived fixes to the mortgage mess since 2008, none of which truly aimed at forcing the banks and Fannie Mae and Freddie Mac to allow principal write-downs of underwater properties. A wisely constructed plan by the FHFA and the administration could easily limit any reductions to those homes actually purchased during the fraudulent run-up in home prices, and those homes who value exceeds that of the original mortgage, excluding refinancing undertaken to make additional unnecessary purchases. Configuring a program to address this problem and stimulate the economy would not be a herculean task.

It is wholly objectionable that the already incommensurate principal reductions proposed by Congress and the President are being insubordinately rejected. However, it should come as no surprise to anyone given the administration’s posture concerning this problem from the very beginning. Setting aside the earlier mentioned waterfall of half-assed programs previously concocted, the furthest the President has been willing to travel down the write-down road has been to propose federally assisted and voluntary refinancing of a small number of homes under lower interest rates. Not a single legitimate attempt has been made to reduce the principal of homes currently in repayment and dramatically underwater. Offering a homeowner the ability to pay twice the value of a home under a lower interest rate is no program at all. It is an insult to each American who had their tax dollars spent drowning large banks and mortgage institutions in liquidity in order to ensure their solvency.

So, Mr. DeMarco, no one is surprised by your decision. Further, only a fool should be surprised by the administration’s lack of movement on this issue. You’re a homeowner, not a bank, and as such, you don’t matter. The most logical course of action is to walk away from any home that is seriously underwater, because help is not coming.

Christine Legarde was right to call upon the American government to offer significant principal reductions to underwater homeowners. She is right because it will boost the American economy, setting free cash to be spent consuming goods and services and alleviating business and personal uncertainty. She is right because it will boost the world economy. She is right because it represents remuneration for the fraud perpetrated upon the people. She is right, quite simply, because it is the moral thing to do.

Apr 30

Wages, Productivity, and You

Assembly LilePerhaps the most underreported aspect of the past few decades, specifically the aftermath of the financial collapse, has been the extraordinary increases in worker productivity and the accompanying stagnation of wages. Whatever the profession or occupation, employers have been demanding more and more from employees and failing to compensate them for the increased output. The phenomenon is referred to as a “speedup.” Rather than hiring additional workers, employers have been capitalizing on workers’ fears of unemployment by requiring that they do more for less. Ultimately it is a case of supply and demand. A greater supply of applicants than open positions to be filled has allowed bosses young and old to pad their own purses at the expense of employees. It has represented a  near complete break from basic morality.

This is nothing short of a sea change. As University of California-Berkeley economist Brad DeLong notes, until not long ago, “businesses would hold on to workers in downturns even when there wasn’t enough for them to do—would put them to work painting the factory—because businesses did not want to see their skilled, experienced workers drift away and then have to go through the expense and loss of training new ones. That era is over. These days firms take advantage of downturns in demand to rationalize operations and increase labor productivity, pleading business necessity to their workers.”

Real wages and total compensation have also eked along just barely keeping pace with inflation recently, continuing a long term trend that has continued since the 1970′s. While it is true that when total compensation–wages plus benefits–is measured and adjusted for inflation, workers compensation has indeed grown more quickly than inflation, the ultimate effect is less money in the pockets of workers, fewer retirement options, greater debt, increasing number of multi-generational households, and a lower standard of living generally. It is also true that the employer foots the bill for much of the benefit cost, but the added investment ultimately benefits neither the employee or the employer.

Productivity has vastly outpaced real wage growth over the past two decades and the prediction going forward is that the downward pressure on wages will continue.

The income story in America is deeply troubling. Inflation-adjusted average hourly earnings for production and nonsupervisory workers (a category that encompasses 80% of the workforce and leaves out higher-paid managers and supervisors) rose by an anemic 0.1% a year from 1979 to 2007, according to the EPI. A potent combination of economic and social forces has conspired to keep wages down for most workers with the exception of a brief period of white-hot economic growth in 1995-2000. Private-sector unions have largely disappeared. Companies have outsourced all kinds of tasks to cheaper places overseas and low-cost contractors at home. The upward spiral in health-care costs has eroded wages.

What the downward spiral of real wage growth means for the economy is simple–stagnant growth. With less real buying power remaining after fixed costs, retirement savings, and debt service have been factored in, workers will not be able to purchase the necessary goods and services in order to sustain growth in the larger economy. The economy has shown evidence of this recently, with orders for durable goods down and recent manufacturing spurred by a short term need to increase inventories also now trending downward.

I do maintain a certain level of sympathy for employers however, as costs to provide medical insurance continue to outpace inflation by nearly 7% on average. Each dollar spent on inefficient and expensive health care plans is a dollar necessarily unable to be spent on wages employer sponsored retirement plans. While there is no guarantee that employers would pass along any health care savings to the employees should costs somehow be reined in, under the current system employers have not been provided with that option. Obviously, as labor supply outstrips labor demand, employers lack any real incentive to do so even if given the choice, but at some point the labor supply will more evenly mirror demand, yet it is unlikely that reductions in health care costs will have come to pass in the interim.

If you are like me you have a twitter account. If you are are interested in finance you probably also follow several respected economists using that very same twitter account. If you take the time to track back and read the vast majority of posts and links to all of the mind-numbingly dense economic data–charts, charts of charts, charts within charts clarifying other charts, bar charts, line graph charts, area charts, government labor data, Federal Reserve data, Census data, articles, studies, blogs, scholarly publications, and on and on–you will find a dearth of discussion concering real wage growth and inflation. You will be peppered with astonishing amounts of information concerning inflation, unemployment, productivity, compensation costs, among other data sets, but you will not find a bona fide widespread discussion among mainstream economists surrounding real wages and productivity.

Unfortunately the trend should surprise no one. It is a consequence of decades of deregulation, attacks on public sector workers, attacks on labor unions,  and above all an intense campaign by corporate American to manitain the myth of Horatio Alger and the American Dream. Look, I even capitalized it, “American Dream.” I am not certain that it is required, but my very first instinct was to make sure that everyone is able to distinguish the idea from each of the other meaningless words surrounding it. The fact of the matter is that as worker productivity has increases and wages have stagnated, the profits of the employers have not showed a correlative decrease. In fact, profits have increased, as has executive pay and compensation. In other words, corporate America has used your otherwise laudable American work ethic to pound you into dust.

You know the feeling–guilt for not completing a task or set of tasks, no matter how unreasonable. The feeling of anguish at the thought of calling in sick. The overwhelming barrage of conflicting information you are faced with when you dare demand to have a modicum of work-life balance. The idea that working two, three, or four jobs is admirable and worthy of respect and recognition. You’re a hero, because that is what Americans do–we get up every day to make someone else filthy rich and we’re damn proud of it. It has all been orchestrated to brainwash you into believing that you are a failure if you do not do whatever is required of you by your employer. Astonishingly, corporate America has been able to maintain this myth even as it demanded more and more from you for less and less in return. It’s wrong and it has to stop.

Apr 28

Neither Side is being Reasonable on Taxes

Ryan - ObamaAs the election draws near and the competing interpretations of deficit bean counting becomes louder and louder, taxes, specifically income taxes, will be occupying a more pronounced amount of the political space. On the one side, Republicans, who oppose raising taxes on anyone for any reason, and who have been so dreadfully frightened by Grover Norquist and his ridiculous tax pledge that its reasonable members don’t dare speak honestly. On the other side–because we only have two sides after all–are the Democrats, who oppose raising taxes on anyone making less than $250,000. How the Democrats arrived at that number has been the subject of debate, but the party has sufficiently pigeon-holed itself on that number, so it is just as if Moses himself carried it down the Capitol steps and announced it as God’s will. Neither side is correct, and neither side is moving.

The Republican position is uniquely barbaric. Assuming no legislative change from status-quo, the top wage earners in the United States in 2012 will pay a top rate of 35% on incomes over $388,350 and 33% on incomes roughly over $218,000. Comparatively, most European nations carry a top tax rate of over 40%, and significant sales taxes and luxury taxes. Germany has a top income tax rate of 42%, and is currently the only thing standing between Europe and total economic destruction, rightly or wrongly. The Republicans are demanding not only that the top tax rate not be raised, but rather that it and other taxes affecting top earners be lowered dramatically, to 25%. Each of the lower marginal tax brackets would be lowered to 10%. They offer no compromise on this position.

Democrats on the other hand are standing pat on the position that taxes should be raised to pre-Bush levels for top earners of as high as 39.6%, and proposing that marginal tax rates for lower income earners not be changed from current levels for families earning less than $250,000 and individuals earning less that $200,000. There is also a surtax on unearned income at the higher income levels of 3.8%. Further, any individual earning more than $1 million would pay a minimum income tax rate of 30%.

Setting aside any debate concerning the United States’ arcane corporate tax code, neither party is being reasonable. First, the Republican plan leaves the government $6.2 trillion short on revenues and would necessarily lead to drastic cuts in discretionary spending, be it from programs boosted by Democrats, or from Defense. Second, the Democratic proposal, although much more equitable, also leaves in place the irresponsible Bush tax cuts for lower wage earners. It isn’t smart economics or smart politics to propose tax changes that affect only a small group of taxpayers. Moreover, Obama and the Democrats had their chance to avoid this fight altogether in late 2010. With the Bush tax cuts set to expire, they instead chose to negotiate with the Congress for a two-year extension. That decision was neither politically smart or economically responsible. With deficts almost certainly to be a more resounding issue during the 2012 campaign than tax rates, the Democrats, primarily out of fear, intentionally exacerbated the deficit by signing the 2010 agreement, playing directly into the Republicans’ wheelhouse. Allowing the Bush tax cuts to expire for everyone would have been a much easier political sell for the President and Democrats if they had painted the Republicans as unreasonable and focused on the shared sacrifice inherent in allowing a return to Clinton era rates. Instead, Democrats must fight the battle battle again during an election year. Continue reading

Apr 25

Obama and Department of Education Outsourcing Student Loan Servicing

On April 15, 2012 I received a letter in the mail from EdFinancial, a so called “nonprofit” financial services company, informing me that it would be taking over the serving of my William D. Ford direct consolidation loan, effective April 5, 2012. First and most obviously, the letter was postmarked seven days after the effective date. Most upsetting, the notice arrived just three days prior to my payment being due. I received no contact from the Department of Education, who had been servicing my loans since I graduated from Law School. So, I was left with only a small window of time in order to determine on my own if the letter was legitimate, and then register on the new website and adjust my automatic payments accordingly.

The federal government through the Department of Education has been has been transferring large tranches of federal student loans to new loan-servicing companies for some time now. It has plans to continue to do so through the end of 2012 and beyond.

As our federally-owned loan portfolio continues to grow, we are ready to move to the next step in ensuring an efficient and effective multi-servicer, borrower-centric approach to servicing.  We will further expand our federal loan servicer team through contracts awarded under the HCERA/SAFRA Not-For-Profit (NFP) Servicer Program solicitation.  This solicitation offered NFP entities the opportunity to submit proposals individually or in teams for servicing borrower accounts on our behalf.  Whether individual or team award, our customers will know and face one servicer.  The Department will annually measure each servicer’s performance in the areas of borrower satisfaction and default management and use the results to assign additional volume when applicable.

I am left only to assume that not directly informing borrowers in advance that hundreds of billions of dollars in student debt will be transferred to private entities is an indispensable element of this new “borrower-centric” approach. I also assume that not informing me in a timely fashion of the transfer carries no penalty. I should say loudly that I was very happy with the past service provided by the Department of Education and found its staff to be knowledgeable, helpful, and responsive. Over the years I have had several questions and need for assistance, and each request was handled professionally. I have no doubt that the level of service provided previously will not be duplicated by the private entities paying lower wages and benefits, and providing no job security to its collection agents and staff.

The change was pushed by several nonprofit student loan corporations and their trade groups, including the Education Finance Council, during the health care debate in 2009 and 2010. The rule change was hidden away nicely as part of legislation passed concurrently with the Affordable Care Act. As has been true often during Obama’s tenure, an idea first floated to enable common sense reform, has been bastardized by moneyed interests. The motivation for the law was primarily to allow the government to break from guaranteeing loans offered through banks and credit unions and to begin lending directly to the public. The change made sense, and it has saved the federal government from having to pay fees to the large banks to originate and service the loans. It has also meant that the federal government would be forced into servicing a larger number of loans. However, the apparently influential nonprofit collection servicing business groups won a provision which guaranteed that its members would be granted the rights to service the loans.

As a consequence of the right hand helping while the left hand pummels, many borrowers have suffered problems during the transition. Many borrowers’ payments have been adjusted upwards or downwards without explanation. The vast majority of these same borrowers have since provided the new servicer with the requested information needed to correct the issue, but have not found a resolution. In my case I was simply notified in an unprofessional and untimely manner, although I am certain that additional problems will arise in the future.

I have some initial questions for the Department of Education. For example, how will loan forgiveness procedures be handled? Who will make decisions regarding public service loan forgiveness? How will borrowers’ payments be tracked for purposes of forgiving loan balances once the loans become eligible under the 25 or 20 year provisions? Are we to trust these private companies to keep accurate records and base decisions on government policies and interpret those policies accurately? What new collection rights, if any, will the servicers enjoy that the federal government did not? Will there be an oversight board set up to handle complaints from borrowers when these servicers ultimately engage in fraudulent behavior? Who will punish these entities if they begin to intimidate borrowers? At least six of the servicers that Uncle Sam has negoitiated these no-bid contracts with with have been involved in scandals in the past. How are we borrowers to have any confidence in this process?

The fact of the matter is that this type of government outsourcing never functions as planned. Just ask anyone who has run afoul of parking regulations in Chicago, or the folks who were recently renumerated for fraudulent fines and penalties paid to private operators of toll roads in California. This loan servicing outsourcing was a terrible idea and it will have terrible consequences. Unfortunately, it will be nearly impossible to unwind it.

It is a despairing situation because the President, I believe, had no intention of placing student borrowers into a precarious situation. In attempts to streamline the process he simply traveled down the path of least resistance, likely believing that the servicers’ nonprofit status would in some way shield borrowers from the type or predatory behavior that they had been subjected to by the large banks and private collection companies. In return, he was able to carve out a change that removed billions in fees from the large banks as the government became a direct lender to students. As I write this, the President is traveling around the country attempting to rally support for an extension of lower interest rates for student loan borrowers, and I believe he intimately understands the harm that will be caused by failure. However, outsourcing nearly a trillion dollars in student loan debt to ill-trained, ill-informed, ill-motivated private entities was a poor decision, and one that will likely adversely affect borrowers for decades.

Apr 24

Time for Debt Forgiveness

Robert Skidelsky, Professor Emeritus of Political Economy at Warwick University and a fellow of the British Academy recently published a piece over at Project Syndicate in which he strongly advocates for the forgiveness of debt as a means to push the economic recovery along. Most economic prediction models have forecast growth around the world at far higher levels than what has come to pass, and there is talk that forecasts going forward will have to be revised downward. The reason for this, he argues, is that the medicine prescribed to alleviate the damage caused by the financial crisis was contraindicated. While the lowering of interest rates, the printing of money, the infusion of capital into failing banks, and the increasing government spending all serves to buoy the economy, but the real silver bullet is debt forgiveness. I agree.

With fiscal, monetary, and exchange-rate policies blocked, is there a way out of prolonged recession? John Geanakoplos of Yale University has been arguing for big debt write-offs. Rather than waiting to get rid of debt through bankruptcies, governments should “mandate debt forgiveness.” They could buy bad loans from lenders and forgive part of the principal payable by borrowers, simultaneously reducing lenders’ collateral requirements and borrowers’ debt overhang. In the US, the Term Asset-Backed Securities Loan Facility (TALF) program and the Public-Private Investment Program (PPIP) were in effect debt-forgiveness schemes aimed at sub-prime mortgage holders, but on too small a scale.

But the principle of debt forgiveness clearly has applications for public debt as well, especially in the eurozone. Those who fear excessive public debt are the banks that hold it. Junk public bonds are no safer for them than junk private bonds. Both lenders and borrowers would be better off from a comprehensive debt cancelation. So would citizens whose livelihoods are being destroyed by governments’ desperate attempts to de-leverage.

Philosophically, the debt-forgiveness approach rests on the belief that creditors share culpability for defaults with debtors, since they made the bad loans in the first place. As long as the borrower has not misled the lender at the time of taking the loan, the lender bears at least some responsibility for the transaction.

Here in the United States, much of the sluggishness of the recovery can be pinned directly to the so-called housing and debt  overhang. There are simply too many foreclosures to work through quickly and far too many people servicing loans that exceed the value of the home. There are too many people servicing student loans, credit cards, and other debt. Toss in a heavy dose of unemployment, consumer deleveraging, and banks hoarding cash–desperate to firm up their balance sheets lest the public be made aware of how financially troubled they really are–and you have a recipe for a sluggish recovery. Unfortunately, we here in the United States cling to a ridiculous notion that consumers who took on debt, even fraudulently inflated debt, must pay back what they owe at any cost. The theory goes that to do otherwise is to “reward irresponsible behavior.”

The theory has no merit. This principled position has the practical effect of suffocating the economy far longer than necessary. The pragmatic approach, albeit ethically unsavory to some, frees up disposable income to make better investments, purchase goods, and save for retirement. With consumers–like the banks–finally out from under student loan debts, failed mortgages an exorbitant credit card balances, the economy is resuscitated. The government, being the only entity with the means to both force the creditors to take their medicine and the ability to take on debt itself in order to purchase the debt of the consumers should do so. Most notably, it is specifically at this point, when interest rates are predictably low, that borrowing costs make such an action less troublesome. Once the economy regains its footing, the government is free to restructure its fiscal policy in order to service its own debt effectively. It is the knowing failure to take this approach seriously that has led to the near collapse of Greece, and may lead to a near collapse in Spain and other southern European nations as well.

If the United States and Europe do not finally succumb to fundamental and practical fiscal policy soon, the recession is nearly certain to stretch on for at least a decade. Millions more will lose their homes and jobs. Trillions of dollars in potential growth will be forfeited to satisfy a misguided notion of responsibility.

Update: At the cost of contradicting my own argument, recent reports indicate that American debt as a percentage of disposable income is at 1984 levels. I simply can not buy this data yet. If it is true however, then there is something dramatically wrong with the very foundation of our economy.

Apr 23

Petty Settlement Reached by CFTC with Oil Price Manipulator

The CFTC settled a case late Thursday with a multinational liquidity provider for alleged oil and gasoline futures manipulation. While this settlement comes nearly five years too late, it may mark a turning point in the Obama administration’s general reluctance to take on Wall Street.

Late Thursday, the CFTC announced the $14 million settlement with Optiver over oil and gasoline futures manipulation in March 2007. The CFTC said that traders in Optiver’s Chicago office engaged in a trading scheme where they accumulated large positions in Trading at Settlement contracts in NYMEX light sweet crude, heating oil or gasoline contracts and then offset those positions by trading futures contracts shortly before and during the closing period for those contracts, a scheme known as “banging” or “marking” the close, according to the CFTC.

It has been no secret that the administration has been under significant pressure from the left and the right alike to initiate investigations into what many experts have been reporting are inconsistencies between the market price for oil and gasoline and market forces. Political instability in the Middle East, primarily surrounding Iran, has long been the straw man used by the mainstream media and those with ties to Wall Street to distract the public from oil speculators and their effect on oil prices.

While the $14 million cash portion of the settlement is a relatively insignificant sum to a firm the size of Optiver, the settlement also includes a provision forbidding current and former members of the firm from commodities trading for as long as four years, a substantial penalty. The trading ban almost assuredly is intended to send a message to individual traders and managers to watch their step.

The settlement prohibits van Kempen from trading commodities for two years, Randal Meijer, who was then Optiver’s head of trading, for four years and Christopher Dowson, Optiver’s head trader, for eight years. Dowson is the only defendant that Optiver still employs, according to the CFTC.

The investigation has been ongoing for more than three years. The CFTC claimed in response to questions from the media that the announcement of the settlement was timed to coincide with a speech by President Obama in which he called for investigations into oil speculation and more funding for investigators and staff. I am inclined to believe the administration in this regard. Investigations of this sort, once initiated, tend to take on a life of their own, and settlements are generally reached when both sides have sufficiently vetted each other and are satisfied that the agreement fairly represents either’s chances of success or failure on the merits.

Optiver may not be a household name, but it is well known in Chicago and Amsterdam.

According to the CFTC, Optiver reaped a $1 million profit in 2007 by “banging the close” in crude, gasoline and heating oil markets with a rapid-fire trading program nicknamed “the hammer.”

Optiver is a household name in Chicago’s and Amsterdam’s electronic trading communities, where it is known for high-speed market making and arbitrage strategies in options and other derivatives using super-fast computer algorithms.

Evidence in the CFTC case includes emails and phone recordings showing efforts by traders at Optiver’s Chicago branch to “move,” “whack” and “bully” oil prices in 2007.

High-frequency trading has come under scrutiny in commodity markets in 2011 following a series of violent and seemingly inexplicable price moves that many traders have blamed on its growth.

While I am far from satisfied that the CFTC and the Department of Justice–which has apparently been on sebatical since 2008–has done enough to protect world consumers from predatory commodities trading practices, this settlement and accompanying trading ban is certainly a step in the right direction. It didn’t include any of the usual cast of unscrupulous equity sucking characters as Goldman Sachs or Morgan Stanley, but perhaps further investigations are underway. I wouldn’t hold out hope in that regard, but perhaps this settlement will encourage the big boys to tread lightly.

As far as Optiver is concerned, I believe a recent company job announcement says it all:

For our Trading department we are looking for final-year students or recent graduates from a an analytically related field of study such as Finance, Economics, Econometrics, Financial Engineering, Engineering, Mathematics, Computer Science or Physics. A flair for numbers, a passion for finance and the markets, and a hugely competitive streak are also a must.  (emphasis added).

“A flair for numbers.” Well, that’s rich, but refreshingly honest.

Apr 19

Could the Banks Fail Anyway?

Brian Moynihan

Bank of America CEO Brian Moynihan

Unless you just recently returned from a four-year vacation on the moon or have been trapped in a Massey Energy coal mine, you are aware that the American taxpayers have provided tens of trillions of dollars in direct bailout money and near zero-percent loans to the largest banks operating in the United States since 2008. While specific banks appear to have emerged from living for free in the American People’s pool house quite profitable and have regained their footing, several large banks remain on the verge of–or are currently operating in–insolvency.

Moody’s rating agency recently put nearly each of the large banks in the United States as well as several international banking behemoths on its watch list for a potential downgrade. Bank of America for example, reported first quarter revenues this year nearly $1.4 billion less than last year’s first quarter revenues of $2 billion. The primary reason for the decreased profitability is a  new rule that prevents the bank from reporting junk loans as performing loans.

Moody’s Investors Service has announced a review of 17 banks and securities firms with global capital markets operations. Underpinning this review is Moody’s view that these firms face challenges that are not fully captured in their current ratings. Capital markets firms are confronting evolving challenges, such as more fragile funding conditions, wider credit spreads, increased regulatory burdens and more difficult operating conditions. These difficulties, together with inherent vulnerabilities such as confidence-sensitivity, interconnectedness, and opacity of risk, have diminished the longer term profitability and growth prospects of these firms.

The New York Times ran an earlier story on this development at the large banking conglomerates in late May. In the report, the Times also uncovered a major concern for the large banks: The largest mutual fund players may seek to renegotiate contracts with certain banks or walk away from the relationship entirely in search of more financial stable partners. Without these trading contracts with the mutual fund companies, further stress with beset the overall profitability of the banks.

Nearly four years after the largest financial institutions in the world were bailed out by the American and European taxpayers, the very same banks are hat in hand demanding more assistance. Perhaps most importantly, the sheer magnitude of the bailouts and loans fail to capture the entirety of the destruction supervened upon the people. Budget cuts and ensuing layoffs, unemployment, trillions in lost home value and investment value, higher education and public school cuts, public park closures, unanticipated bankruptcies, infrastructure funding cuts, public health and assistance cuts, just to name a few. This entire adventure illustrates precisely why it is bad policy to allow any industry group to blackmail a government into action. It never ends, and eventually the crook comes banging at the door for more, and more, until policymakers are forced to act responsibly, as they should have from the very beginning. It is at this point that the industry is forced to take its medicine. It is time for the Obama administration to follow through on its first failed attempt to break up one or more of these large banking leeches and sell off the parts to smaller community banks rather than to continue to throw good money after bad. Maybe this time Timmy Geithner and company will do as their told. Or maybe we’ll continue down the same failed path.