Financial Crisis

CEO Bonuses: Who Pays the Price?

Matthew Stevenson — Thu, 28 Mar 2013 01:38:17 -0400

Because so many chief executives of failed or mediocre companies have walked away with millions in bonuses and swag bags, both Switzerland and the European Union recently voted to put a cap on corporate bonuses, limiting them to a small multiple of base salary. What prompted the acceptance of the “Minder Initiative”—named after the independent parliamentarian who sponsored the referendum — is a string of stunning business losses that had no affect on the bonuses paid to the sitting executives.

Swissair went bankrupt in 2001, although not before it could pay out a $10 million bonus to its grounded chairman. The chief executive of the Swiss pharmaceutical giant, Novartis, was recently offered a $78 million sendoff. The Swiss bank, UBS AG, appears regularly in the headlines as the poster-child of bad loans ($40 billion absorbed by the government), LIBOR rate rigging ($1.5 billion in fines), and other dim practices (a so-called rogue trader lost $2.3 billion in London), although the losses are never enough to drain the bonus pool.

The architect that turned the once-staid UBS into an off-track betting parlor, chairman Marcel Ospel, regularly paid himself CHF (Swiss Francs) 24 million in annual salary, something that Swiss voters had in mind, along with the Novartis proposal, when casting their votes with Minder. After the vote, UBS quietly offered an incoming executive a $28 million sign-on bonus — something the law, when enacted, will prohibit.

In the US, corporate activists and some regulators want shareholders to have a “say on pay” of the top CEOs, or for Congress to tax away paycheck windfalls. So far, most reforms have been non-binding.

Members of the business community, nevertheless, resent the intrusion of state or federal bureaucracies into their corner offices. In their minds, salaries are best left to compensation committees and captive boards of directors, which are free to rain money on a handful of senior executives, some of whom are chairmen of the same boards that dole out their pay.

According to the latest estimate, Fortune 500 CEOs have to scrape by with compensation that averages $12 million a year and that is 380 times the pay of the average worker. In 1965, this ratio stood at 24 times and in 1990 it was 71 times.

Meanwhile, real American wages have been declining since 1974, and per capita average income in the country is about $27,000, just above the poverty line of $21,000. The median income for American households is about $50,000 a year. The reason most American corporations reward senior management and stiff the rest of the work force is because many public companies are little different from banana republics.

In theory, the shareholders elect the board, and the board watches their interests, a mandate that includes signing off on the top salaries. In practice, shareholders, even big ones, have little say in who is put on the board, especially if the CEO is also chairman. In those cases, board members serve at the whim of the same CEO. Often such an approval rating depends on voting the prince a big salary, along with big bonuses and stock options.

Under the new Swiss law and other corporate reform proposals, shareholders are given the right to approve the top pay packages in a company. This sounds democratic enough, except that most corporate proxy votes turn out results that would be familiar to commissars in the Soviet Union.

One reason is that many mutual and pension funds, which own the large positions in many public companies, are required by charter to vote with management or, if they disagree, to sell the positions. It's unusual for a large institutional shareholder to both hold on to a position and vote against management. So letting shareholders approve top compensation will not keep managers from pocketing $50 million pay envelopes.

The usual justification for multimillion-dollar rewards is that the company has performed well “in the market” or “exceeded the budget forecasts.” Of course, meeting such a benchmark explains a bonus of $250,000, not necessarily one of $20 million. Yes, the CEO has responsibilities and “duties of care,” but if the board were to auction off the position of CEO in most companies, it's likely that they would find many qualified takers for $1 million a year.

The truism about salaries—“You don’t get what you deserve; you get what you negotiate”—does not apply to the C-suite, which gets what the board is dumb enough to give away almost blindly. They go along with the lavish payouts based on similar compensation paid by competitors.

Because of this mutual-remuneration self-congratulatory circle, salaries have skyrocketed, even if stock prices have remained flat or plummeted. General Electric’s CEO has earned $54 million in the past five years, while the company’s stock went from $37 to $7 and back up to $23 a share. As the Death of Salesman line goes, “No man only needs a little salary.”

Ex-Treasury Secretary Robert Rubin pulled down $126 million from 1999 to 2009 as a top Citigroup senior executive, but when it went bust said that he had no responsibility for the bank’s creditworthiness. He confessed, “My great regret is that I and so many of us who have been involved in this industry for so long did not recognize the serious possibility of the extreme circumstances that the financial system faces today.” But he didn’t give back any of the money. Rubin’s boss, Charles Prince, left the chairmanship of Citi with about $80 million in his pockets, even though the company went to the wall the moment he was out the door.

The goal should not be just to limit CEO pay, but to increase average wages and salaries, and think of increasing the dividend, especially in companies eager to throw millions at the boss. Stock options and profit sharing could be allocated equally to all employees, and not simply reserved as corner-suite perks.

Likewise, cumulative voting of board directors allows smaller blocks of shareholders to elect a representative (you put all of your votes on one candidate).

Many top CEOs live in a bubble of private jets and pillowed suites, and are accountable to only a handful of cronies—certainly not the vote of the employees or the shareholders. They thrive in the cozy confines of oligopoly — think of a golf club lounge — in which a corporation’s success is due only to the top managers, not to the shareholders’ capital or to the workers.

Why not have a companywide plebiscite on the chief executive every two years? The Greeks knew that war was too important to be left to the generals, and had their soldiers elect them.

Employees, pensioners and shareholders all ought to have seats at the table. The Chinese garment workers in sweat shops who stitch together all those sailor suits that are sold at vast markups might be less inclined to pay Ralph Lauren $66 million a year than the board in New York would.

Minder’s law and its clones in the EU or, were legislation to come about, in the US, won't solve the problem on their own. Rather than passing legislation that sounds good in the headlines (The Economist: “Fixing the Fat Cats”) but achieves little reform at the office, the most significant recovery for the ransoms paid to many senior executives would be to overhaul how boards of directors are established and operated — to make them legally accountable for the company’s performance and representative of all stakeholders, including the work force. Keep in mind that when salesman Willy Loman asked for a golden parachute, he only needed fifty dollars "to set his table.”

Flickr photo by World Affairs Council of Philadelphia: Former Citigroup Director and executive Robert Rubin. Is that the size of his bonus?

Matthew Stevenson, a contributing editor of Harper’s Magazine, is the author of Remembering the Twentieth Century Limited, a collection of historical travel essays. His next book is Whistle-Stopping America.

The Age of Bernanke

Joel Kotkin — Mon, 04 Mar 2013 00:38:12 -0500

To many presidential idolaters, this era will be known as the Age of Obama. But, in reality, we live in what may best be called the Age of Bernanke. Essentially, Obamaism increasingly serves as a front for the big-money interests who benefit from the Federal Reserve's largesse and interest rate policies; progressive rhetoric serves as the beard for royalist results.

Overall, the impacts of ultralow interest rate, cash-machine policies of Fed Chairman Ben Bernanke trump everything else. The presidential stimulus was, at best, modestly effectively, and certainly did little to turn around the fortunes of most Americans or spark much economic growth. Unemployment remains stuck at around 8 percent and 8.5 million workers have exited the labor force.

But the Bernanke policies have succeeded in reshaping the economic landscape in ways that, while good for the plutocracy and Wall Street, are not particularly positive for the vast majority of Americans.

Economic Losers

Many of the biggest losers in the Bernanke era are key Democratic constituencies, such as minorities and the young, who have seen their opportunities dim under the Bernanke regime. The cruelest cuts have been to the poor, whose numbers have surged by more than 2.6 million under a president who has promised relentlessly to reduce poverty.

Things, of course, have not too great for the middle-age and middle-class – more of them now supporting both aging parents and underemployed children. Median income in America is down 8 percent from 2007, and dropping. Things, in reality, are not getting better for anyone but the most affluent.

A particular loser has been small business. As we enter the sixth year since the onset of the Great Recession, and nearly four years after the "recovery" officially began, small business remains in a largely defensive mode. Critically, start-up rates are well below those than following previous downturns in 1976 and 1983. The number of startup jobs per 1000 – a key source of job growth in the past – over the past four years is down a full 30 percent from the Bush and Clinton eras. New firms – those five years or younger – now account for less than 8 percent of all companies, down from 12 percent to 13 percent in the early 1980s, another period following a deep recession.

With demand and growth still weak, small business enters the new year with among the lowest expectations of any large economic sector. As Gallup points out, one in five small companies expects to lower its employee count, one in three expect to decrease capital spending and almost as many expect to be in more severe cash-flow troubles by the end of the year.

This decline of small-business sentiment constitutes arguably the biggest reason for our poor job-creation numbers. If small business had come out of the recession maintaining just the rate of start-ups generated in 2007, notes McKinsey, the U.S. economy would today have almost 2.5 million more jobs than it does.

Smaller Banks

One source for this decline lies in the difficulties faced by smaller community banks, which tend to be those most likely to lend to entrepreneurial firms. Jeff Ball, chairman-elect of the California Bankers Association and founder of Whittier-based Friendly Hills Bank, suggests the Fed's policies – as well as growing regulatory policies – has led to an unprecedented concentration of financial assets in the hands of a few large "too big to fail banks" while the number of smaller community banks has been shrinking.

"Everywhere you turn there's a 'gotcha' from the regulators," Ball notes. "The big banks can deal with the regulations far more easily than the community banks. And because some banks are perceived as 'too big to fail,' there's easier access to credit, and they are perceived to be better to invest in."

So, who have been the big winners in the Age of Bernanke? The very people who were supposed to be the bête noires of the age of Obama: the large financial institutions. In 2013, the top four banks controlled more than 40 percent of the credit markets in the top 10 states, up by 10 percent from 2009 and roughly twice their share in 2000. At the same time, since the passage of the Dodd-Frank financial regulations, there are some 330 fewer small banks. Under the current regime, the oligopolization of the credit markets will continue apace, as much, or even more, than if Mitt Romney had won the presidency.

Higher Profits

Under these circumstances, it's not surprising that large financial institutions and hedge fund have enjoyed close-to-record profits under Obama. This fall, for example, Wells Fargo and JP Morgan announced record profit. And despite widespread condemnation their executives have continued to enjoy outsized compensation, often greater than under George W. President Bush.

Unlike smaller firms, or the middle class, the big financial institutions have feasted like pigs at the trough, with the six largest banks borrowing almost a half-trillion dollars from Uncle Ben Bernanke's printing press. While millions of Americans have lost homes and much of their net worth, there has been not a single high-level prosecution by the Obama administration of the grandees of the very financial giants at the heart of the mass misery.

Even the nascent housing recovery – which could create wealth for the middle class – appears largely to be creating opportunities for wealthy investors. In California, as well as other hard-hit real estate markets, such as in Florida, Arizona and Nevada, private investors constitute a large portion of buyers. The big private-equity firm Blackstone recently announced plans to buy $100 million in homes every week.

These wildly divergent results between the hoi polloi and the financial elites do not seem to bother our "organizer in chief," particularly with re-election behind him. Instead, the Bernanke regime seems to be cementing a strong alliance of convenience between the government sector – which needs low interest rates to keep funding itself – and those with the easiest access to cheap money.

Some observers, such as former Clinton Administration advisor Bill Galston, suggest we could see the emergence of a closer political alliance between big business and the public sector interests. Democrats, he suggests, have a natural alliance with larger firms, not only in the financial industry, while small-business lobbies remain "a building-block of the Republican base."

New Corporatism

This new corporatism that is becoming an integral part of the supposedly middle-class oriented Democratic Party. Close Obama advisers, like disgraced investment banker and political fixer Steven Rattner, Obama's czar for the auto bailout, justify collusional capitalism, both in China and in America's "too big to fail" regime.

The reality remains that, rhetoric aside, corporate cronyism remains at the core of this administration and, sadly, the once-proudly populist Democratic Party. After his confirmation, we can expect former Citigroup profiteer Jacob Lew to follow Treasury Secretary Timothy Geithner, working along with Bernanke, to make sure the big Wall Street firms continue to thrive – even if the rest of us don't.

All this is reminiscent of something out of the declining days of the Roman Empire. The masses get bread (food stamps) and circuses, with virtually all of Hollywood and much of the media ready to perform on cue. The majority, losers in the Bernanke economy, lack the will and, maybe, the attention span to realize what is happening to them.

"The Roman people are dying and laughing," the fifth-century Christian writer Salvian wrote. Like America today, entertainment-mad Rome suffered from a declining middle class, mass poverty and domination by a few wealthy patricians, propped up by a compliant government. Unless Americans of both left and right wake up to reality, our civilization could suffer a similar inexorable decline in the Age or Bernanke.

Joel Kotkin is executive editor of NewGeography.com and a distinguished presidential fellow in urban futures at Chapman University, and a member of the editorial board of the Orange County Register. He is author of The City: A Global History and The Next Hundred Million: America in 2050. His most recent study, The Rise of Postfamilialism, has been widely discussed and distributed internationally. He lives in Los Angeles, CA.

This piece originally appeared in the Orange County Register.

The Swaps of Damocles

Susanne Trimbath — Tue, 23 Oct 2012 01:38:08 -0400

"Privileged people don't march and protest; their world is safe and clean and governed by laws designed to keep them happy...." Michael Brock in John Grisham's The Street Lawyer (Doubleday, 1998).

"There can be nothing happy for the person over whom some fear always looms…” Cicero, Tusculan Disputations 5.62, via Wikipedia.com

If you were fearful after Wall Street decimated your life-savings in September 2008 then you should know that the sword of Damocles remains above your head.

Absolutely nothing of any significance has changed. Not rules, laws or regulations. Not government oversight or external auditing. Nothing. What happened to our financial well-being in the Fall of 2008 can happen again tomorrow. If anything is being done, it is being expertly designed to make things worse for Main Street and better for Wall Street. When the tech bubble burst in March 2000, the Federal Reserve dropped dollar bills from helicopters and inflated the housing market. At least that time around, it was obvious where the next bubble would come. In an effort to hide the inflation this time around, the Fed is pumping money into dark corners of finance where it will eventually impact everything everywhere.

First, a quick recap: During 2007, mortgage-backed bonds began failing faster than actual mortgages. Wall Street wrote bonds faster than Main Street needed mortgages – two bankruptcy judges estimated that one-third of the bonds didn’t have mortgages backing them.

Meanwhile, insurance companies like AIG were writing credit default swaps even faster – some say there were as many as 15 swaps for every bond (by value). In 2008, AIG was unable to pay off on the credit default swaps (like insurance contracts) they wrote for the Wall Street bankers. The bankers had named themselves beneficiaries and they began cashing in – again – when the whole thing went up in flames.

Then-Secretary of the Treasury Hank Paulson went to Congress and said the world would end if taxpayers did not give him $750 billion to bailout the banks. Congress said, “Sure, why not, you seem like a nice guy” and the Wall Street Bailout was signed into law by George W. Bush on October 1, 2008. In the months that followed, we learned that the Federal Reserve topped off the Wall Street tanks with trillions more dollars – a lot of which went to foreigners and private companies not under their regulatory purview. Since then, Federal Reserve Chairman Ben Bernanke has been dropping dollar bills out of helicopters by buying more and more mortgage un-backed bonds from Wall Street because – well, no one is quite sure why he is doing this.

Eventually, Senator Chris Dodd (D-CT) and Representative Barney Frank (D-MA) got their names attached to a new public law, which President Obama signed on July 21, 2010 – about two years after the bailout – that was supposed to reform Wall Street and protect Consumers. Five months after the signing, Sen. Dodd announced his retirement (not long after it was made public that he and several Senators received very friendly terms on a mortgage from sub-prime mortgage bond King Angelo Mozilo of Countrywide). Rep. Frank will not seek reelection in November 2012. Neither Dodd nor Frank planned to be around when the bill is actually effective. You see, a lot of Dodd-Frank was only to require that someone else do studies, write reports and propose rules. Less than half of the rules were required to be written before Rep. Frank leaves office – Dodd left office before any action was required under the public law with his name on it.

Both Dodd and Frank are retiring with full pensions, but the same cannot be said about the public law with their names on it. As of September 21, 2012, about as many Dodd-Frank rules have been proposed as there are mortgages backing those mortgage-bonds the Fed is buying. According to a review by New York law firm Davis Polk (as of September 4, 2012):

Of the 398 total Dodd-Frank rulemaking requirements:

131 (32.9%) have final rules
135 (33.9%) have proposed rules
132 (33.2%) have not yet been proposed

Of the 247 rulemaking deadlines that have passed:

145 (61.2%) have been missed
31 (13%) have not even had proposals
Source: http://regreformtracker.aba.com

So far as I was concerned, the only actual success of Dodd-Frank came from an amendment which required the Federal Reserve to disclose exactly to whom they gave the bailout money – information on 21,000 transactions valued at $16 trillion that Fox News, Bloomberg and Rolling Stone Magazine sued to get after the Chairman and Vice Chairman of the Fed refused to reply to questions from Congress. Turns out the Fed officials went from sins of omission to sins of commission – Bloomberg reported in December that they hid billions of dollars in loans from the mandated reports. Despite now knowing that the Federal Reserve is giving money to unregulated companies with no means of retrieving it, the U.S. public – outside of a faithful few Occupy Wall Street protestors still out there – have failed to notice or react. Hence, nothing has changed that would prevent a repeat of the events that precipitated the 2008 bailouts from occurring again tomorrow.

“But wait! That’s not all!” as they say in late-night TV infomercials. More than ignoring the law, more than delaying the reforms, Wall Street is now actively working to get new laws written to exempt themselves from Dodd-Frank – which, we thought, was specifically written to reform their activities. On September 19, H.R. 2827 was passed by Congress to exempt from any Dodd–Frank rulemaking the very activity that is bankrupting some US cities and states and counties.

The law they are now exempted from is the one that would require them to accept legal responsibility for putting the best interests of the municipalities and taxpayers first – a blanket requirement for fiduciary duty that already exists but is consistently ignored by the “survivors of Wall Street survivors of the financial crisis” as they are called by William D. Cohan, author of the New York Times bestseller House of Cards: A Tale of Hubris and Wretched Excess on Wall Street. Cohan emphasizes that bribing clients like Jefferson County is not new – although it seems evident that the problem may be more wide spread now than ever before in US history. Jefferson County (AL) may be the best known – bankruptcy followed on the heels of bribes and billions of dollars worth of toxic swap deals. The Wall Street banks not only bribe officials to commit municipal taxpayers to financial obligations they can never repay, they also pay competing banks so they can charge higher fees and interest rates. This breaches the simple trust you are entitled to expect even from used car salesmen (in states with “Lemon Laws”) – but no such protection is afforded anyone who has to deal with Wall Street.

In the end, we are all required to deal with Wall Street. This is a danger more real, and more imminent, than anything the world may ever have faced. It is as if we have been told that an asteroid the size of Texas is barreling toward Earth and Ben Bernanke hit the button that launched the nuke --- that missed. It’s still coming. Wall Street remains unreformed and consumers of financial services remain unprotected.

Susanne Trimbath, Ph.D. is CEO and Chief Economist of STP Advisory Services. Dr. Trimbath’s credits include appearances on national television and radio programs and the Emmy® Award nominated Bloomberg report Phantom Shares. She appears in four documentaries on the financial crisis, including Stock Shock: the Rise of Sirius XM and Collapse of Wall Street Ethics and the newly released Wall Street Conspiracy. Dr. Trimbath was formerly Senior Research Economist at the Milken Institute. She served as Senior Advisor on United States Agency for International Development capital markets projects in Russia, Romania and Ukraine. Dr. Trimbath teaches graduate and undergraduate finance and economics.

How California Lost its Mojo

Bill Watkins — Tue, 09 Oct 2012 01:38:23 -0400

The preferred story for California's economy runs like this:

In the beginning there was prosperity. It started with gold. Then, agriculture thrived in California's climate. Movies and entertainment came along in the early 20th Century. In the 1930s there was migration from the Dust Bowl. California became an industrial powerhouse in World War II. Defense, aerospace, the world's best higher education system, theme parks, entertainment, and tech combined to drive California's post-war expansion.

Then, in the evening of November 9th, 1989, the Berlin Wall came down. On December 25, 1991, the Soviet Union was dissolved. The Cold War was over. America responded by cutting defense spending and called the savings the Peace Dividend.

California paid that peace dividend. A huge portion of California's military industrial complex was destroyed. The aerospace industry was downsized, never to come back. Hundreds of thousands of well-paying manufacturing and engineering jobs were lost.

The ever-resilient California bounced back though. Tech, driven by an entrepreneurial culture and fed by California's great universities drove California's economy to new heights.

Then, there was the dot.com bust. A mild national recession was much more painful for a California dependent on its tech sector. Eventually California recovered. California's tech sector and climate, aided by a housing boom, restored California's prosperity.

The housing boom was followed by a housing bust. Again, California paid a high price, and unemployment skyrocketed to 30 percent above the national average.

Today, California is recovering. Its tech sector is once again bringing prosperity to the state. Furthermore, California's green legislation is providing the motivation for a brave new future of economic growth and environmental virtue.

The story is true through the Peace Dividend. California did pay a high price for the collapse of the Soviet Union. California's defense sector did begin a decline, and it never recovered. But, defense recovered in other places, as the country expanded defense spending by 21 percent in the 2000s. The United States has constantly been engaged in wars and conflicts for over a decade. On a real-per-person basis, the United States is spending as much on defense as it has at any time since 1960.

But when it comes to the present, the narrative falls down. Defense has rebounded, but not in California. California's defense sector is small and declining, not because of a permanently smaller U.S. defense sector, but because of something about California.

California's tech sector did boom after the collapse of California's defense sector, but that doesn't mean that California recovered. In fact, much of California never recovered. It's the aggregation problem.

The 1990s' recovery was largely a Bay Area recovery. Los Angeles hardly saw any uptick in employment. Here is a chart comparing Los Angeles County's jobs growth rate with the San Jose Metropolitan Statistical Area (MSA):

San Jose probably had California's fastest growing job market in the 1990s. Los Angeles was not the states slowest. Still, the differences are striking.

A few years ago, a couple of my graduate students looked at California data from 1990 through 1999. They divided California into two regions, the Bay Area and everywhere else. The Bay Area was defined as Sonoma, Marin, Napa, Solano, Contra Costa, Alameda, Santa Clara, Santa Cruz, San Mateo, and San Francisco counties. Using seven indicators of economic growth, they performed relatively simple statistical tests to see if the two geographies experienced similar economies. The indicators were employment, wages, home prices, bank deposits, population growth, construction permits, and household income.

By every measure except population growth, the Bay Area outperformed the rest of the state. The exception was probably due to commuters to the Bay Area, given that region’s exceptionally high housing prices.

Some economists will tell you that California saw faster-than-national job growth from the mid 1990s until the great recession. This is another aggregation problem. The claim is technically true, but only in the sense that California had a higher proportion of the nation's jobs in 2007 than it did in 1995. If you look at annual data, you will see that California's share of the nation's jobs only grew from 1995 through 2002. Since then, California's share of United States jobs resumed its decline:

In reality, California never recovered from the dot.com bust. California, perhaps the best place on the planet to live, couldn't keep up in a housing boom. Something was wrong.

California had lost its mojo.

Opportunity is now greater outside California than inside California. For almost 150 years, California was as widely known for its opportunity as it was for its sunshine. The combination was like a drug. George Stoneman, an army officer destined to become California's 15th governor, spoke for millions when he said "I will embrace the first opportunity to get to California and it is altogether probable that when once there I shall never again leave it."

They did come to California, and they made an amazing place. Opportunity-driven migrants are different than other people. They take big risks to leave everything they know for an uncertain future in a new place. They are confident, bold, and brash. California became just as confident, bold, and brash. The Anglo-American novelist Taylor Caldwell spoke the truth when she said "If they can't do it in California, it can't be done anywhere."

That was then. Today, California can't even rebuild an old Hotel.

The Miramar Hotel is a partially-demolished eyesore beside the 101 Freeway in Montecito, just south of Santa Barbara. The Hotel's initial structure was built in 1889. Over the years, it was expanded to a 29 structure luxury hotel and resort. In September 2000 it was closed for renovations which were expected to take 18 months. That was when the fighting started. Community groups, neighbors, and governments all had their own idea of what the Miramar should be. Two owners later, and after millions of dollars, the future to the Miramar is still uncertain.

The Miramar Hotel is a case study of what is wrong with post-industrial California, precisely because it should have been easy, and because it is not unique. Everything is hard to do in California. The state that once moved rivers of water hundreds of miles across deserts and over or through mountain ranges can't rebuild a hotel.

The situation will get worse. California has become the place people are leaving. The following chart shows that for 20 years more people have left California for other states than came to California from other states:

California's population is still increasing because of births and international immigration.

Two decades of negative domestic migration has taken its toll. Millions of risk-taking, confident, bold, and brash people have left California. They took California's mojo with them.

That seems pretty clear when you look at some statistics: California's unemployment is way above the national average. With only about 12 percent of the nation's population, California has over 30 percent of the nation's welfare recipients. San Bernardino has the nation's second highest poverty rate among cities over 200,000.

Sometimes though, aggregated data can hide California's weakness, and some, representing the always-present constituency for the status quo, use these data to deny that California's future is any less golden.

Most recently, those representing the constituency for the status quo have used California's aggregated jobs data to argue that all is well in California. They argue that California's tech sector is leading California to a new golden future.

Year-over-year data confirm that, through August 2012, California gained jobs at a faster pace than the United States. Once again, though, that growth is largely confined to one industry and one geography. California's tech sector is recovering, and amidst a generally weak recovery, it appears strong enough to generate pretty impressive aggregated results. If we disaggregate California's data, we will find that there is not just one California. There is a rich and mostly coastal California, with a few smaller inland counties on the San Francisco-Lake Tahoe corridor. Another California is very poor and mostly inland.

Here's a list of California's poorest counties by poverty rate:

County	Poverty Rate	Child Poverty Rate	Rank
Del Norte	23.5	30.6	3
Fresno	26.8	38.2	1
Imperial	22.3	31.8	6
Kern	21.4	30.3	10
Kings	22.5	29.7	5
Madera	21.7	31.7	8
Merced	23.1	31.4	4
Modoc	21.9	32.5	7
Siskiyou	21.5	30.7	9
Tulare	33.6	33.6	2

Here's a list of California richest counties by poverty rate:

County	Poverty Rate	Child Poverty Rate	Rank
Calaveras	11.1	18.3	10
Contra Costa	9.3	12.7	4
El Dorado	9.4	11.6	5
Marin	9.2	10.9	3
Mono	10.8	15	8
Napa	10.7	14.7	7
Placer	9.1	10.7	2
San Mateo	7	8.5	1
Santa Clara	10.6	13.3	6
Ventura	11	15.3	9

There are some big differences here. The percentage of Fresno's children living in poverty is four and half times the percentage of San Mateo children living in poverty. In fact, the data for California's poorest counties looks like third-world data.

When disaggregated, the job-growth data shows the same story. Through 2012's second quarter, jobs in the San Jose MSA were up 3.6 percent on a year-over-year basis. In Los Angeles, jobs were up only 1.1 percent, while in Sacramento they were up only 0.6 percent. For comparison, U.S. jobs were up about 1.3 percent for the same time period.

You can perform this analysis for all types of data. When the data are disaggregated, the story is always the same. It's telling us that California needs to get its mojo back, and the current tech boom is likely not to be enough for its recovery.

Bill Watkins is a professor at California Lutheran University and runs the Center for Economic Research and Forecasting, which can be found at clucerf.org.

Unemployment photo by BigStockPhoto.com.

Libor: Is The City of London Fixed?

Matthew Stevenson — Tue, 31 Jul 2012 01:38:39 -0400

Having worked inside banking, do I think that banks colluded to post an artificial London interbank offered rate, otherwise known as Libor? For those not in the brotherhood, that acronym is a compendium of average borrowing prices from sixteen large banks, pronounced either as lee-boar or lie-bore. Before turning to conspiracy theories, let’s review the facts of a scandal that began more than four years ago, and are so murky that I, for one — despite twenty-five years in international banking — have a hard time grasping.

In 2008, around the time of the September panic, Barclays and perhaps other large banks began obfuscating the true costs of their interbank borrowing, and submitted rates to the “fix” (in all senses of the word) that were less than their actual cost of funds. Why?

Few creditors wanted to take a chance on leaving their deposits in large European or American banks, especially since so many, such as Lehman, Merrill Lynch, Countrywide, and the UK's Northern Rock were shuttering their branch windows.

Only by paying over the market rates could banks like Barclays fund their bloated balance sheets of subprime assets. (Big banks in 2008 were more like pyramid schemes.) If the market got wind of their true borrowing costs, it would have eroded what little confidence was left in the banking system. Barclays and the British government concocted (shall we say colluded?) to post rates to the Libor “fix” that did not reflect the bank’s actual cost of borrowing funds.

As in Olympic scoring, when setting the Libor the highs and lows are thrown out, leaving the financial world with an approximation of what big banks pay to borrow from each other. When big banks actually trade with each other, however, they have to pay what they agree to with their creditors, not the Libor rates printed in the Wall Street Journal.

In 2008, Barclays was paying over Libor. The British government was helping it to cover its wobbly funding tracks in the interest of showing the financial world that London banks were solid and creditworthy.

Before this shell game, there was the another leg of the current scandal. From about 2005 onward, Barclays and others had been posting artificially high interbank borrowing costs, so that borrowers across the world would be paying higher benchmark rates on their loans and derivative contracts, valued in the trillions of dollars.

The reasons are easy to calculate. Imagine that the world’s big banks can borrow from each other at 2%, but that they secretly agree to establish a Libor benchmark rate of 2.5%. The fifty basis points are pure profit to anyone funding loans at 2%, and then charging a margin on top of 2.5%.

If true, Libor’s three-card Monte could have drained a reported $22 billion from unwitting borrowers. Nevertheless, while cabalistic traders were feathering their plush-carpeted nests, global regulators were also willing accomplices to the large banks in these rigged markets.

After the crash, institutions like the Bank of England and the Federal Reserve Bank were desperate to recapitalize the banking system. The presumed results would be to improve the profitability of the banks, and make them less dependent on state funding.

In fixing Libor, both high and low, Barclays probably thought it was doing the king’s bidding. No wonder its $39-million-a-year Chairman Bob Diamond expected a knighthood rather than a pillory.

If much of this finagling happened between 2005 and 2008, why are bankers now heading to jail for aiding and abetting their senior managements or the regulators? Why now the moral outrage, Senate hearings, presidential soundbites, indictments, hair shirts, resignations, and headlines that the banks have yet again stolen our money?

Although in theory banks are credit institutions, at least according to their charters, in reality they are political interest groups that occasionally grant loans.

Among the oldest arguments in American politics are those that center on whether the US should have national or just state banks, and whether the circulating currency should be tethered to some commodity (gold, silver, toasters) or allowed to float unhinged on world money markets, as they now do (Nixon ended the dollar’s convertibility in 1971).

Another divisive political argument has been whether banking and money should be beholden to big city interests (for example, robber baron J.P. Morgan) or to agricultural concerns (Andrew Jackson had them in mind). Morgan got rich on deflation when money was tied to gold; the farmers won with inflation because they could repay their loans with cheaper dollars.

In Europe, the similar divide is between the propertied and working classes. In the Libor scandal, Barclays is synonymous with the remittance men in the House of Lords, living off coupons.

Now on both continents, the political question is whether the financial system should be geared toward stimulus (cheaper money) or austerity (debt reduction; gold standards). In the US. election, Romney speaks for the hard money men while the Obama administration, like French President François Hollande, believes in fiat money with the revolutionary passions of Marat and Robespierre.

Because both political blocs have their constituents and henchmen, Libor bankers are walking the plank for constricting the money supply, and spendthrift politicians are being turned out of office, charged with debasing the paper currency.

Although the fine print of the outrage is obscure, Libor is at the subconscious center of the 2012 election and the future of Europe. No wonder headline writers and prosecutors are rounding up the usual banking suspects.

The soundbite storyboards are perfect for a prime-time, election-season docudrama, starring greedy bankers, virtuous senators, victimized home owners who were bilked out of billions in a scam hatched in City of London pubs and carried out in corner offices.

On the campaign trail the President could be heard to imply that plutocratic, Republican supporters of Mitt Romney are hand-in-black-glove with the rate fixers. The message is clear. The reason the world’s economies are in recession is not incompetent economic policies, but collusion between Wall Street and its UK counterpart, the City of London.

In other words, the banking system has fulfilled its historic political mandate: to give every presidential election “a good, safe menace,” so that nervous voters can cast their ballots to keep the moneychangers away from the temples of democracy, even though they need a billion in soft money to light the altar candles.

Flickr Photo by Garry Knight – The Dragon from the City of London's coat of arms, cast as a statue.

Matthew Stevenson, a contributing editor of Harper's Magazine, is the author of Remembering the Twentieth Century Limited, a collection of historical travel essays. His next book is Whistle-Stopping America.

Enjoying the Kool-Aid in Omaha

Susanne Trimbath — Tue, 10 Apr 2012 01:38:59 -0400

I left Santa Monica for Omaha less than 3 months before the collapse of the global financial infrastructure in September 2008. The impending problems in housing and credit markets – obvious from early 2007 and exacerbated by the pile-on effect of derivatives gone wild – were increasingly in the bank of my mind. I made the decision to leave the dense urban population center of southern California and head to a place where —as recently described in an episode of The Walking Dead – there is a small population and lots of guns. I figured if the world was going to fall apart (something short of being over-run by zombies but worse than a minor recession) I’d rather not be sitting with my back to the ocean and no boat.

Omaha has turned out to be blessed. The farm economy is strong. It is home to 5 of the Fortune 500: ConAgra, Berkshire Hathaway, Union Pacific, Peter Kiewit Sons’ and Mutual of Omaha Insurance all call Omaha home. Best of all, Omaha is home to Warren Buffett – the Oracle of Omaha and financial genius of Wall Street, one of the world’s richest men, head of legendary Berkshire Hathaway and, best of all for me, patron of the arts, humanities, community and politics in Nebraska.

We all hail Uncle Warren’s beneficence but we may not want to look too closely at where the money comes from – like the 15 percent return he’s earning on the $5 billion investment he made in Goldman Sachs the week before they got a $10 billion bailout; or the fact that Berkshire Hathaway was the largest shareholder in American Express Co. when they received $3.4 billion from Uncle Sam. Nebraska may be a red state but Buffett has chosen Democrats, like retiring Senator Ben Nelson, to service his economic agenda. According to data from the Federal Election Commission, Uncle Buffett’s political contributions go almost exclusively to Democrats. I could write a whole story just on what Ben Nelson has done for Nebraska, but to conserve space, let me just say “Cornhusker Kickback” – you get the picture. We have more roads, bridges, and military contractors than can likely be required in a state with a population of 2 million – about the same as the population of Manhattan. This in a place where rush hour means there is a car in front of you and you can see more than 12 cars on either side of the road – compare that to Los Angeles (see photos above). The one electoral vote from Nebraska that went to Obama in 2008 is the one that includes Uncle Buffett’s house.

Author Peter Schweizer (Reason March 2012) describes Buffett using a “bootleggers and Baptists” comparison that’s too close to Immanuel Kant’s “Private vice, public virtue” dichotomy to be accurate. I think Uncle Buffett is much more open about his vices. He does his good works in public but clearly publically influences his politicians. Buffett made that $5 billion investment in Goldman Sachs on September 23, 2008 – a week before Senator Nelson voted “aye” on the bailout that greatly enhanced Goldman’s value and protected it from the massive losses which would have resulted from the need to raise capital by liquidating assets at collapsing market prices. The Wall Street Bailout not only gave Goldman Sachs an infusion of capital but it also covered the credit default swap payments that Goldman Sachs demanded from American International Group (AIG) as it was going into bankruptcy. Goldman’s share of the AIG bailout was $2.5 billion in credit default swap payments, plus $5.6 billion in payments from the Federal Reserve Bank of New York and another $4.8 billion as “vig” for lending securities to AIG. That’s enough to cover the dividend payments to Buffett for 14 years with enough left over to pay back the principle. Ten percent rate of return with zero risk – not the risk/reward tradeoff I learned about in college.

Most Omaha residents know Buffett’s political savvy and appreciate his understated style. Ben Nelson does. He bragged at a Chamber of Commerce meeting that he took advice from Warren before he voted for the Wall Street Bailout. He completely ignored the irony: a Senator asks a banker for advice on a bank bailout, the banker encourages the senator to payout $750 billion of taxpayer money to banks. This is something much less benign than drinkin’ likker on Saturday night and singin’ in the choir on Sunday morning.

Ben Nelson is among the members of congress who invested in shares of Berkshire Hathaway before passing the Bailout that Benefited Buffett – a move that would probably have gotten them fired from Berkshire Hathaway. The very fact that Buffett was reported as saying something so banal as “I’d never be so brave as to try to influence congress” is all you need to hear to know that he’s not telling the truth. According the Congressional testimony of former- Special Inspector General for the Troubled Asset Relief Program (SigTARP) Neil Barofsky, and a report from the Government Accountability Office, the TARP bailout program was rigged. Firms with “political connections,” were more likely to get TARP funds. This was reported to Congress at hearings and reported here in 2009:

“Treasury, the New York Federal Reserve and even Presidential Economic Advisor Larry Summers may be passing information to their friends that can be used for financial gain, giving positions in bailout programs to business associates, and engaging in ‘too cordial relationships’ with bailout recipients.”

We may object to Warren Buffet’s manipulations on moral ground but residents of Omaha and Nebraska get to enjoy his largess. The procession of bailouts is anathema to many here. Uncle Buffett may live halfway from Wall Street but he is an insider in the classic sense. His huge bets on municipal bonds mean he needs to work to keep cities and counties from bankruptcy. In March 2008, just months after credit markets began to seize up, Buffett told CNBC he had “written 206 transactions in the last three weeks” which were default swaps on municipal bonds – the financing used by cities, counties and states to fund everything from building schools to running services. Since that means Buffett will have to payout if the municipalities experience “credit events” (like missing bond payments), he has the incentive to push for another bailout. The virtue? The bailout will also benefit the millions of people who live and work in places like Detroit, Illinois, and Jefferson County, Alabama. The vice? He controls enough bank stock to have managed a refinance for those municipalities without siphoning off significant premiums for profit. Buffett is willing to pay to get a government that caters to profligate cities and offers bailouts to companies in his industry, too. Buffett hosts a fundraiser for Obama’s political campaign and Obama names a tax-reform after Buffett – one hand washes the other, all done in the bright sunshine of Sunday morning.

There is no denying that Buffett is smart with his money. In the same way, it would be foolish to suggest that he does this for some personal gratification instead of for profit. His long-hailed strategy of “value investing” has now gone by the wayside in favor of a strategy that can only be described as “grab the profit while you can but don’t stray too far from the government teat.” When the music stops Uncle Buffett will get bailed out, again, by his good friend Uncle Sam.

So I’m not disagreeing with the point being made by Shweitzer and others that “America’s favorite billionaire plays politics to make money.” I’m not even disagreeing that this is bad for America. In fact, I side with Nebraska’s Republican Governor Dave Heineman when it comes to the doings of Buffett and Nelson: If it’s bad for America in the short run, it can’t be good for Nebraska long term. I don’t agree with what Buffett and Nelson have been doing for Nebraska but I am enjoying the benefits. And maybe that’s your answer – move into their neighborhoods, enjoy the protection, but whatever you do – don’t drink the Kool-Aid.*

*Wikipedia cites a reporter from the Washington Post who wrote about seeing “’packets of unopened Flavor Aid’ scattered in the dust in Guyana….”, not actual Kool-Aid. (Source: Krause, Charles A. (Dec. 17, 1978). "Jonestown Is an Eerie Ghost Town Now.") As an aside, Kool-Aid was invented in the 1920s by a Nebraska mail-order entrepreneur.

Lead Photo: 7:15pm May 21, 2011, Santa Monica Freeway, Eastbound © STP Advisory Services, LLC

Commanding Bureaucracies & 'The New Normal'

Bill Watkins — Tue, 03 Apr 2012 01:38:17 -0400

Prior to the fifteenth century, China led the world in technological sophistication. Then, it went into a period of long decline. Here’s what Gregory Clark had to say about it in Farewell to Alms:

... When Marco Polo visited China in the 1290s he found that the Chinese were far ahead of the Europeans in technical prowess. Their oceangoing junks, for example, were larger and stronger than European ships. In them the Chinese sailed as far as Africa.

The Portuguese, after a century of struggle, reached Calicut, India, in the person of Vasco da Gama in 1498 with four ships of 70-300 tons and perhaps 170 men. There they found they had been preceded years before by Zheng He, whose fleet may have had as many as three hundred ships and 28,000 men. Yet by the time the Portuguese reached China in 1514, the Chinese had lost the ability to build large oceangoing ships.

Similarly Marco Polo had been impressed and surprised by the deep coalmines of China. Yet by the nineteenth century Chinese coalmines were primitive shallow affairs, which relied completely on manual power. By the eleventh century AD the Chinese measured time accurately using water clocks, yet when the Jesuits arrived in China in the 1580s they found only the most primitive methods of time measurement in use, and amazed the Chinese by showing them mechanical clocks. The decline in technological abilities in China was not caused by any catastrophic social turmoil. Indeed in the period after 1400 China continued to expand by colonizing in the south, the population grew, and there was increased commercialization.

China’s technological decline is a fascinating topic, with lessons for us today.

Right now, the United States is approximately six million jobs short of our pre-recession high, even though we’re almost three years into a recovery. We have about the same number of jobs as we had in 2000. That is worth saying again. On net, the United States has seen no job growth in over a decade, even though we’ve recently seen some slow job growth — slow relative both to past recoveries, and to potential.

Prospects for improved growth are not good. Already, the Federal Reserve has all but promised to keep I low interest rates through 2013. This is a sure sign that its 300+ economists don’t anticipate significant improvement soon.

Some observers are claiming that this is 'the new normal,' and we have to get used to a future of slower growth. These people are doing us a disservice. The United States still has all of the economic potential it ever had. Our job growth is unacceptably low because of our policy choices.

Bad policy is not a partisan issue. The disastrous Sarbanes-Oxley was passed during the George W. Bush administration, as was the irresponsible expansion (subsidizing prescription benefits) of the by-then-obviously-troubled Medicare program. The supposedly free-market administration instituted a tariff on steel imports, presided over an increase in government spending as a percentage of gross product, and ran persistent federal budget deficits. Finally, in a panicked reaction to the September 2008 financial crisis, it created the TARP program, a program that exacerbated our financial sector’s existing moral hazard problems.

The current administration has dramatically expanded the size and scope of government. Today, total government spending is over 35 percent of gross national product. This exceeds that of World War II. Federal debt, as a percentage of GNP, will soon surpass that of World War II, and no decline is in sight. The Dodd-Frank Act does not address any of the problems that caused the 2008 financial crisis, while imposing huge regulatory burdens on financial firms. The healthcare restructure imposes another large regulatory burden while failing to address the fundamental problem: consumption of medical services and payment for medical services have become separated.

Our bureaucracies are growing at the expense of the private sector. For evidence, look at Joel Kotkin’s piece on the relative prosperity of the Washington DC area, a region that has boomed throughout the recession. Similarly, the Sacramento Bee recently ran an article on the 200,000 plus people trying to get a job with the State government.

When government bureaucracies become very large, they attract people directly through working conditions, benefits and pay packages, job security, and power. The bureaucracy becomes the place where important decisions are made, and talented people want to make important decisions. Dealing with bureaucracy also becomes a major growth industry. Financial institutions need more compliance officers to stay out of trouble with the regulators. Pharmaceutical companies need people to navigate the approval process for new drugs. Companies across America need specialists to help them comply with employment and environmental regulations. When profits become dependent on regulatory compliance, the best and brightest become employed in facilitating compliance, or finding ways around it. Production suffers as a result.

Some would argue that government is the source of prosperity. Outside of the relatively small government necessary to ensure property rights, this is not true. As the following chart from the New York Times shows, most of government’s increased spending has gone to transfer payments.

What’s to be done? I’ve argued elsewhere that legal immigration should be increased. That can be done immediately, and it would have immediate impacts. Repeal of Sarbanes-Oxley and Dodd-Frank would also have immediate benefits. Redoing healthcare in such a way that consumption of medical services would be tied to the payment of medical services would help, too. Increasing United States carbon-based energy production would provide an immediate boost.

In the longer run, government’s share of the economy needs to decline. The least painful way would be to cap inflation-adjusted total government spending, and keep it capped while the economy grows, allowing governments share to decline to, say, 2000 levels. This would require changes to Social Security and Medicare benefits.

Which brings us back to China. It appears that a large centralized bureaucracy was a significant contributor to China’s decline. It did this through three channels: Central bureaucracies imposed inefficiencies on the economy (just as we saw in the failed USSR). Bureaucracies are also risk averse, which limited China's upside potential. And, like other bureaucracies, it attracted the best talent.

This is not to say that the United States is 14th century China, and about to enter into an extended period of decline. But it is to say a cause of the United States sub-par economic performance is its large and growing central bureaucracy.

Photo by IvanWalsh.com: Museum of Ancient Architecture, Beijing, China

Bill Watkins is a professor at California Lutheran University and runs the Center for Economic Research and Forecasting, which can be found at clucerf.org

The Next Public Debt Crisis Has Arrived

Susanne Trimbath — Fri, 30 Mar 2012 17:30:33 -0400

In July of 2009, while the smoke from the global financial bonfire was still thick in the air, I wrote for this website about another crisis of massive proportions just looming on the horizon: the Global Crisis in Public Debt.

Three years later, the news of defaults, bankruptcies, debt forgiveness requests, receiverships, and bailouts are in the news every day. Across the globe, sovereign entities – from US cities to European nations – are suffering under staggering debt loads, decimated revenues and intense pressure from the very capital markets that they should be able to turn to for refuge. Last month, Jefferson County, the largest in Alabama, moved forward with their bankruptcy proceedings over the objections of the Wall Street banks. Suffolk County in New York declared a financial emergency. The Financial Times has an interactive map showing all but 12 U.S. states with budget shortfalls for 2012. Eleven U.S. cities, counties and villages have filed bankruptcy since 2008, plus 21 municipal non-government entities (e.g., utilities, hospitals, schools, etc.), according to the Pew Center on the States.

This crisis for cities, states and nations, like so many other financial crises, has its root in the free flow of credit that existed during the preceding economic boom years. The market prices of assets rose steadily. Rising valuations, especially based on improving revenues from robust economic activity, led to rising income streams for governments. This encouraged governments to borrow more, perhaps often to expand services – and the bureaucracy required to deliver them – and sometimes to improve infrastructure and make capital investments.

At the same time, rising market prices for financial assets encouraged more savers and investors into the market. In the US, the flow of cash to Wall Street was further encouraged by favorable tax treatment for the earnings on retirement savings and municipal bonds. The steady influx of new money produced an increasing supply of investable funds, which drove demand for sovereign and municipal debt (in addition to the mortgage-backed securities).

This process was driven more by the financial services industry than the real economy. As of March 5, 2012, the Federal Reserve Bank of New York reported more than $5,000,000,000,000 ($5 trillion) in overnight securities financing – that’s money that makes money but nothing else – that’s more than 20% of US GDP sitting around, not creating jobs, not building infrastructure, just sitting. Since the investment of securities financing is virtually all done electronically, it creates very few jobs. What it does produce is a boost in revenues for bankers – which they can translate into often lavish bonuses.

The financial sector also adds to its profits from issuance fees, trading fees, underwriting fees, etc. Then there’s “Market Risk Trading,” a euphemism for letting anyone buy a contract to gamble on the probability that Greece won’t be able to repay their debt or that you will miss a mortgage payment. Anyone can buy that contract, even the arsonist next door who has a say in whether or not Greece gets access to capital. In the end it is the borrowers who will suffer the consequences because they will be unable to refinance their debt and the gamblers who will win by withholding financing in anticipation of the insurance payout.

At the end of June 2009, only Italy, Turkey and Brazil were covered by more credit default swap contracts than JP Morgan Chase and Bank of America. Goldman Sachs, Morgan Stanley, and Wells Fargo Bank all had more credit derivate coverage than the Philippines.

Entered the Top 1,000 for credit default swaps after 2009

Reference Entity	Debt as %GDP	CDS* as %Debt
Australia	30.3%	11.2%
New Jersey	7.8%	11.2%
New Zealand	33.7%	8.6%
Illinois	6.8%	8.2%
Texas	3.4%	6.6%
Kingdom of Saudi Arabia	9.4%	3.8%
Lebanese Republic	137.1%	2.4%
Arab Republic of Egypt	85.7%	1.0%

*CDS are credit default swaps, financial contracts that pay off if the named (reference) entity experiences a credit event like a ratings downgrade or a missed payment.
[Abu Dhabi also appears in the 2012 list of the top 1,000 entities named in credit default swaps at DTCC, but debt and GDP data are not available.]

What was a potential default problem in 2009 has become reality in 2012. In 2009, gross credit default swaps outstanding for the debt of Iceland were equal to 66 percent of GDP, and around 18 percent for Portugal. As these countries struggle with their debt, the global banks – primarily the US banks – sell credit derivatives and stand to collect enormous payments – whether or not the defaulting countries receive any support or bailouts from international donor organizations. The reason is that most credit derivatives contracts pay out on “credit events.” A “credit event” can be something as simple as a downgrade from Moody’s or Standard and Poor’s – whose managers testified before Congress that credit rating changes can be bought. Standard & Poor’s executives admitted in 2008 that they were being forced to relax rating requirements to improve revenues. If, for example, $69 billion worth of credit derivative payoffs are available on a Greek default then how much could the owner of a credit swap afford to pay for a rating change?

The absurdity of rating Egypt more credit worthy than Australia is only part of the story. The sad fact is that Wall Street banks can sell more credit risk protection than there is credit risk. If all the public debt of a country is $1 billion, it means that country has borrowed $1 billion in public capital markets. But Wall Street banks are buying and selling more credit risk insurance than there is credit risk. This is the same problem I wrote about in 2008 that we saw in the Treasury bond market – when you sell more bonds than exist these trades are called “naked” sales or “phantoms”. A similar problem in stocks contributed to the 2008 crash.

There are more cities, counties, states and nations in financial trouble According to the Bank for International Settlements, there were $615 trillion in Over-The-Counter (OTC) derivatives contracts outstanding worldwide at the end of 2009. That's about 9 times global GDP. In other words, the entire world would have to work for 9 year just to produce enough to pay off the derivatives – before we had a dime left over to pay off the original debts.

In this environment, the sovereign debt crises may produce something scarier than anything we have experienced in the past. The use of credit derivate products has increased the chance of a default turning into a global catastrophe. It won’t be enough to pay off the debt owed by one of these sovereigns. That payoff will be magnified by the value of the credit derivatives. These derivatives will have a multiplier effect on every sovereign debt default or “credit event.” The table at the end of this article only includes the credit derivatives warehoused with the Depository Trust and Clearing Corporation in the US – there is no source of information on the real magnitude.

A crisis in sovereign debt would cause problems not just within those nations, states or cities but also for the global financial institutions who sell default protection through the credit derivatives markets. The bankruptcy of Jefferson County (AL) threatens to take down muni-bond insurer Syncora Guarantee (who, by the way, is suing JPMorgan Chase over losses in mortgage-backed securities saying that JPMorgan Chase misrepresented the loans to obtain the insurance). Another such institution was Ambac Financial Group, Inc., which I described in an article published here months before the original prediction of the global crisis in public debt. Ambac – like Berkshire Hathaway – was in the business of guaranteeing the payments of public debt (and mortgage backed securities). Ambac filed for bankruptcy in November 2010. With Ambac gone, Berkshire is next in line to pay because of Warren Buffett’s credit default swaps.

Policy makers have had few options available across the globe to combat this crisis. The European Union Commission is attempting to control the amount of credit insurance being sold by limiting the sale of “naked” credit default swaps. A proposal was approved by the European Parliament on November 15, 2011 to restrict the sale of credit insurance to any buyer who “does not have ownership of the underlying government debt.” The limited regulation passed by the EU Parliament allows the sale if the buyer has ownership in something vaguely related to the sovereign debt – like allowing the purchase of swaps on Italian government debt if the buyer owns shares of an Italian bank. French President Sarkozy said in January that he would propose “special levies on naked credit default swaps.” The imposition of fines or taxes (levies) has not eliminated similar activity in stock and bond markets in the US, though it is at least a start which is more than US regulators have done.

Meanwhile, Federal Reserve Chairman Ben Bernanke and Treasury Secretary Timothy Geithner continue to load the helicopter with dollar bills to finance the payouts with freshly-minted U.S. dollars. They sell us the fantasy of free-market capitalism while laying down a labyrinth of financial rules and regulations allowing a dozen or so politically connected banks to reap the rewards while avoiding the risk of failing, US financial institutions have been placing losing bets through unregulated derivatives markets only to be bailed out as “systemically important” – a euphemism for “too politically connected to fail.” The rest of the world is taking steps to stop the damage. When will the US government step up to the plate?

Sovereigns named in most credit default protection*
	2009	2012	2009	2012
Sovereign Entity	Debt % GDP	Debt % GDP	CDS % Debt	CDS % Debt	CDS change 2008 to 2012***	Region
REPUBLIC OF ICELAND	23.0%	130.1%	315.2%	40.4%	-2,322,155,904	Europe
REPUBLIC OF ESTONIA	3.8%	5.8%	206.7%	193.4%	844,012,716	Europe
UKRAINE	10.0%	44.8%	194.5%	28.9%	-23,102,981,592	Europe
REPUBLIC OF KAZAKHSTAN	9.1%	16.0%	144.0%	57.5%	-3,440,253,859	Europe
REPUBLIC OF BULGARIA	16.7%	17.5%	100.6%	112.5%	4,163,215,975	Europe
REPUBLIC OF LATVIA	17.0%	44.8%	92.4%	62.3%	3,369,945,521	Europe
BOLIVARIAN REPUBLIC OF VENEZUELA	17.4%	38.0%	80.7%	45.9%	5,646,959,440	Americas
STATE OF QATAR	6.0%	8.9%	76.4%	55.4%	5,040,787,988	Europe
RUSSIAN FEDERATION	6.8%	8.7%	72.7%	55.7%	4,966,368,803	Europe
REPUBLIC OF TURKEY	37.1%	42.4%	56.1%	32.5%	-43,726,859,566	Europe
REPUBLIC OF LITHUANIA	11.9%	37.7%	42.7%	28.8%	3,438,691,822	Europe
REPUBLIC OF PANAMA	46.4%	41.7%	36.7%	37.1%	989,207,525	Americas
REPUBLIC OF THE PHILIPPINES	56.5%	49.4%	36.6%	28.8%	-10,157,402,334	Asia Ex-Japan
REPUBLIC OF PERU	24.1%	21.9%	34.1%	41.1%	7,324,285,482	Americas
ROMANIA	14.1%	34.0%	31.2%	20.6%	6,566,917,982	Europe
REPUBLIC OF CHILE	3.8%	9.4%	30.9%	21.2%	2,719,694,915	Americas
IRELAND	31.5%	209.2%	28.2%	22.5%	27,767,560,886	Europe
UNITED MEXICAN STATES	20.3%	37.5%	23.7%	20.2%	50,658,161,703	Americas
REPUBLIC OF SLOVENIA	22.0%	45.5%	22.5%	23.0%	3,206,639,043	Europe
REPUBLIC OF HUNGARY	73.8%	76.0%	21.6%	47.1%	37,403,179,311	Europe
REPUBLIC OF SOUTH AFRICA	29.9%	35.6%	21.5%	24.6%	17,010,145,334	Europe
ARGENTINE REPUBLIC	51.0%	42.9%	18.7%	17.2%	-2,448,737,614	Americas
FEDERATIVE REPUBLIC OF BRAZIL	40.7%	54.4%	18.2%	13.0%	14,703,918,548	Americas
PORTUGUESE REPUBLIC	64.2%	72.1%	15.9%	25.2%	39,897,746,989	Europe
REPUBLIC OF COLOMBIA	48.0%	45.6%	15.9%	14.9%	1,221,052,625	Americas
SLOVAK REPUBLIC	35.0%	44.5%	12.8%	19.3%	5,533,166,393	Europe
KINGDOM OF SPAIN	37.5%	68.2%	11.9%	16.9%	101,554,412,387	Europe
REPUBLIC OF KOREA	32.7%	22.9%	11.8%	20.0%	22,088,912,724	Asia Ex-Japan
REPUBLIC OF CROATIA	48.9%	60.5%	11.5%	19.9%	5,612,474,098	Europe
HELLENIC REPUBLIC (Greece)	90.1%	165.4%	11.1%	13.6%	34,488,989,840	Europe
REPUBLIC OF INDONESIA	30.1%	24.5%	11.0%	16.1%	13,723,880,843	Asia Ex-Japan
MALAYSIA	42.7%	57.9%	9.7%	7.8%	4,044,633,137	Asia Ex-Japan
KINGDOM OF DENMARK	21.8%	46.9%	9.3%	17.2%	12,665,229,924	Europe
STATE OF FLORIDA	3.2%	17.9%	8.1%	16.8%	2,787,096,121	Americas
REPUBLIC OF AUSTRIA	58.8%	103.3%	7.9%	21.3%	38,904,764,846	Europe
REPUBLIC OF ITALY	103.7%	120.1%	7.9%	14.6%	171,818,588,038	Europe
KINGDOM OF THAILAND	42.0%	45.6%	7.1%	6.5%	1,675,447,429	Asia Ex-Japan
SOCIALIST REPUBLIC OF VIETNAM	38.6%	54.5%	6.4%	5.9%	3,717,696,305	Asia Ex-Japan
CZECH REPUBLIC	29.4%	39.9%	6.0%	11.5%	7,793,110,452	Europe
REPUBLIC OF POLAND	41.6%	56.7%	5.9%	9.7%	25,523,188,448	Europe
REPUBLIC OF FINLAND	33.0%	49.0%	5.7%	17.3%	12,868,084,419	Europe
THE CITY OF NEW YORK	**	7.5%	4.3%	8.4%	3,555,950,000	Americas
STATE OF NEW YORK	4.2%	24.8%	4.3%	5.3%	1,215,398,707	Americas
KINGDOM OF SWEDEN	36.5%	36.8%	4.1%	15.0%	15,665,446,384	Europe
KINGDOM OF BELGIUM	80.8%	99.7%	3.9%	15.1%	49,607,728,521	Europe
STATE OF ISRAEL	75.7%	74.0%	3.4%	7.0%	7,093,224,168	Europe
STATE OF CALIFORNIA	3.9%	18.3%	3.2%	12.7%	8,068,160,000	Americas
FEDERAL REPUBLIC OF GERMANY	62.6%	81.5%	2.1%	4.5%	75,770,481,300	Europe
KINGDOM OF NORWAY	52.0%	48.4%	1.6%	6.3%	5,953,647,323	Europe
KINGDOM OF THE NETHERLANDS	43.0%	64.4%	1.6%	5.3%	19,494,129,128	Europe
PEOPLE'S REPUBLIC OF CHINA	15.7%	16.3%	1.5%	3.7%	49,294,027,432	Asia Ex-Japan
FRENCH REPUBLIC	67.0%	85.5%	1.5%	6.8%	108,226,300,245	Europe
UNITED KINGDOM OF GREAT BRITAIN & NORTHERN IRELAND	47.2%	79.5%	1.2%	3.6%	51,470,774,560	Europe
JAPAN	170.4%	208.2%	0.1%	0.8%	67,160,972,268	Japan
UNITED STATES OF AMERICA	60.8%	69.4%	0.1%	0.2%	19,471,174,892	Americas

*List from Depository Trust and Clearing Corporation. [www.dtcc.com] Dubai was also on this list, but debt and GDP data were not available.
**2012 GDP for City of NY was calculated by subtracting all other MSA output from state GDP.
*** Lower totals may indicate that some credit default swap contracts have been paid off.
Countries in Italics had not failed to meet their debt repayment schedules before 2008 (Reinhart and Rogoff 2008); Thailand and Korea received IMF assistance to avoid default in the 1990s.

Treasury Department photo by BigStockPhoto.com.

This Is America's Moment, If Washington Doesn't Blow It

Joel Kotkin — Thu, 19 Jan 2012 11:13:18 -0500

The vast majority of Americans believe the country is heading in the wrong direction, and, according to a 2011 Pew Survey, close to a majority feel that China has already surpassed the U.S. as an economic power.

These views echo those of the punditry, right and left, who see the U.S. on the road to inevitable decline. Yet the reality is quite different. A confluence of largely unnoticed economic, demographic and political trends has put the U.S. in a far more favorable position than its rivals. Rather than the end of preeminence, America may well be entering a renaissance.

Just survey the globe. The European Union’s prolonged crisis will likely end in further decline. Aging Japan has long passed its prime, its market share receding in everything from autos to high tech. China’s impressive economic juggernaut has slowed down, and the Middle Kingdom faces increased social instability, environmental degradation and a creaky one-party dictatorship.

While the U.S. has its challenges, it is positioned to achieve a more solid long-term trajectory than its European and Asian rivals. What it lacks, however, is a strong political leadership capable of seizing this opportunity.

Resources

Energy constitutes the biggest ace in the hole for the U.S. For almost half a century, an enormous fossil fuel bill that still accounts for 40% of the nation’s trade deficit has hampered economic growth. Now that situation is changing rapidly.

Due to vast new finds and improved technology to exploit them, the U.S. is now the world’s largest producer of natural gas and could emerge as the leading oil producer by 2017. Reserves of natural gas — a clean-burning fuel — are estimated at 100 years supply and could generate more than 1.5 million new jobs over the next two decades.

The U.S. agricultural sector is also booming, with exports reaching a record $135.5 billion in 2011. With global demand increasing, sustained growth will continue across America’s fertile agricultural regions.

Manufacturing

The other big game changer is manufacturing. As President Barack Obama recently acknowledged, this is America’s “moment” to seize the industrial initiative. U.S. manufacturers have expanded their payrolls for two straight years, and they have increased production while Japan, Germany, China and Brazil have scaled back.

A recent survey of manufacturing CEOs revealed that 85% believed production could shift soon from overseas. Both foreign and domestic manufacturers are alarmed about rising wages and labor unrest in China. Some important Japanese, German and Korean companies also have concerns about China’s policies that favor local firms and abscond with investor’s technology.

Foreign Investment

Rising foreign investment reflects the new American competitiveness. Since 2008 foreign direct investment to Germany, France, Japan and Korea has stagnated; in 2009 overall investment in the E.U. dropped 36%.

In contrast, in 2010 foreign investment in the U.S. rose 49%, mostly coming from Canada, Europe, and Japan. Industrial investment rose $30 billion just between 2009 and 2010, while investment in the energy sector more than tripled to $20 billion.

The Information Sector

In the information sector, American domination continues to mount, contrary to predictions of decline over the past two decades. Although high-tech manufacturing has shifted largely to Asia, Americans rule the increasingly strategic software sector. American-based companies, who constitute more than two-thirds of the world’s 500 largest software companies, including nine of the top ten.

Outside the U.S., there are no significant equivalents of Apple, Google, Microsoft, Amazon and Facebook. Hollywood, for its part, rules the entertainment world, producing 40% of world’s audiovisual exports, a dominion that troubles China’s President Hu Jintao, who recently complained that the “cultural fields” represent “the focal area” for Western “infiltration”.

Demographics

The Great Recessionhas slowed population growth everywhere, but the U.S. maintains the youngest and most vibrant demographic profile of any advanced country. Between 1980 and 2010, the U.S population expanded by 75 million to over 300 million. In contrast many European countries, including Germany, have suffered stagnant growth, while in Russia and Japan populations have already started declining.

The disastrous fiscal implications of slow or negative population growth are evident in Greece, Spain and Italy, all of which suffer among the world’s lowest fertility rates. Rapid aging also will soon catch up with Germany. By 2030, Germany will have 48 retirees for every 100 workers — that’s barely two workers per retiree. The numbers are even worse in Japan: 53 retirees for every 100 workers by 2030.

Political Factors

Given the ineptitude of the last two administrations, enthusiasm about America’s political system is hard to justify. But our constitutional systems of laws and checks on central power remain a critical advantage. Immigration has declined with the recession, but the U.S. can expect to welcome religious and political exiles — such as Middle Eastern Christians displaced by the “Arab Spring” — as well as Greeks and Irish fleeing Europe’s economic decline.

Many from Russia and China are seeking to immigrate to the United States, Canada or Australia in order to protect property or just live a freer life. Indeed, among the 20,000 Chinese with incomes over 100 million Yuan ($15 million), 27% have already emigrated and another 47% have said they were considering it, according to a report by China Merchants Bank and U.S. consultants Bain & Co. published in April.

Needed from Washington: A New American Strategy

Sadly no leading politician or political party seems ready to embrace the country’s new strategic advantages. Many on the left may find the very notion distasteful, having swallowed declinism with their academic mother’s milk. The president himself dislikes the notion of American “exceptionalism.” Many key Obama backers like SEIU boss Andy Stern and former auto czar Steven Rattner, embrace the superiority of China’s authoritarian system. Others embrace Europe and even Japan as models for an aging superpower.

Worse still: Some Obama policies work against the well springs of national resurgence. Threats to raise income taxes on families making over $250,000 directly threatens the aspiring entrepreneurial class more than the real “rich” whose fortunes are protected by low capital gains taxes and family trusts. Most critical: The administration’s hostility to fossil fuel represents a direct threat to the country’s greatest new source of advantage and threatens to strangle America’s recovery in its infancy.

Not that the Republicans are any less clueless. Many reject the infrastructure needed by an expanding economy — ports, roads, bridges as well as worker training and support for basic research — as mere “pork.” Budget restraint and fiscal discipline are important, but preparing the country for more rapid economic growth requires an active, supportive government.

Republicans also tend to view immigration as something akin to a hostile invasion. Yet many key industries — notably manufacturing and high tech — rely heavily on immigrant entrepreneurship, intelligence and work values. Running against immigration constitutes an assault on the nation’s increasingly diverse demographics.

So this is where we now sit. With all the essential elements for a strong, sustained recovery place, the big question is whether we will find political leaders capable of tapping this country’s phenomenal potential.

This piece originally appeared at Forbes.com.

Joel Kotkin is executive editor of NewGeography.com and is a distinguished presidential fellow in urban futures at Chapman University, and contributing editor to the City Journal in New York. He is author of The City: A Global History. His newest book is The Next Hundred Million: America in 2050, released in February, 2010.

Photo from BigStockPhoto.com.

Citibank, Citizen Wriston, And The Age of Greed

Henry Ehrlich — Sat, 07 Jan 2012 09:18:45 -0500

Robert Sarnoff , the CEO of RCA before it was absorbed by GE, once said, “Finance is the passing of money from hand to hand until it disappears.” That process is very clearly defined in The Age of Greed by Jeffrey Madrick. It recounts, in concise terms, how a few dozen individuals—some in the private sector, some in government--brought us to our current economic pass, in which finance seems to have been completely detached from life. Names from the past come back, and their crimes are explained. Ivan Boesky, Michael Milken, and Dennis Levine look guiltier in the retelling than they did in the newspapers at the time. And in this telling, the philosopher king of the new finance was Walter Wriston, CEO of Citicorp.

I wrote for Wriston and other senior managers of Citibank from 1980 through his retirement in 1984, and for his successors through 1991. My colleagues and I were charged with helping Wriston make the case that the financial regulatory regime that was put in place during the Depression was obsolete. Let me make it clear: I was a footnote, although I occasionally run into old acquaintances who still shake their fingers at me.

Madrick’s Wriston is by far the book’s most compelling character. As with all the other subjects, there’s a smattering of armchair Freud, although most of the political figures who make appearances here escape their two minutes on the shrink’s couch. Wriston’s psyche was more interesting than the insecurities of Ivan Boesky and Sandy Weill, to name just two; his university-president father Henry Wriston despised the New Deal as it was happening, and imparted that attitude to the son. Henry then remarried too quickly after Walter’s mother died for the son’s taste, and they became estranged.

But there’s more to Wriston than you read in Madrick. He was a restless intellect, impatient with field of diplomacy he had studied for before World War II, and after taking a job in banking, which he once wrote seemed like, “the embodiment of everything dull,” found a vehicle for exerting his imagination, and then for fulfilling his ambitions. The First National City Bank, later to become Citibank and Citicorp, and then Citibank again, had inspired imperial dreams before. Through a series of mergers it became the biggest bank in the biggest city in the country. When trade followed the flag around the world, Citibank’s precursors were right there with it. During the Roaring Twenties, Charles Mitchell dreamed of a “bank for all”, the forerunner of Wriston’s vision of one-stop banking, although Mitchell’s stewardship ended with a trial (and an acquittal) after the stock market crash and the Pecora hearings in the early ‘30s. While the bank had social register threads running through its history—when Wriston started the president was James Stillman Rockefeller, descended both from the Stillmans and the Rockefellers, married to a Carnegie—the patrician elements always had hungry outsiders around to push the envelop of banking practice. When Rockefeller was chairman, he had a president named George Moore, and Wriston was his protégé. However, Moore was too frisky for Rockefeller, and when a successor was chosen, it was Wriston.

Wriston hung a portrait of Friederich Hayek on the wall of his office. He was a reader. When Adam Smith became the Holy Ghost of the Church of Deregulation, Wriston’s top writer (and later my boss) was the man who actually edited The Wealth of Nations for the Great Books. When I was new there, I asked one of the bigshot corporate bankers which great thinkers he liked to quote in his speeches. He answered, “The only person who can get away with that is Walt Wriston, and I’m not sure he can.” Wriston’s ambition may have been shaped by philosophy, but he achieved it with tactics and strategy that sprang from a contrary nature as much as by the force of his ideas, and Madrick recounts that. He wanted his bank to be valued like a growth stock, and promised analysts 15% a year return on equity—not a recipe for safety and soundness.

Whether it was inventing financial instruments to get around interest rate restrictions, making outsize bets on railroad bonds and New York City bonds, creating the Eurodollar market, blitzing the country with credit cards, or wholesale lending to developing countries to recycle petrodollars, Wriston had a knack for making money when the economy was right and then challenging the government to deregulate in time to accommodate his losses. Personally, I think that before the bank was too big to fail, it was too big to succeed.

Looked at now, there’s something quaint about these investments. At least they had to do with real things, like trains, oil, municipal governance, and the ostensible aspirations of people in emerging markets, although they were mostly oligarchs and autocrats. In Madrick’s account, Wriston was dismissive of the government’s capacity to efficiently recycle petro-dollars, among many other things, and contended that his loan officers knew more about their corporate customers than anyone else did, which would enable them to safely make riskier loans than capital standards would permit. We all know how that turned out.

Wriston was a real visionary. To underscore his then-revolutionary idea that information about money was as important as money itself, he bought a transponder on a satellite to carry the bank’s data stream, and then put a satellite on the cover of the annual report. Theoretically, all that proprietary information made it hard to hide bad news about a company’s finances or a country’s; executives and prime ministers beware of poor management! He was undoubtedly the first bank CEO to anticipate what Moore’s Law—quantifying the exponential growth of computing power—would mean to business and society. Unfortunately, that power is exactly what enables the hollow finance we have today.

Reading Madrick’s book was like watching my life pass before my eyes, including the parts I slept through, and it certainly brought me up to date on events that happened long after my eyes glazed over.

It reminded me that when Wriston ran it, Citibank was fun to work for, as jobs in tall buildings went. My closest colleagues were well-educated and witty refugees from college faculties. The bank’s historian worked closely with us, and we learned the secrets that never made it into the deadly official history, such as the fact that one of Wriston’s predecessors kept a house in Paris, where he was known among the haute couturiers as le bonbon, or that when the Titanic went down, some hard-money banker had written to customers that there was good news—the loss of all the paper currency aboard would strengthen the dollar. Wriston set the tone: History counted, an attitude that wouldn’t survive the cost-cutting that came later. Wriston was renown for his sharp needle, but when I found myself in his office with the portrait of Hayek staring down, he seemed to enjoy the relief from the routine pressures of his job. I always had some kind of bleeding heart question based on current events, and he always had a sharp, witty retort.

He was also a citizen. When the City of New York had its own financial collapse in 1975 (“Ford to City: Drop Dead”), Wriston represented the commercial banks on the committee charged with rescuing the city’s finances. One of the bank’s economists assigned to work with him saw the beating Wriston took every day at the hands of the municipal unions and asked why he carried on. He answered, “Because I live here.” I wish some of the new financiers who have benefited from the work Wriston did would exhibit some evidence that they felt that way about the city. About the country. About the world.

Photo: Bigstockphotos.com; the old Citibank and newer Citicorp buildings.

Henry Ehrlich no longer writes for bankers, although he still likes money. He is editor of
www.asthmaallergieschildren.com, and co-author of Asthma Allergies Children: a parent's guide.