Posts Tagged ‘consumer expenditure’

Main stream media on deflation

November 20, 2009

http://www.bloomberg.com/apps/news?pid=20601068&sid=ame31IjWda6w

Here is a concept that is commonly misunderstood. From the article:

A sustained price drop might set off a chain reaction in which lower profits force employers to pare wages and payrolls. That would erode consumer demand, exacerbating wage cuts and firings.

A sustained price drop only reduces nominal revenue. Consequently, wages will have to be pared back.

Good.

But why would lower prices engender lower consumption? If prices and wages drop simultaneously, on a relative basis there would be no change to consumption.

The problem is debt.

Deflation reduces the nominal value of commercial revenues and wages. However, debt and debt service amounts remain at the same value as when they were first generated.

Government finances suffer the same fate. Deflation brings about reduced tax collection and  the bankruptcy of government.

So unless someone somewhere does not find a way to restart the credit markets and inflation at rates approximating anything like the period 2000/2007 Western governments are bankrupt with no possibility to postpone the day of reckoning.

War it is then.

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Deflation at work…

November 17, 2009

http://detnews.com/article/20091117/METRO/911170327/1409/METRO/Silverdome-sale-price-disappoints

Nearly 35 years after taxpayers spent $55.7 million building the Pontiac Silverdome and a year after a $20 million sale fell through, city officials have sold the arena once called the most desirable property in Oakland County. […]  The price: $583,000. […] We had hoped it would have brought more, but now the city can be freed of its upkeep and get it back on the tax rolls,

This is what deflation does. It reduces nominal wealth thus it reduces overall revenue streams and so it reduces tax revenue. As nominal wealth declines, entities can no longer expand outstanding debt due to diminished collateral. As revenue declines, entities can no longer expand debt and/or service existing debt and must lay off workers. As tax revenue falls, local governments have to lay off and curtail public spending.

Allowing banks to disregard mark-to-market accounting rules aims to avoid just this type of situation in the hope to buy time.

But inflation has a limit. If that were not the case, then you would expect some degree of direct correlation between inflation and GDP progression. But that is not the case. Since 1980 government and household debt expanded by 1200% to $26Trillion but GDP only expanded by 100% to $14Trillion. Thus inflation conforms to the law of diminishing returns.

From the inception of the modern Dollar in 1913 inflation proved to be a barrier almost immediately in 1929. Subsequently, by declaring convertibility to gold but not allowing anyone to check the quantities of the metal in storage, the USA were free to pretty much print whatever amount of money they wanted. Till the late 60s when the situation was fairly similar to where we are today.

By the early 70s it was decided to abrogate the monetary agreement that had been in force since WWII in favor of floating exchange rates meaning that now Europe too was on a fiat monetary system. Thus inflation could now be pushed into the new vacuum of the European markets. Then came globalization effectively allowing us to push inflation into the last remaining markets and the Euro that allowed us to inject a further dose of inflation in Euroland. Thus till very recently, inflation could come to the rescue of governments by decreasing nominal debt outstanding.

There are no more markets of any consequence that we can bring in on the inflationary gig. Thus my contention that we’ve reached the end of the inflationary cycle.

Industrial capacity and debt obligations are at historic highs. Interest rates, savings and capacity utilisation are at historic lows.

Why would gargantuan spending by governments to add even more industrial and commercial capacity solve anything?

Incidentally. Gargantuan government spending guarantees prolonged deflation because increased taxes will erode spending, hiring and investment. Therefore, if anything, spending of this magnitude only serves to delay the eventual recovery.

So, buying time may be a viable strategy if and when inflation has room to run. I think inflation can no longer be expanded at this point and that a gradual contraction in prices, wages and asset values is with us for some years to come.

The trouble is that the existence of government if predicated on inflation. No inflation = the bankruptcy of government.

Can a Western government declare bankruptcy?

 

 

Curtailing public services (mail service)

November 17, 2009

Chipping away at public services one item at the time….

As government is unable to expand credit markets and as most tax revenue is going towards debt service despite the lowest interest rates in history, public service must be curtailed.

Curtail enough public services (police, fire fighting, refuse disposal… health care…… pensions) in an environment where unemployment is rising at the same time that the power and business elites are implicated in scandal after scandal and you got yourself the ideal conditions for civil unrest.

http://money.cnn.com/2009/11/16/news/companies/US_postal_service/index.htm

Civil unrest means government will fall.

I know that. Some other people know that. Some politicians may know it too and of those that don’t know it, they can feel the winds of change bearing down on their little fiefdoms.

How do you prevent a total loss of power of the incumbents? You engineer a war of course and, at this rate, the next war will be a real war where Western society will be packed off to the front, civilian industry will be turned into war industry and food and energy will be rationed.

You may think I am off my rocker.

If I am right and, so far, empirical evidence tells me I am because:

The gargantuan amount of money that has been created in the past year alone has so far failed to work it’s multiplier magic on the overall economy

Graph: M1 Money Multiplier

And since the gargantuan sums that have been handed over to banks are just sitting there

FRED Graph

And because we still have significant overcapacity

Graph: Capacity Utilization: Total Industry

… and because of this…

FRED Graph

… and because of this…

FRED Graph

… and finally, in an economy that is 80% consumer based, because of this…

Graph: Personal Saving Rate

… if I am right (and the above data says I am) and we have entered a cyclical deflationary era, government won’t be able to expand credit markets no matter what it does and monetization of the debt issued by the treasury is not going to help if not to destroy the currency thus the economy.

Incidentally, considering that the Bank of International Settlements estimates global financial obligations to be worth at a minimum US$500Trillion and that world GDP was at one point hovering around US$50Trillion and that the majority of these derivatives are held by US and EU banks (and only four banks hold the lion share of the lot)… major global currencies are not going to take kindly to the moment in time when these obligations must be satisfied…

Can a Western government declare bankruptcy and, in one fell swoop, admit that, in fact, we are no better than your garden variety Mugabe?

I think not.

If any of the above indicators don’t start trending in the opposite direction we’ll have us a war by 2013/2015 latest.

Something even uglier this way cometh… (government employment)

November 2, 2009

You’ve heard me screech that as the inflationary time line progresses government becomes progressively a larger actor in the economy. You’ve heard me wail that at the end of the inflationary dynamic, tax revenue dwindles forcing government to curtail public spending. You’ve heard me lament that as unemployment rises but social expenditure is curtailed, we would reach a flash-point making civil disorder very likely … and you’ve heard me howl that persistent and widespread civil disorder will be further fueled by rising scandals implicating politicians and the power elite leading eventually to the fall of governments across the West…. but that before that would happen, Western governments will engineer a war of global proportions….

Now read this courtesy of the team at Financial Sense (hat tip to Jasper on the VOY forum):

http://www.financialsense.com/Market/wrapup.htm

Significant excerpts:

As the chart shows us, the current year over year rate of [government payroll] contraction has no equal until we reach back to 1982

Although this may not be common knowledge, the bulk of government employees are found at the State and local levels of government. In fact, Federal government employment only accounts for 12.6% of total aggregate government employment as of September 2009-month end. That’s pocket change compared to State and local levels of employment. And of course the current cycle irony is that it’s the State and local governments that are hurting big time under the duress of not only infrastructure, maintenance and support, but pension issues, loss of Federal support payments, etc.

And then, this pearl with an accompanying chart

As of now, unfortunately for the US economy as a whole, government employees outnumber US manufacturing sector employees literally just shy of two to one. Now is the rhythm of government payrolls important enough for you?

This is a pearl because Western economies are largely service based economies. As I never tire to ask, in an economy that is 80% consumption, how much real wealth is being generated?

Essentially, when credit creation outpaces GDP progression by a wide margin (remember that even without considering corporate debt, household and government debt combined since 1980 has expanded 1200%  but GDP has only expanded by 100%) how much intrinsic value is there left in the economy to sustain those people that are losing their jobs?

This is not a question borne of idle curiosity. This is a question the answer to which is vital to understanding why I think we will be thrown into a world war by our “leaders”.

The research published recently indicates that we have entered and are fairly well into a deflationary cycle. I understand that opinions may diverge on whether we have or we haven’t and that’s fine.

However, what I feel is imperative is that all proponents of one type of “flation” or the other sit together and thrash out a hypothetical scenario of what would happen in case the “de” flationists should be right. Only once the perils and dangers of a deflationary outcome are identified and understood can we sit down with unions and economic actors and put forward a coherent argument as to what should be done at personal, household, corporate, union and government level in order to mitigate the repercussions of deflation.

But, for as long as government is hell bent on denying reality, then a world war is pretty much dialed-in.

When I say world war I don’t mean a war as we’ve had for the past forty years in remote backwaters against tin pot governments run exclusively by the armed forces without any sacrifice of the civilian population in the West. I mean a real war where the human and material resources of the West along with Western civilian industry will be marshaled and employed towards the war effort complete with rationing of food and electricity. That sort of war.

Even more proof the secular inflationary cycle has ended…

November 1, 2009

Via the team at Zero Hedge

http://www.zerohedge.com/article/guest-post-dear-prudence-wont-you-come-out-play

Read the entire post and look at the graphs. This is just more proof that traditional monetary policy has lost traction and that government is “pushing on” the proverbial “string”.

Important excerpts:

It should be no surprise to anyone that household debt outstanding fell again in 2Q (the latest Fed Flow of Funds data), making this now three quarters in a row of household net debt contraction.  The important character fingerprint in the 2Q period being that debt contraction at the household level accelerated. […] Household sector credit contraction is a first in post War history (emphasis added).

[…]

If households are paying debt down, then something has to be given up for that balance sheet reconciliation decision.  And the give up is consumption.  Although you may not realize this, and this is clearly one of the key reasons why the long tenured Street truism suggests no one bet against the US consumer, personal consumption in nominal dollars has actually increased during each and every recession of the last six decades (at least).  Each and every recession until the present, that is. […]  Lastly, we believe it’s also important perspective to remember that in our current circumstances, households have been treated to some of the lowest interest rates of a lifetime and consumer product price weakness has been pronounced.  Yet still zip in terms of consumption gains 19 months into official recession territory.

 

All I can say, is that you should be accumulating gold and silver bullion.

 

Backdoor taxes hit Americans with public financing in the dark

October 26, 2009

This article highlights information that is much too important to show excerpts for. I warmly suggest you read the whole thing because it will give you an idea of the scope, breadth and depth of this debacle. I will reproduce the full text of the article and intersperse my comments in brackets prefixed by “GR” in Italics.

http://www.bloomberg.com/apps/news?pid=20601109&sid=aBarSkIcch2k

Oct. 26 (Bloomberg) — Salvatore Calvanese, the treasurer of Springfield, Massachusetts, for four years, had a ready defense for why he risked $14 million of taxpayer money on collateralized-debt obligations laden with subprime mortgages in 2007.

He didn’t know what he was buying, he says, and trusted the financial professionals who sold them and told him they were safe.

“I thought they were money markets that were just paying more,” Calvanese said in an interview. “Nobody ever used the term ‘CDO,’ and I am not sure I would have known what that was anyway.” (GR: This, I remind you, from a “Treasurer”; a County Treasurer to boot. These are the type of people that are in charge of public funds)

Such financial mistakes, often enabled by public officials’ lack of disclosure and accountability for almost 90 percent of government financings in the $2.8 trillion municipal bond market, are costing U.S. taxpayers as much as $6 billion a year, according to data compiled by Bloomberg in more than a dozen states.

The money lost to taxpayers — when the worst recession since the Great Depression is forcing local governments to cut university funding, delay paying bills and raise taxes — is enough to buy health care for everybody in Minneapolis; Orlando, Florida; and Grand Rapids, Michigan, according to figures from the U.S. Census Bureau and the U.S. Department of Health and Human Services.

Florida county commissioners sent deals to their favorite banks in an arrangement that led to criminal convictions. Pennsylvania school board members lost $4 million on an interest-rate swap agreement they didn’t understand in the unregulated $300 billion market for municipal derivatives.

Trouble With Swaps

Local agencies in Indianapolis, Philadelphia, Miami and Oakland, California, spent $331 million to end interest-rate swaps with banks including JPMorgan Chase & Co. of New York and Charlotte, North Carolina-based Bank of America Corp. during the past 18 months. The swaps, agreements to exchange periodic interest payments with banks or insurers, were intended to save borrowing costs. Payments increased instead.

New Jersey taxpayers are sending almost $1 million a month to a partnership run by Goldman Sachs Group Inc. for protection against rising interest costs on bonds the state redeemed more than a year ago, Bloomberg News reported Friday.

The interest-rate swap agreement, which the state entered in 2003 under former Governor James E. McGreevey, remained in place even after the state Transportation Trust Fund Authority replaced $345 million in auction-rate bonds that had fluctuating yields with fixed-rate securities last year.

Harvard Pays

Now, the 3.6 percent the trust fund is paying on the swap has pushed the cost on the original debt to 7.8 percent, the most the authority has paid since it was formed in 1985, according to records on its Web site. Canceling the swap before 2011 would require the state to pay an estimated $37.6 million fee, according to state records.

Even Harvard University, whose endowment of $26 billion makes it the world’s richest academic institution, fell for Wall Street’s financing in the dark: The Cambridge, Massachusetts- based university paid $497.6 million to investment banks during the year ended June 30 to cancel $1.1 billion of swaps. (GR: This from Harvard… that sacrosanct temple of knowledge)

The public needs more transparency in municipal debt transactions, said Elizabeth Warren, chairwoman of the Congressional Oversight Panel for the Troubled Asset Relief Program. Proposed reforms, such as an oversight agency for consumer finance, could help spur improvements, she said in an interview this month.

‘Worldview Change’

“We need a worldview change about transparency, and that includes municipal finance,” said Warren, a professor of bankruptcy law at Harvard Law School.

The public paid extra costs for borrowing with tax-exempt bonds because local governments resist providing investors the same level of disclosure as corporate borrowers, which file quarterly reports.

Municipalities typically file financial statements only once a year. Detroit, the largest U.S. city with a less-than- investment-grade credit rating, released its annual report for fiscal 2007 in March, more than 18 months later.

State and local governments that share more financial information than the minimum required pay yields as much as 0.20 percentage points lower than others, said Lisa Fairchild, professor and chairman of the finance department at Baltimore’s Loyola University Maryland, who produced a 1998 study on disclosure.

Applied across the tax-exempt bond market, that’s $5.6 billion a year, enough to buy more than 12,000 $465,608 pumper- tender fire trucks. That’s more than one truck for every county in the U.S. The rest could form a parade 50 miles (80 kilometers) long.

Build America Bonds

State and local governments that sold $43.8 billion of taxable Build America Bonds this year will pay $385 million a year more in interest than similarly rated corporate borrowers, based on data compiled by Bloomberg.

The bonds, for which the federal government subsidizes 35 percent of interest costs, pay an average yield that’s 0.8 percentage points more, relative to benchmark rates, than yields for corporate securities with the same credit ratings, the data show.

As a result, it costs New Jersey road authorities, Georgia sewer districts and other agencies more to borrow, even though they, unlike corporations, can raise fees or taxes to make up for deficits. Corporations are at least 90 times more likely to default than local governments, according to Moody’s Investors Service.

Discounted to their present value, those additional payments by municipal borrowers add up to $6.1 billion over the life of the debt.

‘It’s Horrendous’

“I think it’s horrendous, but it’s very hard to get anybody to pay much attention to it,” said Stanley Langbein, a law professor at the University of Miami and a former tax counsel at the U.S. Treasury in Washington.

Underwriters — banks or securities firms that guarantee the purchase of debt issuers’ bonds — have an interest in keeping prices low, and yields high, because it means higher returns for them and the first investors, Langbein said.

Many Build America bonds traded at higher prices immediately after agencies sold them, a sign that taxpayers lost, he said.

The Government Finance Officers Association, a professional group based in Chicago, warns municipalities of “competing objectives” in their relationships with underwriters. Many don’t heed that warning, said Christopher “Kit” Taylor, who was the top regulator of the municipal bond market from 1978 to 2007.

‘Stockholm Syndrome’

“They’re suffering from Stockholm syndrome,” he said, referring to the psychological phenomenon in which hostages begin to identify with and grow sympathetic to their captors. “They are being held hostage by their investment bank.”

Public officials shunned competitive bids for more than 85 percent of the $308.9 billion in new tax-exempt bond sales in the first nine months of this year, according to data compiled by Bloomberg. That’s up from 17 percent in 1970 and 68 percent in 1982, according to the Government Accountability Office.

Most borrowing costs that state and local taxpayers incur are set in private negotiations. Finance professionals say no- bid sales allow them to market debt to particular investors, helping issuers find demand when credit markets are tight.

The method boosts interest rates by as much as 0.06 percentage point, according to several academic studies reviewed by the GAO.

Excess Fees

Palm Beach County, Florida, paid $880,000 in excess bank fees and as much as $1.3 million a year in unnecessary interest because its commissioners sold bonds without bids, according to a county report in April.

Each commissioner nominated his or her favorite bank and work was parceled out on a rotating basis, the report showed. That allowed former commissioner Mary McCarty to steer more than $600 million in debt issues to banks that employed her husband, Kevin McCarty, according to federal charges that led to guilty pleas from both this year.

After the McCartys were charged, the county adopted a policy stating a preference for competitive bond sales. When bonds are sold by negotiation, a financing committee will circulate a request for proposals, evaluate them and then recommend an underwriter to commissioners, said Liz Bloeser, Palm Beach’s budget director.

No Bids

Beaver County, Pennsylvania, commissioners haven’t taken bids for bond underwriters since 1986, county records show. After relying on the same firm for more than two decades, they paid as much as $2.8 million more than they had to on a bond sale in January, based on trading records from the Municipal Securities Rulemaking Board, which oversees the tax-exempt bond market.

Using the same underwriter repeatedly for negotiated sales increases borrowing costs each time, according to a study published in the Winter 2008 edition of the Municipal Finance Journal. The study found that if an issuer had used the same bank twice before, its borrowing cost on $100 million of 10- year bonds increased by more than $1 million over the life of the debt.

Other financial mistakes can be difficult to quantify. Taylor, who studied government finances for 30 years as the executive director of the MSRB, said as many as five out of 10 local governments “aren’t getting the best deal by a long shot” on their investments.

Overpaid for Securities

Apache County, Arizona, overpaid its broker almost $500,000 for U.S. government securities, county records show. A price check would have caught the problem. The county has no record that it ever did one.

Many local officials are unprepared for Wall Street’s sales pitches, said Mary Christine Jackman, Maryland’s director of investments in Annapolis.

“When you combine people who are less sophisticated with people who can sell as those on Wall Street usually can, you end up with a very big problem,” she said. Jackman tries to offer basic training and advice to small municipalities, she said.

There are more than 89,000 cities, counties, school districts and other municipal authorities in the U.S., according to data from the Census Bureau. Each year, about 5,000 people attend training sponsored by the Government Finance Officers Association, which has 18,000 members, said Jeff Esser, the group’s executive director.

‘Doing Nothing’

The GFOA has never tried to make a comprehensive tally of its members’ educational attainment or professional backgrounds, he said. He added that during his 30 years with the organization, he has seen “a significant increase” in members’ education, training and professionalism.

Supervisors in Mohave County, Arizona, took issue with the professionalism of its treasurer, Lee Fabrizio, during an investigation last year in which employees reported that he played a lot of golf and was rarely in the office.

“It’s nice to get this paycheck for doing nothing,” Fabrizio told employees once, according to the July 2008 report by the county manager.

Fabrizio, who received a $56,500 annual salary, said he doesn’t remember making that statement and was in the office every day. He said he played nine holes of golf a day for two hours at lunchtime.

An employee’s grievance sparked the investigation and ultimately a state audit, which reported Aug. 28 that the treasurer bought corporate bonds with no evidence of competitive bidding, didn’t vet brokers’ backgrounds and continued to value a $5 million Lehman Brothers Holdings Inc. bond at full cost even after the firm’s Sept. 15, 2008, bankruptcy.

Not an Expert

The Lehman bond was purchased in late 2007, when the treasurer put $50 million, about 25 percent of the county portfolio, into 11 corporate bonds, 10 of them in financial firms including Lehman and Bear Stearns Cos.

“Even if it was a bad investment, I wouldn’t have known the difference; I’m not an investment expert,” Fabrizio said, adding that he relied on his hired deputy for those decisions. The deputy e-mailed competing brokers and had them fill out questionnaires, he said.

The county never sanctioned him, and he was voted out of office last year.

The Lehman loss cost the 7,000-student district in Kingman, Arizona, the county seat, almost $1 million, according to Wanda Hubbard, the schools’ finance director. The real losers are taxpayers, who will be levied more as a result, she said. The owner of a $250,000 house in the district may pay $25 extra this year, Hubbard estimated.

‘Back-Door Tax’

“It was kind of a back-door tax increase,” she said.

Officials are up against increasingly sophisticated financial products, including interest-rate swaps and so-called swaptions. A swaption grants the owner the option to force a particular party into a swap.

The Butler Area School District in western Pennsylvania paid JPMorgan $5.2 million last year to cancel such a pact. The payment was about seven times more than the district had received under the contract. Statewide, 55 Pennsylvania school districts have paid counterparties to exit interest-rate swaps since 2003, according to state records.

Some officials now say they didn’t understand the deals.

“The financial guys would come in with a lot of stuff that nobody at the district understood,” Penelope Kingman, a former member of the Butler school board who voted against the deal, told Bloomberg News last year. “Local governments are entering into these without fully understanding what they are doing.”

Market Has Grown

While such contracts aren’t traded on regulated exchanges, the market for municipal derivatives has grown to as much as $300 billion annually, the MSRB says. Derivatives are a category of contracts whose value is tied to assets including stocks, bonds, commodities and currencies, or events such as changes in interest rates or the weather.

One type of derivative, the interest-rate swap, helped put Jefferson County, Alabama, on the brink of bankruptcy.

The county refinanced $3 billion of sewer debt in no-bid deals earlier this decade, issuing variable-rate bonds that were hedged with swaps. The plan backfired last year as the global credit crisis took hold. Interest payments due on the bonds more than tripled to 10 percent, while the swap income decreased.

Last week, the former president of the county commission, Larry P. Langford, went on trial in federal court in Tuscaloosa. Langford, now the mayor of Birmingham, pleaded not guilty in December to charges including bribery, conspiracy and filing false income tax returns.

‘Political Witch Hunt’

Prosecutors say he took cash, clothes and Rolex watches from a banker who received $7.1 million in fees on debt sales in 2003 and 2004. Langford has called the case “a political witch hunt.”

The Justice Department and the Securities and Exchange Commission are investigating whether Wall Street banks conspired with some brokers to rig bids and fix prices for municipal derivatives. The probe centers on interest-rate swaps and on investments that cities, states and schools buy with bond proceeds, according to subpoenas received by agencies in Alabama, Illinois, Pennsylvania and New Mexico.

While many municipalities turn to professional consultants for guidance on derivatives, the MSRB reported in April that 73 percent of financial advisers who participated in the municipal bond market in 2008 weren’t subject to the board’s rules because they weren’t registered securities dealers.

Legislation Considered

Congress is considering legislation to regulate the financial advisers. Still, there are other gaps.

Federal law exempts the municipal market from rules regarding disclosure and enforcement that apply to companies. And transactions between broker-dealers and municipalities are rarely scrutinized by the self-regulatory agencies that banks and securities firms use to police themselves, including the Financial Industry Regulatory Authority, said Taylor, the former MSRB chief.

Finra and other regulators presume that institutional clients are sophisticated enough to look after themselves, he said.

“Typically, what happens is, nobody looks,” he said. “Finra doesn’t look, the firm doesn’t look, the city council doesn’t look and the populace, the taxpaying populace, has no idea any of this is going on.” (GR: This is a typical case of people doing something just because everyone else is doing it regardless of whether they understand what they are doing or not)

Nancy Condon, a spokeswoman for Finra, declined to comment. The Strategic Programs Group of the authority’s enforcement department in May sent letters to dealers seeking information about interest-rate swaps, structured notes and other products they may have sold.

Enforcement Questions

Taylor questioned why the information-gathering hasn’t led to anything further.

“Finra wants the world to think it is doing something for investors and the good of the markets without actually bringing any enforcement actions or adopting any rulemaking,” he said.

In Orange County, the home of both Disneyland and the largest municipal bankruptcy in U.S. history, officials echoed the mistakes of 15 years ago by investing in another Wall Street innovation.

Robert Citron, who was county treasurer leading up to the 1994 bankruptcy, bought structured notes that paid off when short-term interest rates were lower than medium-term rates, and increased his gamble with funds from issuing new debt. The county lost $1.6 billion when interest rates rose.

Cost of Insolvency

Payments from the resulting insolvency still cost more than $80 million annually, about 1.5 percent of the county’s proposed fiscal 2010 budget.

County supervisors responded by creating an oversight committee to monitor the treasurer and banning investments in derivatives and the use of leverage to amplify returns.

Under John Moorlach, the accountant who exposed the bad bets and succeeded Citron as treasurer, the county later invested in structured investment vehicles, or SIVs. Banks set up the pools of loans to shift risk from their own balance sheets. They borrowed money at short-term rates to finance longer-term investments such as British credit-card receivables or home mortgages.

Moorlach said he got into SIVs, which often yielded more than the county’s other investments, after a ratings officer from Fitch Ratings told him that such exotic instruments were becoming more mainstream. (GR: The ratings agencies have been shown to be partial and bought for since many years. And yet, no government authority bothered to dismantle any of them. Quite the contrary, they sponsored and rewarded rating agencies for volume of business)

By 2007, one year after Moorlach won election to the county’s board of supervisors and was succeeded as treasurer by Chriss Street, the investments in SIVs totaled more than $800 million. They made up 14 percent of a county investment pool that manages money for the county, schools and local agencies.

‘Weren’t Paying Attention’

The county sold one SIV at $6.4 million below par last year and so far has recovered about $30 million of the $80 million it invested in Whistlejacket Capital LLC, created by London-based bank Standard Chartered Plc. Whistlejacket, which listed Citigroup Inc. debt and U.K. home loans among its assets, went into receivership last year.

“Despite the oversight, despite the audits, they weren’t paying attention — and should have been,” said Terry Fleskes, a member of an independent panel that chastised the treasurer and county auditor in June for allowing more investments in complex financial products. Fleskes is a former controller at a unit of San Diego-based Sempra Energy.

“The lessons of the past have been forgotten,” the Orange County Grand Jury said in its report. The group, which doesn’t have the authority to compel changes, serves as a kind of ombudsman to examine county policies.

‘Best Stuff Around’

The structured vehicles were difficult to evaluate, Moorlach said. He relied on rating companies, which “were treating it like it was the best stuff around.”

“I think the rating agencies have a lot of explaining to do because of the overreliance by hardworking municipal treasurers,” he said. (GR: Rating agencies can be blamed for what were clearly partial and paid-for opinions on the safety of various investment instruments. However, this fact does not detract from the fact that a Treasurer should know what he is getting himself into. This is what fiduciary duty is all about. One thing is a bank clerk peddling investments to an individual consumer whom may not necessarily know better and would fully rely on the rating agency’s advice. An entirely different thing is when a “treasurer” too relies blindly on the agency advice especially considering that even a cursory look at their prospectus would highlight potential conflicts of interest.)

A Fitch spokesman, Kevin Duignan, declined to comment. (GR: No kidding! I wonder why.)

“It’s easy to point the finger at others,” said Bart Hildreth, dean of the Andrew Young School of Policy Studies at Georgia State University in Atlanta and a former finance director of Akron, Ohio. “The rating agency didn’t authorize the allocation of the money.”

Orange County auditor David Sundstrom said the amount at risk in SIVs was nothing like the leveraged wagers made by Citron.

“The controls compared to pre-bankruptcy are incredibly strong,” he said.

Out of SIVs

The county has exited all of its SIV investments except Whistlejacket, in which it has notes in a restructured successor that’s being liquidated. Taking into account interest earned, the county hasn’t lost on the SIVs, said Deputy Treasurer Keith Rodenhuis. Interest totaled $58.6 million, with $50.2 million in capital still outstanding in the Whistlejacket successor. County officials expect to get that money back in time, he said.

While Moorlach said Orange County did what it could, sending an analyst to London to investigate one SIV and examining financial reports, the investments may have been a mistake.

“If something’s taking up so much of your time, maybe it ain’t worth it,” he said in his Santa Ana, California, office, overlooking a courtyard where volunteers from local churches serve hot dinners and distribute essentials like socks and toilet paper to a 40-deep line of needy people.

King County, Washington, the home of Seattle, has recovered less than half of $207 million that it put into four failed SIVs. It sued rating companies in federal court this month, saying it was misled by their assessments.

No Clue

“There’s a basic rule of finance: Don’t get into anything you don’t understand,” said Michael Granof, an accounting professor at the University of Texas in Austin. “Many municipalities had no clue as to what they were buying.”

Apache County, Arizona, an area the size of Maryland where 70,000 people live among vast mesas dotted with shrubs, stuck to safe investments, such as U.S. Treasury securities and federal agency bonds. It just didn’t know how to value them.

County treasurer Katherine Arviso, a school administrator on the Navajo reservation for 40 years until she won election in 2004, said she arrived to find investment records packed away in boxes.

“I had to put the whole office back together,” she said.

Then came an August 2005 letter from Piper Jaffray Cos.’sBradley Winges, the head of sales and trading for the Minneapolis-based firm’s public finance group. He wrote that the firm had reviewed trades in the county’s account and found unacceptable commissions. The firm credited $247,060.79 to the county’s account.

Eventual Refund

Piper Jaffray eventually refunded $472,060.79, according to a settlement obtained by Bloomberg News under the state public records act. That’s more than double the $194,870 that the county, one of the poorest in the U.S., spent on immunization, teen pregnancy prevention and home health care last year. Apache County’s per capita income was $8,986 in the 2000 U.S. Census, less than half the U.S. figure, $21,587.

Three days after sending the letter, the firm fired broker Eric Ely, according to Finra records. Ely didn’t return telephone messages or respond to an e-mail seeking comment for this story.

From Oct. 20, 2003, to June 29, 2005, Ely executed 103 trades for Apache County, buying and selling bonds, according to a subsequent investigation conducted by Edward “Buzz” France, a former deputy county attorney.

Estimated Commissions

In a presentation to county supervisors, France estimated that Piper Jaffray earned commissions of just over $1 million on $158.6 million in principal, an average rate of 0.638 percent. Investment bankers told France the commissions should have been no more than 0.3 percent.

“Our clients’ interests come first,” Piper Jaffray said in a statement. “Four years ago, we discovered a situation in which we believed one employee had run counter to this guiding principle, and we proactively and quickly worked to rectify any client impact, and terminated the employee.”

There was no need for so many trades if the goal was steady, reliable returns, said Charles Anderson, the former manager of field operations for the tax-exempt bond division of the Internal Revenue Service.

A reasonable commission for the $158 million of securities that Apache County purchased would have been $50,000 to $100,000, said Thomas Tucci, head of U.S. government bond trading at RBC Capital Markets Corp. in New York, one of 18 firms that trade directly with the Federal Reserve.

Not Unusual

Basic financial mistakes trip up many local governments, said Kevin Camberg, a partner with Fester & Chapman P.C., a Phoenix accounting firm that has checked the books of Apache County and others in Arizona for the state auditor.

“It’s not as unusual as it should be,” he said.

France, the county investigator, never determined how Piper Jaffray was chosen to handle Apache County’s investment fund. The treasurer at the time, Betty Montoya, declined to comment on the selection process for this story.

Had the county checked Ely’s licensing history with Finra, which oversees almost 4,800 brokerage firms, it would have found previous allegations of infractions. Since 2002, investors have been able to access BrokerCheck reports of disciplinary histories online, said Condon, the Finra spokeswoman.

Ely paid $80,000 toward a $260,000 settlement of a customer’s 1989 complaint of “unauthorized and unsuitable transactions,” according to Finra records. Ely worked for Merrill Lynch & Co. from 1983 to 1990, the records show.

Settlement in Wyoming

In 2002, Piper Jaffray reached a $42,500 settlement of a customer’s allegations that Ely had purchased and sold securities contrary to Wyoming state law or local investment policy, the records show.

Ely, now affiliated with Public Asset Management Group in Greenwood Village, Colorado, and First Financial Equity Corp. in Scottsdale, Arizona, continued seeking business with small local governments. The broker gave a speech called Investment Management Alternatives for the School at a meeting of the Montana Association of School Business Officials in June 2008.

“He said he was interested in all the smaller players,” said Dustin Zuffelato, who attended as business manager of the 2,400-student Columbia Falls School District Six in Flathead County, Montana.

Zuffelato recommended that his school board consider investing about $8 million with Ely. The board declined, citing the logistical hurdles of switching investments from a pool managed by the county treasurer, he said. Zuffelato said he didn’t check for complaints against the broker first.

Investing 101

In June, the broker appeared again at the Montana schools conference, this time teaching a class called Investing 101.

In Springfield, Calvanese, the former city treasurer, said brokers told him he was investing in money-market funds.

City officials could have learned that they were really buying securities that bundle various issuers’ bonds or loans, or both, if they had insisted on seeing disclosure documents about the securities. Calvanese said in an interview that he rarely looked at such documents, which outline risks.

Calvanese was fired after the CDO investment came to light. He has filed suit challenging his dismissal.

Springfield officials and the Massachusetts attorney general argued that the city was misled by its brokers from Merrill Lynch, who sold it financial instruments that violated a state restriction on public investments. Calvanese said the brokers assured him the transaction complied with state law.

Merrill Lynch, now owned by Bank of America, returned the $14 million the city had invested, and agreed to pay an additional $300,000 in July.

A $75,000 portion of that money was set aside for educating municipal officials on investment management.

To contact the reporters on this story: Peter Robison in Seattle at robison@bloomberg.net; Pat Wechsler in New York at pwechsler@bloomberg.net; Martin Braun in New York at mbraun6@bloomberg.net

GR: The moral of the story is that for as long as things are going in one direction, nobody can be bothered to go and look at the detail. Those that do are considered party poopers and those that opt out of what everyone else is doing are routinely blamed for substandard performance and may even lose their jobs. On the other hand when public finances are being squandered and pillaged at the highest echelons of government, how can lower ranking administrations officials be blamed for doing what their bosses are doing? Acting on principle and moral standing will very easily make your life impossible during the blow off phase of the inflationary dynamic.

Detroit house auction flops for urban wasteland

October 26, 2009

County tax revenue is on the ropes and about to hit the mat. Make no mistake. The only difference between a County and the Federal State is that the latter can, for a time, maintain the illusion of solvency by borrowing more. However, it is now abundantly clear that the Federal Government can now only buy government debt from itself. This is what monetization is all about.

A fiat monetary system of floating exchange rates, depends on each sovereign country member of the system buying another country’s debt. If you are able to visualize the absurdity of this system in the first place, then the reasons that will signal the system’s demise should be clear too.

Governments purchasing their own debt rather that the debt of other countries is a clear sign that the system has broken down.

A breakdown in the tax revenue flow at city, municipal, county and state level guarantees that there is a breakdown in tax revenue at federal state too. The fact that governments today are monetizing their own debt guarantees that the fiat monetary system has broken down.

As social costs rise and as social expenditure must by necessity be curtailed, civil unrest will rise. As civil unrest rises, governments will fall.

No western politician is about to relinquish power. Before civil unrest will get out of hand, we’ll have us a world war.

http://news.yahoo.com/s/nm/20091025/us_nm/us_usa_housing_detroit

After five hours of calling out a drumbeat of “no bid” for properties listed in an auction book as thick as a city phone directory, the energy of the county auctioneer began to flag. OK,” he said. “We only have 300 more pages to go.” […] “Despite a minimum bid of $500, less than a fifth of the Detroit land was sold after four days. The county had no estimate of how much was raised by the auction, a second attempt to sell property that had failed to find buyers for the full amount of back taxes in September.”


Houses at $7000 (seven thousand Dollars)

October 16, 2009

The cost of a house can never drop below construction cost right?

Right?

http://finance.yahoo.com/news/At-foreclosure-auctions-rb-853906128.html?x=0&.v=1

We’re having a difficult day,” said Tom Atkins of Zetabid, the company holding the auction. “There was a $1,000 property that no one bid on. You’d think a slum lord at the very least would buy it and put a (federal housing assistance voucher) renter in there for $600 a month.”

Deflation – employment, wages, tax revenue

October 15, 2009

Few are ready for a bout of deflation. Even fewer understand the consequences of a deflationary recession which at this point is probable will turn into a depression.

In an unchecked fiat monetary system, inflation progressively becomes the ultimate and only goal. Towards the end of the inflationary dynamic, credit creation expands exponentially till inflation overwhelms the GDP number. The natural result is that financial value progressively runs away from intrinsic value at an accelerating rate. However, when the underlying economy no longer generates sufficient revenue to service the debt, then asset liquidation is the only solution.

Asset liquidation causes a decrease in nominal wealth, thus in earnings. Decreasing earnings have a double effect: they are responsible for lower tax revenue for the state and they cause layoffs. In turn, layoffs put more pressure on the state in two ways: first because unemployed people pay less taxes but need more state services and second because unemployed people consume less thus generating less revenue for the private sector and, yet again, less revenue for the state and more layoffs.

http://www.nytimes.com/2009/10/14/business/economy/14income.html?_r=2&hpw

In recent decades, layoffs were the standard procedure for shrinking labor costs. Reducing the wages of those who remained on the job was considered demoralizing and risky: the best workers would jump to another employer. But now pay cuts, sometimes the result of downgrades in rank or shortened workweeks, are occurring more frequently than at any time since the Great Depression.

http://www.summitdaily.com/article/20091013/NEWS/910139995/1055/RSS01

Colorado voters approved an adjustable minimum wage in 2006. Supporters of that amendment said they did not intend for wages to fall, but the provision allowing it to fall was crucial to its passage. They have pointed out employers of the estimated 50,000 to 70,000 Coloradans making minimum wage are free to leave wages flat.

http://www.baltimoresun.com/news/maryland/baltimore-city/bal-md.ci.pension14oct14,0,7605979.story

An unusual pension benefit for police and firefighters could cost Baltimore $164.9 million next year, nearly double what the city is now paying and a figure that the city’s finance director says taxpayers cannot afford. […] Pension costs for the roughly 5,800 retired police and firefighters are soaring at a time of deep budget problems. The city recently forced employees to take five unpaid furlough days, laid off workers and halted capital projects to chop $60 million from its current budget. Declines in projected tax revenues and cuts from the state prompted cuts. Another round of budget reductions is expected early next year.

For all intents and purposes, most people alive today, particularly in the West, have lived in an inflationary environment that has caused a steady rise in the cost of living. Few can contemplate an environment of falling wages and reduction of public services let alone the discontinuation of some public services that we have come to take for granted.

When the streets of Western capitals will be teeming with unemployed, homeless and angry citizens, a world war will be the only way our politicians will be able to maintain a grip on power. It has happened before. There is absolutely no reason why it should not happen again this time around. Deflationary busts are stealthy, insidious even if all too predictable.

Got bullion?

Curtailing public spending – a precursor to war

October 11, 2009

http://news.yahoo.com/s/nm/20091009/pl_nm/us_usa_state_budgets

Excerpt:

Lower tax revenues could lead to higher taxes or another sharp reduction in services if receipts do not show signs of improvement before year-end, as every state but Vermont is required by law to balance their budgets.

That could mean fewer teachers, early prisoner releases and fewer highway repairs as residents battle soaring unemployment. ”

The article repeatedly alludes to “signs of recovery” but from where I am standing, that is just wishful thinking. I will give you that the stock market has bounced higher and farther than most people expected. However, other than the fact that there is little short term relation between the stock market and the economy, similar bounces are not unprecedented in times of deep recessions. What matters is that industrial capacity utilization is still too low, unemployment is still rising and the money multiplier is still stuck below 1 despite the gargantuan financial effort put out by the financial authorities of the world. Finally, credit is still contracting at a fast clip:

http://www.marketwatch.com/story/banks-cutting-back-on-loans-to-businesses-2009-10-09