Posts Tagged ‘treasury’

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.

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A change in sentiment?

October 17, 2009

It would appear that the main stream media is in the process of becoming somewhat more critical of government action and may be willing to take a stand against what are flagrant and obvious illegal if not criminal practices.

Here is a clip by MSNBC’s Dylan Ratigan whom along with a number of other commentators I cannot recall ever questioning the actions of our “leaders” and monetary “authorities”.

I don’t know what is causing the change in sentiment in the main stream press and, for the time being, I reserve judgment.

The information provided in the video clip is factual if greatly watered down. I suspect the watering down is necessary to make it intelligible to the greatest number of people. For example, it is true Goldman Sachs have taken public money and have made a killing by acquiring assets at distressed prices at the height of the financial panic. What is not explained is how Goldman Sachs should know which assets to acquire. That, is a much more complex concept that relates to far more criminal behavior than taking public money and retaining all the profits. If you browse any of the blog sources you find on my blog such as Karl Denninger or the team at Zero Hedge or search for High Frequency Trading on my blog (HFT) you will realize that criminal behavior runs deep and involves government collusion. HFT is not the only illegal action undertaken by GS or the government. There are dozen of other instances of criminal collusion and contravention to the letter of the law. Things like the suspension of mark-to-market rules for example. How about taking over Fannie Mae and Freddy Mac two clearly private enterprises that have never been government sponsored entities? Or the riding roughshod over GM bondholders but unilaterally and arbitrarily sparing bank bondholders. How about the information black-out imposed by government on who got TARP money and how much?

The list of acts of fiduciary negligence and criminal activity is fairly long and was heralded by numerous red flags along the way.

However, what seems to escape most people is what might have caused this latest crisis. Indeed, is there one overarching action or decision or dynamic that can be highlighted and pointed at that would explain what is happening today?

If you’ve read any of my posts, I think there is.

In my opinion, this is nothing but the logical conclusion of the dynamic brought about by our monetary system. That is, what is happening today is nothing but the direct and logical consequence of the use of an unchecked fiat monetary system.

Incidentally, I wish everyone to realize that although we live in societies that are presumably steeped in economic and personal freedom, no government anywhere in the “free” West has ever asked ratification for their unilateral and arbitrary choice of monetary system.  Even worse, in our presumed economically free capitalist societies, government retains the power to set interest rates.

Once the government of a democratic society awards itself the right to impose the monetary system and manipulate interest rates, the one logical and inescapable outcome is the gradual erosion of the purchasing power of the unit of currency i.e. inflation.

Inflation is a dynamic that is both exponential in nature and, therefore, limited mathematically. Being exponential, inflation has a number of preordained and inevitable effects on society and the economy. One of the inescapable ramifications of inflation is that by artificially, pervasively and aggressively inducing inflation into a monetary system, government induces a rise in price level hence a rise in GDP. However, as GDP progression becomes ever more dependent on generating more inflation, the intrinsic wealth structure of society is progressively impaired. As the dynamic progresses, financial value runs away from intrinsic value at ever greater speed until the only way to induce more inflation requires ever greater degrees of government collusion in carrying out actions that eventually become criminal. This causes government to become an ever greater actor in the economy and eventually the existence of the political structure becomes dependent on generating ever more inflation.

But since expanding government can only subsist if it is financed by increasing tax revenue, then the generation of ever greater inflation becomes a goal unto itself.

The problem is that the logical conclusion of a fiat monetary system is known and inevitable. It has happened before. We know how it ends. Government intervention can at best stretch out the time line but cannot avoid the conclusion. In the process, government becomes a progressively larger actor in the economy. But as government is a non profit construct, its existence is predicated on increasing tax revenue thus progressively sapping the life blood of the economy.

The point at which the economy no longer generates enough revenue to service debt, that is the point at which financial value spurred on by leverage and gimmickry (i.e. hedonic adjustments, CPI manipulation, absurd leverage of 80 t0 1 )  is the most distant from intrinsic value. At that point, due to the yawning gap between what assets are worth on the market and the amount of debt that needs to be extinguished, returning to equilibrium causes social and economic devastation in the form of rising unemployment and a reduction of social services expenditure (road maintenance, mail delivery, social medicine, teacher salaries, civil servant salaries, food stamps… pensions… ).

Historically, similar junctures have resulted in world wars. We can only hope that this time will be different. But hope, as you know, is not a sound strategy.

http://www.msnbc.msn.com/id/31510813/ns/msnbc_tv-morning_meeting/#33346455

(look for “Ratigan: Goldman Sachs magic trick”)

Must read – Karl Denninger

August 20, 2009

And here is proof of government complicity in illegal and criminal deception.

http://market-ticker.org/archives/1352-We-Need-RTC-II-NOW.html

Stop the looting now (Karl Denninger)

August 11, 2009

And this, ladies and gentlemen, is the how and why we are hurtling towards a world war. The kitty is empty and no Western politician worth his salt will ever admit it or do what is required. And now that high unemployment is guaranteed and that large swathes of society will become destitute and could, very likely, revolt, we’ll just conjure up some nasty character somewhere and we’ll tell the great unwashed that something evil is being plotted against Western society and “freedom”.

http://market-ticker.org/archives/1317-DAMNIT,-STOP-THE-LOOTING-NOW!.html

Excellent reading today

August 11, 2009

Some outstanding essays from Gary Shilling via John Mauldin and from Dave Rosenberg via Mike Shedlock.

First Gary Shilling (GS):

http://www.investorsinsight.com/blogs/john_mauldins_outside_the_box/archive/2009/08/10/slow-long-term-growth-and-government-s-response.aspx

It is a long read packed with insightful information and graphs that are really worth your time. Not withstanding his conclusion and the dynamics that lead him to it, that I tend to wholeheartedly agree with, in my opinion GS too fails to explain the how and why of the dynamics.

For exmaple, in the opening paragraph, GS correctly identifies the problem when he says: “Beyond the current recession, the worst since the 1930s, lies years of slow growth…” . However, GS does not explain how and why we’ve had slow growth for many years. Because to be correct, we’ve had slow “real” growth. But other than real growth, GDP has been chugging along at an average of 4% yoy at a nominal rate. Hence the question I ask in many of my essays. That is, in a service economy that is composed of 70% consumption, how much real wealth is created in a 4% yoy progression? The answer of course is to be found in the quantity of inflation that is induced into the system. Considering that inflation as measured by the growth of credit and money supply has been progressing at an average 10% yoy (with peaks at 20%), it is immediately evident that there has been little “real” wealth generated. However, even identifying the cause of weak “real” growth does not explain why that should have been so. And the answer to this question, of course, is to be found in the choice of monetary system. A choice, I might add, that is arbitrary and unilateral and has never been submitted to the people for ratification. So, by completely disregarding the monetary system, GS still falls for many popular myths on which more later.

Also, although he identifies increased government regulation as a drag on the economy, in reading the paragraph I cannot help but get the feeling that GS may agree with some of the proposed regulation. However, other than forcing derivatives on an exchange, I strongly disagree that any increased regulation might help preventing anything. We do have strong regulation but enshrined in the Fiat monetary logic is the necessity to disregard practices that are initially border line legal but that, as the inflationary dynamic develops, become down right illegal and criminal – (SIVs, off balance sheet entities, mark to model accounting … ). Once again; the fiat monetary logic conforms to the law of diminishing returns. Therefore you always need greater degrees of inflation in order to bring about the same GDP expansion. Once the inflationary logic goes beyond its half way point, fraud is virtually guaranteed by necessity and aided and abetted by government.

Somewhere in the essay GS also believes in the “savings glut” claptrap. There is no such thing of course. What there is instead, is a fiat monetary system that is predicated on inflation and is inherently exponential in nature. Thus inducing ever greater quantities of inflation in the system results in the logical transition from a manufacturing economy to a service economy which, by necessity, becomes an economy based on imports and consumption. That being the case, inflation (as measured by money supply and credit) is exchanged for goods and services overseas. So, the savings glut would not exist if it weren’t for excessive inflation of the global reserve currency: i.e. the US Dollar.

Somewhere in the essay, GS also says that “bankers fear inflation”. To which I can only say: right! Inflation is the conditio-sine-qua-non of the fiat monetary system. Bankers’ only way to make money is to generate inflation. In the absence of inflation, banks would have to create far less credit and money thereby limiting profits. In a fiat monetary system the authority that is charged with creating money does so and charges interest. In the particular case of the USA, the Federal Reserve creates the money and gives it to the Treasury and charges interest in the process. Thus, every Dollar bill that leaves the Fed is devalued by that much. The less intuitive ramification of this monetary system is that debt can never be repaid. That’s because if you rustled up all the coins and $ bills in circulation and gave them back to the Fed, you would still owe them interest on the last bill that was created and delivered. Thus, a fiat monetary system can only survive in an inflationary environment. Absent inflation, the fiat monetary system implodes and with it so do governments.

Also, in chart 9, GS seems to think of inflation in terms of prices. Prices of course are a function of inflation; they are the manifestation of inflation but are not the cause.

Towards the end of the essay, GS states that he sees local government and state spending increasing at 5% and says that as tax revenue dwindles at state level, the money will have to come from Washington. Of course, if you’ve read any of my essays, you will know that there is very little difference between individuals, corporations, local government, state government or, indeed, the Federal Government. That is, when bankruptcy overwhelms individuals and corporations, it will progressively overwhelm local, state and Federal Governments too. So, we may want increased spending from our governments but in a situation of global bankruptcy and rising interest rates, governments will have a hard time borrowing even more than what they already have. Not only that, but how much more production capacity can we really absorb world wide? I mean, considering that industrial capacity utilization has been steadily declining over the years thereby progressively eroding pricing power, why should we create even more of it now?

I have to run now and will polish and add to my comments at a later date. For the time being do read the two essays from Gary Shilling and Dave Rosenberg because they are really worth it.

Dave Rosenberg essay via Mike Shedlock

http://globaleconomicanalysis.blogspot.com/2009/08/us-consumer-credit-shows-steepest.html

Really?! I like the odds of taking the other side of this bet

August 2, 2009

Just posting this article so I can refer back to it five years from now.

Welcome to the bottom: housing begins slow rebound

http://finance.yahoo.com/news/Welcome-to-the-bottom-Housing-apf-3190332284.html?x=0&sec=topStories&pos=1&asset=&ccode=

The futility of stimulus on the back of an over stimulated economy

August 2, 2009

This is a chart of US deficit spending since 1935

FRED Graph

The following, is the related chart of US government borrowing (debt)…

Graph: Gross Federal Debt

… and this is a chart of US GDP year on year (yoy) percentage progression …

FRED Graph

All charts are official US government data provided by the Fed of St Louis. And although self explanatory, I am going to parse what these charts mean.

The short explanation is that despite borrowing and spending ever increasing amounts of money, we are not getting wealthier and each additional dollar of “stimulus” has an exponentially decreasing effect on GDP expansion with the result that Western governments are today bankrupt and, by necessity, are shifting towards a fascist form of government.

The longer answer.

As stated in previous essays, government is not a for profit entity. Government’s only income is through taxes (licenses, fees, duties, income taxes, inheritance taxes, sales tax, stamp duty …).

Just like you and me, if government spends more than what it receives in taxes, then it must borrow the difference.

Just like you and me, when government borrows money, it pays interest. The more money you borrow, the more money you have to spend on interest… but… government has no income so it can only pay more interest if it extracts more money from the economy in the form of taxes.

If you can get your head around that, then observe the charts I present above.

What the first chart at top indicates is that the US government has pretty much always run a deficit. In other words, the US gov has consistently spent more than what it earned and other than an outlier during the Clinton era, the secular trend has resumed its downward trend with a vengeance.

Before you stand up and clap for Clinton, observe the next chart in the middle.

Although in the first chart it would appear that Clinton brought deficit spending under control during his tenure, the second chart shows that his borrowing did not abate.

The third chart is the chart of US GDP yoy progression that you will find in many of my essays.

When you take the three charts together, the conclusion is inevitable. The US gov has consistently spent more than what it made in taxes and made up the shortfall by taking on increasing quantities of debt…. but GDP has only ever progressed at a rate of 3% year on year with occasional peaks at 6%

So, despite having overspent like the proverbial drunken sailor for the best part of the last forty years, despite having borrowed sums that have no comparison in human history, we’ve only ever been able to get GDP growing at a clip of 3%yoy.

But wait. That’s not all!!

Not only has GDP only progressed at 3%yoy but, in the meantime, we’ve become a service based economy to the point that consumption constitutes 70% of GDP. This is important to the extent that somebody should ponder the question of how much real wealth is created in a consumer economy; i.e. what part of the 70% of consumption creates the conditions and the means to create something else.

But wait. That’s not all!!

Not only has GDP only progressed at 3%yoy and, along the way, we’ve become a service economy but debt and the monetary base have consistenly expanded at an average of 10%yoy over the past forty years. When money and credit expand faster than the economy, you have inflation. So, a good chunck of that 3% is due to inflation really.

As I point out here, here, here and here, a fiat monetary system combined with “democracy” has an inherently logical and inescapable conclusion. The only variable is time; i.e. how long a government can postpone said conclusion. A fiat monetary system is in fact a pyramid scheme; that is, its existence is predicated on your ability to bring new contributors in at the bottom of the pyramid.

I maintain that our modern fiat monetary system was conceived along with the inception of the US Federal Reserve in 1913. Since then, as the hegemon, the US was able first to manipulate gold’s convertibility domestically thus creating the conditions for unchecked inflation which brought us to 1929. That first crisis lead us straight into WWII. After that, the US was still able to use inflation and debt to carry out hegemonic activities like the Marshall Plan, putting a man on the moon and expanding the military and nuclear arsenal till the late 60s when the cows came home. At that point, Bretton Woods was abrogated and the US convinced all then industrialized countries to abandon a monetary system based on gold and to adopt instead the US$ as their reserve currency along with fiat money. Thus, the hegemon was able to bring in several new contributors at the bottom of the pyramid. Then in order to keep feeding the pyramid, we immediately set to work on the Euro to devalue the currencies of the European countries thus giving a breath of fresh air to the now interconnected global monetary system as well as globalization thus brining in all other countries in on the US$ reserve fiat monetary system.

Great.

Except that today, short of introducing a new world currency, we have run out of contributors to bring in at the bottom of the pyramid.

Of course, if you scan my blog you will find clues that, indeed, we are working on a world currency. The question is, can we effectively introduce a global currency in useful time to give the global US$ based fiat monetary system some new wind. “Useful” time here means in a few months from today!

So, unless someone, somewhere, does not come up with a brilliant idea to restart a modicum of inflation, we are pretty much looking at the same situation the US found itself in at the end of the 60s – that is, sovereign countries are staring at bankruptcy.

Of course, by now you know that I maintain that no Western country will admit to bankruptcy. But as unemployment climbs to unprecedented heights and as social services are reduced and then necessarily discontinued, the West becomes a tinder box of social unrest. As Western governments feel they are losing their grip on power, they will engineer a war.

At this rate and unless something changes in the coming months, I say we have us a global conflict by 2013/2015

Got bullion?

Deflation, deflation, deflation…

August 1, 2009

… leading to… revolution or world war…

http://www.bloomberg.com/apps/news?pid=20601087&sid=aBevuxMdwyDU

http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aM5.JQngUK44

http://finance.yahoo.com/banking-budgeting/article/107445/after-rescue-new-weakness-seen-at-aig.html?sec=topStories&pos=5&asset=&ccode=

Here are your green shoots

July 29, 2009

Hat tip to Zero Hedge

What matters here is not so much the number of banks going under. What matters is the stress that is placed on the FDIC… the same FDIC that is supposed to sponsor the PPIP and that is supposed to back stop any and all banks including the “big boys” that as some point will blow up too.

https://i1.wp.com/www.zerohedge.com/sites/default/files/images/7-24-09-bank-failures.gif

Bank of International Settlements June 09 report

July 29, 2009

This is a brief explanation of fiat money, the inflation dynamic and the role of debt along with the BIS’s December 2008 report

https://guidoromero.wordpress.com/2009/07/02/inflation-deflation-fiat-money-currencies/

Today we have the BIS’s latest findings along with Zero Hedge’s comment as an added bonus…

http://www.zerohedge.com/article/fitch-financial-companies-hold-997-all-derivative-contracts

Folks! Things are not getting better at all. You laugh; three years from now you’ll be scanning these pages again!