Posts Tagged ‘crisis’

Cartoon of the day

Posted: 11 June 2016 in Uncategorized
Tags: , ,

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Next week, after the Memorial Day recess, the entire House is expected to take up the bill, which last week was approved (by a vote of 29-10) within the House Natural Resources Committee, with support from the White House, to handle the Puerto Rico debt crisis.

The folks at the Wall Street Journal couldn’t be happier.

The bill offers debt relief to Puerto Rico in return for a mechanism to overrule the territory’s feckless current government and impose reform. The legislation explicitly pre-empts conflicting laws and regulations passed by the commonwealth. It also stipulates that legal challenges will be heard in federal rather than commonwealth court.

The key to the reform is a seven-person control board modeled after the board that pulled the District of Columbia out of a debt spiral in the 1990s. The President would select the board from nominations by the House Speaker (two), Senate Majority Leader (two), House Minority Leader (one) and Senate Minority Leader (one). The President has sole discretion to choose the seventh. The appointments must be made by Dec. 1, and the terms last three years, so the GOP majority’s choices will steer the board’s crucial early decisions. . .

After ensuring that financial audits and a fiscal plan have been completed, the board would propose a plan of adjustment that is fair and equitable. The legislation explicitly requires that the plan respect creditor priorities and liens and be “in the best interest of creditors.” So if Democrats later control the board, they couldn’t subordinate general obligation bondholders to pensioners.

As we know, similar programs elsewhere—in Europe (e.g., Greece) and in the United States (e.g., Detroit and Flint)—have proven disastrous, at least for the majority of the population. They have only helped the “vulture creditors,” who have already profited enormously from extending high-interest loans and purchasing tax-privileged bonds. In each case, the possibility of real debt relief was scuttled in favor of repaying the creditors and imposing the kinds of economic and political “reforms” elites both inside and outside have long wanted to implement.

Last August, Joseph Stiglitz and Mark Medish warned that Puerto Rico “can’t pay its debts today, and with short-term debt financing at the high interest rates demanded by creditors, it will be even less able to pay its debts tomorrow.” As for the United States, it needs to

take responsibility for its imperialist past and neocolonial present. Washington owes Puerto Ricans a future based on democratic legitimacy and a financially and socially viable development strategy—a development strategy that is more than a set of tax breaks for profitable U.S. corporations.

The new deal is exactly the opposite of taking that responsibility, since (as Erik Levitz [ht: sm] explains) it means establishing “a pseudo-colonial shadow government tasked with trading debt haircuts for austerity measures.”

It should come as no surprise, then, that Bernie Sanders, in the midst of his own presidential campaign, is strenuously campaigning against the bipartisan Puerto Rico deal.

In my view, we must never give an unelected control board the power to make life and death decisions for the people of Puerto Rico without any meaningful input from them at all. We must not balance Puerto Rico’s budget on the backs of children, senior citizens, the sick and the most vulnerable people in Puerto Rico.

Moreover, this legislation requires that any restructuring of Puerto Rico’s debt must be “in the best interests of creditors,” not in the best interests of the 3.5 million U.S. citizens living in Puerto Rico.

“Not in the best interests of 3.5 million U.S. citizens living in Puerto Rico”—who may soon find themselves in the same position as the citizens of Greece, Detroit, and Flint.

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Special mention

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The Social Security system, now in its 81st year, is (according to the Congressional Budget Office [pdf]) solvent until 2029. In that year, the trust fund will be exhausted—but, still, even without any changes, the program will be able to pay out at least 71 percent of mandated benefits. And all it would take is eliminating the earnings cap (currently $118,500) to make the program fully financed for the foreseeable future.

But you wouldn’t know that from Wharton economist Olivia S. Mitchell, who like many others who have attempted to propose “reforms” to the system attempts to gin up the numbers. Her particular version is to get people to delay taking their monthly payments by promising them a lump-sum payout at the later date.

The problem, of course, is we should be doing exactly the opposite—lowering the retirement age and expanding benefits (which we could do by eliminating the earnings cap).

Even more, as Michael Hiltzik explains, Mitchell cites a particular statistic in order to create the specter of a system facing imminent crisis, to which she can then offer a “painless solution.”

The questionable part of her article appears near the bottom, where she writes:

“The Social Security shortfall is enormous. Actuaries have estimated that it’s on the order of $28 trillion in present value. That’s twice the size of the gross domestic product of the U.S. So a small delay in claiming won’t solve the problem. We’re also going to have to change the benefit formula. We’re going to have to make changes in the retirement age.” (Emphasis added.)

Most Social Security experts view that $28-trillion figure as a red flag. That’s because many people who cite it are ideologues aiming to scare the public into thinking the program’s finances are far worse than they really are. Let’s see what makes the statistic, and Mitchell’s use of it, so misleading.

The figure is an estimate of the present value of Social Security’s unfunded obligation not as it exists today, but as if it were calculated out to infinity. Economists find the so-called infinite horizon model useful in some contexts. But as it’s typically applied to Social Security it’s beloved by ideologues because it produces a really big, and really scary, estimate of the accumulated deficit.

The infinite projection appears in the annual Social Security Trustees Report, but its placement there is controversial. The Social Security Advisory Board’s 2015 technical panel of economists, actuaries and demographers recommended dropping the infinite projection from the trustees reports altogether, for two reasons. One is that it incorporates enormous uncertainties. Estimating costs, revenues and policy changes for Social Security’s conventional 75-year forecasts is hard enough; the influences playing on the program hundreds or thousands of years into the future are literally unimaginable. That makes the infinite projection “unhelpful as a guide to policy-making,” the panel reported.

The second reason is that it’s so vulnerable to misinterpretation. As an earlier technical panel observed, the projection is sometimes “quoted in policy discussions without including its relation to corresponding GDP, which is both misleading and shifts the focus from more useful metrics.”

Interestingly, that’s exactly what Mitchell does. (We should mention in passing that Mitchell actually gets her numbers wrong. The infinite projection deficit, as published by the trustees in their most recent report, was $25.8 trillion as of Jan. 1, not $28 trillion; U.S. GDP, according to the Bureau of Economic Analysis, was $18.2 trillion as of the end of 2015, not $14 trillion as Mitchell implies.)

In her MarketWatch article, Mitchell doesn’t disclose that the figure she’s citing is the infinite projection, which could lead some readers to think she’s talking about Social Security’s current deficit. (In current terms, Social Security actually runs an annual surplus and is expected to do so until 2020.) Even worse, she juxtaposes it with current gross domestic product by stating that it’s “twice the size” of GDP today. The unwary reader might be led to think that a Social Security “crisis” is on the verge of bankrupting the U.S. in the here and now. . .

Mitchell’s lump-sum plan might be a useful element in a Social Security fix if it were entirely clear that a fix was necessary. But the fact that she relied on an exaggerated statistic to make her case suggests that there may not be such a strong case, after all.

The CBO’s projection of the 75-year actuarial deficit of the Social Security program as a share of GDP is only 1.45 percent—not nearly as dramatic as Mitchell’s statistic. It’s a number that doesn’t conjure up crisis or induce panic. All it suggests is that “tweaking” the system (by, as I suggested, raising the earnings cap) will make the program solvent and create the space for what we should really be doing, lowering the retirement age and expanding benefits for American workers.

Lies, damned lies, and Mitchell’s statistic serve a very different purpose.

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The latest bank to admit criminal fraud is Wells-Fargo. The largest U.S. mortgage lender and third-largest U.S. bank by assets, Wells-Fargo deceived the U.S. government into insuring thousands of risky mortgages, and formally reached a record $1.2 billion settlement of a U.S. Department of Justice lawsuit. Several lenders, including Bank of America Corp, Citigroup Inc, Deutsche Bank AG, and JPMorgan Chase & Co, previously settled similar federal lawsuits.

To read Paul Krugman (who’s “been doing a lot of shovel work for the Hillary Clinton campaign lately”), the real problem in the run-up to the spectacular crash of 2007-08 was not Too Big to Fail banks like Wells-Fargo, but the so-called shadow-banking system. But, as Matt Taibi [ht: db] explains, “Krugman is just wrong about this.”

The root problem of the ’08 crisis lay in a broad criminal fraud scheme in the mortgage markets. Real-estate agents fanned out into middle- and low-income neighborhoods in huge numbers and coaxed as many people as possible into loans, whether they could afford them or not.

Those loans in turn were bought up by giant financial companies on Wall Street, who chopped them up into a kind of mortgage hamburger. Out of this hamburger, they made securities. These securities were then sold to institutional investors like pension funds, unions, insurance companies and hedge funds.

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source (pdf)

There’s no doubt shadow-banking activities surpassed those of the traditional banking system in the years leading up to the crash. But—and this is crucial—they weren’t two separate systems or sets of institutions; they were just two different sets of activities by a wide variety of firms within the financial system. And so-called traditional banks were heavily involved in the shadow-banking activities.

The two economically most important shadow banking activities are securitization and collateral intermediation. According to Stijn Claessens, Zoltan Pozsar, Lev Ratnovski, and Manmohan Singh,

The first key shadow banking function, securitisation, is a process that repackages cash flows from loans to create assets that are perceived by market participants as almost fully safe and liquid. The repackaging occurs in steps, and takes the form of risk transfer. First, risky long-term loans are ‘tranched’ into safe and complementary (‘equity’ and ‘mezzanine’ respectively) tranches. Then the safe tranche is funded in short-term money markets, with additional protection provided by liquidity lines from banks. The resulting assets, such as Asset-Backed Commercial Papers (ABCPs), were regarded prior to the crisis by market participants as safe, liquid, and short-term, i.e. almost money-like, but with returns exceeding those on short-term government debt. . .

Another key function of shadow banking is supporting collateral-based operations within the financial system. Such operations include secured funding (of bank and, especially, nonbank investors), securities lending, and hedging (including with OTC derivatives). Collateral helps deal with counterpart risks and more generally greases financial intermediation. One of the main challenges in using collateral is its scarcity. The shadow banking system deals with the scarcity through an intensive re-use of collateral, so that it can support as large as possible a volume of financial transactions. The multiplier of the volume of transactions to the volume of collateral (the ‘velocity’ of collateral) was recently about 2.5 to 3.

The key is that traditional banks (such as Goldman Sachs, Morgan Stanley, JP Morgan, Bank of America-Merrill Lynch, and Citibank in the United States, in addition to Barclays, BNP Paribas, Crédit Suisse, Deutsche Bank, HSBC, Royal Bank of Scotland, Société Générale, Nomura, and UBS elsewhere—all of them classified as “strategically important financial institutions”) both financed and directly participated in shadow-banking activities. The traditional banks made record profits from those activities and served both to expand shadow banking and to increase the degree of risk, instability, and contagion.

In other words, traditional banks played a key role in creating the financial house of cards that came crashing down in 2007-08.

So, it’s simply wrong to assert that Too Big to Fail or Jail banks were peripheral in creating the conditions that caused the global financial crisis—or, for that matter, that continue to plague the financial system today.

What this means is that regulating and transforming the financial system—by taxing financial transactions, breaking up the now-Too Bigger to Fail banks, and creating new forms of financial intermediation (such as various forms of public and community banking)—are still on the agenda.

It’s time, then, to bring both the financial system and arguments by mainstream economists that attempt to shield traditional banks and their favorite political candidates out of the shadows.

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