February 21 – CNBC (John Carney): “The Washington Post ran a long and well-wrought article on Modern Monetary Theory over the weekend. The piece, by Dylan Matthews, starts with Jamie Galbraith’s experience trying to explain to a large audience of economists in the Clinton White House that the budget surpluses the federal government was running was immensely destructive. Or, rather, it starts with those economists laughing at Galbraith’s attempt to explain this. It was obvious to me way back before I had ever heard of MMT that governments should probably never run a budget surplus—or should do so only in dire emergencies. When the government runs a surplus, that means it is taking more money out of the economy than it is spending back into the economy. It is making us poorer.”
In my initial CBB back in 1999, I trumpeted the need for a Contemporary Theory of Money and Credit. Some thirteen years later, I lament that the void remains as large as ever. Mr. Matthews’ Washington Post article highlighted “Modern Monetary Theory,” an alternative economic framework with Keynesian roots that is receiving heightened attention in our age of unrelenting government stimulus. I will not be jumping on board.
From Mr. Matthews’ article: “‘Modern Monetary Theory’ was coined by Bill Mitchell, an Australian economist and prominent proponent, but its roots are much older. The term is a reference to John Maynard Keynes, the founder of modern macroeconomics. In ‘A Treatise on Money,’ Keynes asserted that ‘all modern States’ have had the ability to decide what is money and what is not for at least 4,000 years. This claim, that money is a ‘creature of the state,’ is central to the theory. In a ‘fiat money’ system like the one in place in the United States, all money is ultimately created by the government, which prints it and puts it into circulation. Consequently, the thinking goes, the government can never run out of money. It can always make more.”
And from Wikipedia: “Chartalism is a descriptive economic theory that details the procedures and consequences of using government-issued tokens as the unit of money, i.e. fiat money… The modern theoretical body of work on chartalism is known as Modern Monetary Theory (MMT). MMT aims to describe and analyze modern economies in which the national currency is fiat money, established and created exclusively by the government. In MMT, money enters circulation through government spending; Taxation is employed to establish the fiat money as currency, giving it value by creating demand for it in the form of a private tax obligation… Because the government can issue its own currency at will, MMT maintains that the level of taxation relative to government spending (the government’s deficit spending or budget surplus) is in reality a policy tool that regulates inflation and unemployment, and not a means of funding the government’s activities per se.”
My “contemporary theory…” takes an altogether different approach. “Money” is not foremost a creature “ultimately created by the government,” but is instead primarily an issue of market perceptions. “Money” is as money does (“economic functionality”). The reality is that we today operate in an age of globalized electronic Credit – a comprehensive virtual web of computerized general ledger debit and Credit entries linking creditors and debtors round the globe. This “system” of electronic IOUs comprises myriad types of financial obligations of diverse structure, maturity, Creditworthiness and currency units of accounts. Importantly, if the marketplace perceives that a Credit instrument will act as a highly liquid and stable store of nominal value, this Credit enjoys “moneyness.” It is the nature and nuances of contemporary marketable debt – especially with respect to the prominence of governmental and central bank support - that should be the analytical focal point. A static view of government-based “fiat money” is anachronistic.
Economists argued in the late-nineties that government budget deficits were a “fiscal economic drag.” They later claimed that the 2001 recession proved their point. Many of these same economists today support ongoing massive deficit spending. They fret over the thought of “austerity.” I take issue with this line analysis, especially from a monetary theory perspective.
First of all, it’s generally inaccurate to claim that government surpluses “take money out of the economy” and “make us poorer.” To this day, the economic community fails to appreciate key monetary dynamics from the nineties – issues that remain just as relevant today. The federal government ran a small surplus in 1998, a surplus of about $100bn in 1999 and one approaching $200bn in 2000. There was talk of paying down the entire federal debt. Economists and policymakers alike were oblivious to momentously destabilizing developments in “money” and Credit. We’ve made little analytical headway since.
Nineties’ surpluses were primarily driven by a massive inflation of government receipts. In the five year period 1995-2000, federal revenue surged 46% to $2.057 TN. Over this period, federal spending rose 16% to $1.872 TN – hardly a fiscal drag and harbinger of recession. Why were receipts exploding? Well, because system Credit was surging. In the four years ended in 1999, total U.S. marketable debt jumped 37% ($6.9TN) to $25.389 TN. The annual growth in system marketable debt increased from 1995’s $1.196 TN to 1999’s $2.070 TN. In four years, Non-Financial debt expanded 27% ($3.6TN) to $17.291 TN, although the real fireworks were courtesy of an evolving financial sector.
In the four years ended 1999, total Financial Sector borrowings jumped 74% ($3.1TN) to $7.349 TN. What was driving this historic growth? Primarily the GSEs. In just four years, GSE Credit obligations (agency debt and GSE MBS) jumped 64% ($1.5TN) to $3.888 TN. And with rampant GSE Credit growth ensuring market liquidity abundance, outstanding Financial Sector corporate bonds jumped 56% in four years, while the Asset-backed Securities (ABS) marketplace doubled. CPI may have been relatively tame, but Credit and speculative excess were fueling historic asset market inflation. And asset market capital gains – bonds, tech stocks, houses, etc. – were helping fill government coffers (and boosting expenditures!) from Sacramento to WashingtonD.C.
I’m not sure how a modern monetary theory can be relevant without delving deeply into the profound role the evolution of GSE and Wall Street finance had on U.S. and global finance; on the fiscal position of the U.S. and advanced economies; on our asset markets, economic structure and on financial fragility more generally. To focus on federal spending, surpluses and deficits at the expense of recognizing the momentous distortions wrought by Washington finance (Treasury, GSE and Federal Reserve – OK, throw in the IMF and World Bank) is a failure of analytical diligence.
The 2008 crisis and subsequent economic and financial fragilities were a direct consequence of a historic Bubble in mortgage finance. Washington’s fingerprints were all over the mispricing of finance that fueled near-catastrophic asset market distortions and economic maladjustment. It was an abject failure in policymaking. Those that have called for even greater government involvement in our economy and markets are content to disregard past mistakes. For those of us paying attention, there’s no doubt that we want Washington extricated from monkeying with market pricing mechanisms.
The lack of respect for “money” and moneyness is a primary issue I have with most monetary analysis. They don’t get it. From the perspective of my analytical framework, money is both powerful and precious. Historically, sound money has been as rare as government-induced monetary inflation has been commonplace. The biggest risk coming out of the 2008 crisis was that runaway Washington fiscal and monetary stimulus would destroy Creditworthiness at the heart of our monetary system. We're well on our way. Throughout history, mistakes in monetary management have tended to beget only bigger mistakes.
Somehow, many “monetary” economists seem to believe that money is like Doritos chips: don’t fret, quite easy for us to make a lot more. After witnessing the consequences of a collapse in confidence in Wall Street Credit and, more recently, the Credit obligations of Greece and Portugal, there is no excuse for such complacency. Yet conventional wisdom holds that Washington will always enjoy the capacity to “print” its way out of trouble. Default risk is a myth, it is believed. It is similar thinking that ensured the spectacular mortgage Credit boom and bust. It is one thing to issue fiat currency; it is quite another to sustain market confidence when Credit is expanding uncontrollably.
The GSE/mortgage monetary inflation was not as conspicuous. Today, we are witnessing in broad daylight the dangerous side of “money.” The Treasury is issuing Trillions of debt - in an environment of virtually insatiable demand. Over the years, I’ve noted how a boom fueled by risky junk bonds wouldn’t be that dangerous from a systemic point of view. Limited demand for junk would create self-imposed market constraints. A Bubble in “money,” on the other hand, would tend to last longer, go to greater excess and, as such, have much greater deleterious impacts on financial and economic structures. And severe structural impairment can require multi-decade workouts and restructuring periods (think Great Depression and Japan). Money, even in its modern form, remains precious and, potentially, extremely dangerous – and this is the bedrock of my Contemporary Theory of Money and Credit.
Fine, economists can sit around and debate deficit spending and the role of fiscal stimulus in recessions and recoveries. Meantime, there is scant discussion of the extraordinary monetary backdrop and untested experimental nature of monetary management. Governments have assumed unprecedented roles in the marketplace, much to the advantage of a multi-Trillion global leveraged speculating community. Government market backstops have been instrumental in the mushrooming of global derivative positions to the hundreds of Trillions. A financial insurance marketplace of unfathomable scope has been operating on the flimsy premise of liquid and continuous securities markets. Meanwhile, most economists, “monetary” and otherwise, argue that tame inflation ensures that there is little risk associated with ongoing massive government stimulus and market intervention.
Most today fail to appreciate the potential catastrophic consequences of a crisis of confidence in “money” – a crisis of confidence in the moneyness of government debt and associated obligations. I sense little appreciation for the momentous role played by “money” as the core foundation of overall global Credit – or for Credit as the fuel for global economic activity. We saw again in 2011 how abruptly things can begin to unravel when the marketplace perceives that policymakers don’t have the situation under control. We’ve witnessed, as well, how quickly aggressive concerted global policy responses can transform de-risking/de-leveraging back to re-risking/re-leveraging. In a span of a few weeks, problematically illiquid markets morphed right back into liquidity abundance and speculative excess.
From a monetary and market perspective, we’ve returned to the precarious stage. Risk embracement and leveraging create market liquidity abundance. Strong markets then emboldened the perception that policymakers have everything under control, which stokes even more speculation and stronger risk market inflation. And global risk asset prices - from stocks, to junk bonds to sovereign debt to emerging market debt and equities – enjoy inflated prices based on the view that policymakers can ensure a low-risk macro backdrop. Market players impute moneyness upon Trillions of debt instruments of suspect quality – Credit that will be vulnerable in the next bout of risk aversion and attendant de-leveraging.
I just don’t believe that policymakers have the situation under control. Sure, they can incite a reversal of short positions and risk hedges. They so far retain the capacity to foment “risk on” and speculative excess. Yet, in reality, this is more destabilizing than it is a source of system stability. The amount of mercurial speculative finance has become so enormous as to be unmanageable. When this massive pool embraces risk things can quickly get out of hand (how about $150 crude?). But when this pool inevitably turns risk averse, illiquidity and market disruption once again become immediate problems. And it all hinges on the perception of the efficacy of policymaking and the moneyness of sovereign debt – and, in the end, the sustainability of the massive issuance of non-productive government Credit. The analysis of Bubbles and Bubble dynamics is integral to a Contemporary Theory of Money and Credit.
This afternoon, former Bundesbank Vice President and ECB Executive Board member Juergen Stark warned that public finances in advanced economies were in “dire straits” and that fiscal deficits were “unsustainable.” He was also critical of the ECB bond purchase program, warning that “intervention in the sovereign bond markets postponed adjustment requirements.” I’m with Mr. Stark on this – and I’m with the German economic viewpoint more generally. Indeed, my analytical framework draws heavily from the “Austrian”/German perspective of the overriding importance of stable money and Credit. The Germans well appreciate the danger of monetary inflation, flawed policymaking doctrine, economic maladjustment and Bubbles. And most American economists believe the Germans remain hopelessly fixated on the Weimar hyperinflation experience. I fear our economic community remains hopelessly fixated on flawed economics.
For the Week:
The S&P500 added 0.3% (up 8.6% y-t-d), and the Dow increased 0.3% (up 6.3%). The broader market was resilient. The S&P 400 Mid-Caps added 0.1% (up 12.1%), while the small cap Russell 2000 dipped 0.2% (up 11.6%). The Morgan Stanley Cyclicals gave up 0.4% (up 15.7%), and the Transports dropped 1.9% (up 2.4%). The Morgan Stanley Consumer index declined 1.2% (up 2.9%), while the Utilities added 0.1% (down 3.2%). The Banks were down 2.0% (up 13.5%), while the Broker/Dealers were up 1.8% (up 20.1%). The Nasdaq100 added 0.8% (up 14.3%), and the Morgan Stanley High Tech index gained 0.8% (up 17.6%). The Semiconductors fell 1.9% (up 16.3%). The InteractiveWeek Internet index slipped 0.4% (up 11.7%). The Biotechs declined 0.6% (up 23.6%). Although bullion was little changed, the HUI gold index jumped 4.1% (up 8.7%).
One-month Treasury bill rates ended the week at 7 bps and three-month bills closed at 9 bps. Two-year government yields were little changed at 0.29%. Five-year T-note yields ended the week up a basis point to 0.85%. Ten-year yields declined 3 bps to 1.97%. Long bond yields ended down 5 bps to 3.06%. Benchmark Fannie MBS yields dipped 3 bps to 2.84%. The spread between 10-year Treasury yields and benchmark MBS yields was little changed at 87 bps. The implied yield on December 2012 eurodollar futures rose 4 bps to 0.61%. The two-year dollar swap spread increased 2.5 to 31 bps. The 10-year dollar swap spread increased 2.5 to 10.5 bps. Corporate bond spreads narrowed. An index of investment grade bond risk declined 3 to 96 bps. An index of junk bond risk fell 24 bps to 547 bps.
Debt issuance picked up. Investment grade issuers included American Honda $1.75bn, John Deere $1.5bn, Citigroup $1.25bn, Reliance Holdings $1.5bn, Cargill $1.0bn, Viacom $750 million, Alexandria Real Estate $550 million, Marriott International $400 million, Ryder System $350 million, and CSX $300 million.
Junk bond funds saw inflows decline to $837 million (from Lipper). Junk issuers included United Rentals $2.8bn, Ball Corp $750 million, Goodyear Tire $700 million, Range Resources $600 million, and Viasat $275 million.
I saw no convertible issuance this week.
International dollar bond issuers included BHP Billiton $5.25bn, Arcelormittal $3.0bn, DBS Bank $1.0bn, Banco Bradesco $1.0bn, Buenos Aires $415 million, and Methanex $250 million.
Ten-year Portuguese yields jumped 60 bps to 12.41.% (down 36bps y-t-d). Italian 10-yr yields ended the week down 9 bps to 5.47% (down 156bps). Spain's 10-year yields fell 20 bps to 5.03% (up one basis point). German bund yields declined 4 bps to 1.88% (up 6bps), and French yields declined 5 bps to 2.95% (down 19bps). The French to German 10-year bond spread narrowed one basis point to 107bps. Greek two-year yields ended the week up 1,050 bps to 199% (up 7,347bps). Greek 10-year yields slipped 3 bps to 32.07% (up 75bps). U.K. 10-year gilt yields fell 12 bps to 2.07% (up 9bps). Irish yields declined 3 bps to 6.82% (down 144bps).
The German DAX equities index added 0.2% (up 16.4% y-t-d). Japanese 10-year "JGB" yields rose 3 bps to 0.97% (down a basis point). Japan's Nikkei jumped 2.8% (up 14.1%). Emerging markets were mixed. For the week, Brazil's Bovespa equities index slipped 0.4% (up 16.2%), while Mexico's Bolsa added 0.1% (up 2.3%). South Korea's Kospi index slipped 0.2% (up 10.6%). India’s Sensex equities index fell 2.0% (up 16%). China’s Shanghai Exchange jumped 3.5% (up 10.9%). Brazil’s benchmark dollar bond yields fell 4 bps to 3.19%, while Mexico's dollar bond yields were little changed at 3.54%.
Freddie Mac 30-year fixed mortgage rates were up 7 bps to 3.95% (down 100bps y-o-y). Fifteen-year fixed rates increased 3 bps to 3.19% (down 103bps). One-year ARMs were down 9 bps to 2.73% (down 67bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates up 10 bps to 4.72% (down 83bps).
Federal Reserve Credit declined $0.7bn to $2.917 TN. Fed Credit was up $412bn from a year ago, or 16.4%. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 2/22) jumped $14.4bn to $3.462 TN (3-wk gain of $52bn). "Custody holdings" were up $73.3bn year-over-year, or 2.2%.
Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg – were up $943bn y-o-y, or 10.1% to $10.253 TN. Over two years, reserves were $2.437 TN higher, for 31% growth.
M2 (narrow) "money" supply surged $27.8bn to a record $9.80 TN. "Narrow money" has expanded 12.6% annualized year-to-date and was up 10.1% from a year ago. For the week, Currency increased $4.1bn. Demand and Checkable Deposits slipped $0.4bn, while Savings Deposits surged $29.5bn. Small Denominated Deposits declined $2.8bn. Retail Money Funds dipped $2.3bn.
Total Money Fund assets rose $6.0bn to $2.665 TN. Money Fund assets were down $30bn y-t-d and $85bn over the past year, or 3.1%.
Total Commercial Paper outstanding dropped $24.5bn to $937.6bn. CP was down $109bn from one year ago, or down 10.4%.
Global Credit Watch:
February 23 – Bloomberg (Sandrine Rastello): “The International Monetary Fund will seek to keep its exposure to Greece under a new bailout package at 30 billion euros ($39.8bn), including money still owed from a previous loan, an IMF official said. IMF Managing Director Christine Lagarde has indicated that the fund’s credit to Greece after the second loan will remain at the maximum available under a 30 billion-euro loan agreed in 2010, said the official, who spoke… on condition of anonymity. About 10 billion euros of the first loan hasn’t been disbursed, the official said.”
February 21 – New York Times (Peter Eavis): “Greece's debt restructuring is dragging credit-default swaps back into the spotlight. The last time this financial instrument was on the global stage was in 2008, when the American International Group’s credit-default swaps brought the insurer, as well as the wider financial system, to the brink of collapse. A.I.G. had unique weaknesses, and regulators have started to overhaul the credit-default swap market since 2008. European policy makers have nonetheless looked warily at credit-default swaps, at least until recently, while they structured the Greek rescue over the last six months. They aimed for a voluntary debt exchange that would not initiate the default swaps, fearing that payments on the swaps might set off destabilizing chain reactions through Europe's financial system. But now, with Europe's $172 billion aid package for Greece, it appears that the nation is going to take a step that substantially increases the likelihood that its swaps take effect.”
February 21 – Bloomberg (Marcus Bensasson): “Greece’s economy will contract 4.3% this year and stall next year before returning to growth in 2014 under assumptions used to calculate the country’s debt sustainability before of an agreement on a second bailout. The nation’s debt will peak at 168% of gross domestic product in 2013 and decline to 129% in 2020, according to a base scenario… from the troika…”
February 20 – Bloomberg (Angeline Benoit): “Spain’s debt load is set to double from where it was when Europe’s sovereign debt crisis began, eroding the economic advantages that distinguished it from the region’s periphery and helped shield it from Greek contagion… Spain went into the crisis with public debt of 40% of its gross domestic product, compared with an average ratio of 70% in the euro region. The European Union forecasts its debt will have almost doubled by next year, as Moody’s… says Spain is losing one of its ‘key relative credit strengths.’”
February 23 – Bloomberg (Angeline Benoit): “Spanish residential mortgages decreased for a 20th month in December as the euro area’s fourth-largest economy contracted and banks reined in lending amid a surge in bad loans. The number of home loans fell 37.2% from a year earlier after a 35.8% drop in November... The total amount lent on all mortgages fell 37.4%...”
Global Bubble Watch:
February 20 – Bloomberg (Keiko Ujikane): “Standard and Poor’s affirmed Japan’s sovereign-debt rating at AA-while maintaining a negative outlook and warning that a downgrade is likely if medium-term growth prospects weaken. The ranking is ‘supported by the country’s ample net external asset position, relatively strong financial system, and diversified economy,’ S&P said… It cited the yen’s role as a ‘key international reserve currency.’”
February 20 – Bloomberg (Svenja O’Donnell): “Asking prices for London homes rose to close to a record in February, helping push national values up the most in almost a decade, Rightmove Plc said. Average asking prices in the U.K. capital rose 2.5% from January to 449,252 pounds ($710,300), less than 1,000 pounds below the record reached in October…”
The dollar index declined 1.2% this week (down 2.2% y-t-d). On the upside, the Swiss franc increased 2.7%, the Swedish krona 2.6%, the Norwegian krone 2.5%, the euro 2.3%, the South African rand 1.9%, the New Zealand dollar 0.4%, the British pound 0.3%, the Singapore dollar 0.3%, and the Brazilian real 0.2%. On the downside, the Japanese yen declined 2.0%, the Mexican peso 1.1%, the Canadian dollar 0.3%, the Australian dollar 0.1% and the Taiwanese dollar 0.1%.
February 20 – Bloomberg (Chanyaporn Chanjaroen and Nicholas Larkin): “Malca-Amit Global Ltd., a Hong Kong- based company that stores and transports precious metals and diamonds, plans to open a vault in Beijing and is doubling space in Singapore as rising demand spurs gold’s 12th year of gains.”
The CRB index jumped 2.7% this week (up 6.8% y-t-d). The Goldman Sachs Commodities Index surged 3.9% (up 10.9%). Spot Gold was little changed at $1,722 (up 10.2%). Silver surged 6.0% to $35.42 (up 27%). April Crude jumped $6.17 to $109.77 (up 11%). March Gasoline rose 4.5% (up 19%), while March Natural Gas dropped 5.0% (down 15%). March Copper gained 4.1% (up 13%). March Wheat slipped 0.5% (down 2%), and March Corn declined 0.2% (down 1%).
February 20 – Bloomberg: “China’s January home prices recorded their worst performance in at least a year, with none of the 70 cities monitored by the government posting gains as Premier Wen Jiabao reiterated his determination to maintain property curbs. Prices in 47 of the cities fell, while home values in the remaining 23 were unchanged from December…”
February 20 – Bloomberg: “Lamborghini SpA, maker of the $1 million Aventador LP 700-4, said industry sales of ultra-luxury sports cars may slow as signs that China’s economy is weakening puts off some buyers. ‘If you look at the economy right now, there may be some uncertainty to make people wait a little,’ Christian Mastro, Lamborghini’s Asia Pacific general manager, said… ‘The number of people able to spend this kind of money is limited, it’s not unlimited.’”
February 20 – Bloomberg (Sophie Leung): “Hong Kong’s inflation accelerated to 6.1%, the fastest pace in six months, in January… The increase in the consumer price index from a year earlier compared with 5.7% in December…”
February 20 – Bloomberg (Andy Sharp): “Japan posted a record trade deficit in January as the yen’s strength and weaker global demand eroded manufacturers’ profits and slowed the nation’s recovery from last year’s earthquake and tsunami. The gap widened to 1.48 trillion yen ($19bn) and shipments dropped 9.3% from a year earlier as energy imports surged…”
February 24 – Bloomberg (Shigeru Sato, Takako Taniguchi and Mariko Ishikawa): “Japan’s lenders are missing out on a global rally in bank bonds as the central bank warns that their near record holdings of government debt put them at risk of writedowns… A 1 percentage-point increase in benchmark yields would cause a loss of 3.5 trillion yen ($44bn) on Japanese government bonds, or JGBs, held by the nation’s major banks, BOJ Governor Masaaki Shirakawa said…”
Asia Bubble Watch:
February 23 – Bloomberg (Katrina Nicholas): “The region’s biggest lenders say property deals and refinancing will buoy Asia-Pacific syndicated loans in 2012 after the slowest start in eight years… Syndicated lending dropped to $12.8 billion this year, down 71% from the same period last year, making it the worst start since 2004… Companies outside of Japan have as much as $47.9 billion of bank debt to refinance this year and an additional $210 billion before 2016, data on 1,531 loans tracked by Bloomberg show.”
Latin America Watch:
February 23 – Bloomberg (Matthew Bristow): “Brazil’s current account deficit in January was the widest on record after the real appreciated the most of any major currency this year. The deficit in the current account… rose to $7.1 billion from $6 billion in December…”
Unbalanced Global Economy Watch:
February 22 – Bloomberg (Fergal O’Brien): “European services and manufacturing output unexpectedly shrank in February as the euro-area economy struggled to rebound from a contraction in the fourth quarter. A euro-area composite index based on a survey of purchasing managers in both industries dropped to 49.7 from 50.4 in January…”
February 22 – Bloomberg (Johan Carlstrom): “Swedish unemployment rose more than estimated last month as growth slows in the largest Nordic economy… The… unemployment rate… rose to 8% from 7.1% in December…”
February 20 – Bloomberg (Kati Pohjanpalo): “Finnish inflation accelerated in January from the lowest level in a year as taxes on alcohol and fuels increased. Consumer price inflation… accelerated to an annual 3.2% last month, compared with 2.9% in December…”
February 23 – Bloomberg (Alison Vekshin): “After a man with a laptop walked into Best PC Value computer repair in Stockton, California, owner Richard La Frentz telephoned the police. Hours before, the same man had been recorded by a security camera hopping a locked gate behind the store and stealing the computer. The police didn’t come. They told La Frentz to call his insurance company, he said. ‘It is the Wild West out here,’ said La Frentz… who keeps two handguns at his store in Stockton’s Miracle Mile shopping district. ‘When I call the police department, I don’t get help. The city can’t help me because of the condition that it’s in.’ Stockton, an agricultural center of about 292,000, is fighting to avert bankruptcy by shrinking its payroll, including a quarter of the roughly 425-member police force.”
February 24 – Bloomberg (Alison Vekshin and Michael B. Marois): “Stockton, California, may take the first steps toward becoming the most populous U.S. city to file for bankruptcy next week, according to a revised City Council agenda… Local officials will consider whether to begin a type of mediation that allows creditors to participate, the first move toward a Chapter 9 bankruptcy filing under a new state law…”
Wall Street’s 2010 results were disappointing and the howls of banker anguish over shrunken bonuses have reverberated through the better Manhattan restaurants, bars and clubs. The rise in financial services’ share of the economy, seemingly so inexorable, has at least paused. Is this merely a blip, or is it the beginning of a reversal, in which financial services returns to its historically modest position in our economic life, and other forms of wealth creation take its place?
The increasing share of financial services in GDP has been inexorable since World War II. Taking the “finance and insurance” sector of the national accounts as a benchmark, its share of GDP rose from 2.4% of GDP in 1947 (the first year available) to a local peak of 4.3% of GDP in 1972. Then it was flat for a few years, surged during the 1980s to 6.0% of GDP in 1987 and surged again in the 1990s to a peak of 8.2% in 2001. That later peak was not surpassed during the housing finance boom of the mid-2000s, surprisingly, but was finally topped in 2010, in which the sector represented 8.5% of GDP. Thus the surge in financial services activity is consistent and long-term, nearly quadrupling as a share of GDP over the last 63 years.
At first sight, that makes it appear as though financial services’ growth is an inexorable feature of a modern economy. However if you go back further, recognizing that GDP figures before 1947 are not very accurate (the concept was only invented in 1934) you will see a further surge in financial services, from a low of about 1.5% of GDP in 1880 to a peak around 6% of GDP in 1929 – followed by a catastrophic drop during the Depression and World War II.
The 1930s decline in financial services income is not surprising. Stock brokerage and investment management, which had been becoming major businesses by 1929, were decimated by the downturn. The Glass-Steagall Act, separating commercial from investment banking, may have been useful safety legislation, but it resulted in the de-capitalization of brokerage and underwriting businesses, leading to a dearth in public debt and stock issues in the late 1930s such as had not been seen since before the Civil War. Home mortgage lending, conducted in the 1920s without government guarantees, but on unsound principles of 10-year maturities and inadequate amortization, was equally decimated by the decline in house prices. Deposit banking was badly damaged by the disappearance of one third of U.S. banks in 1932-33.
Only insurance remained a stable and reliable financial services product, and seems likely to have maintained its share of GDP, more or less. However the decline in other financial services was not just a product of poor markets (thought it was to an extent a cause of them) but represented a reorientation of the U.S. economy away from finance – egged on by populist politicians who found it easier to blame the Great Depression on finance rather than on their own errors.
It has to be said therefore that Barack Obama has so far failed where FDR succeeded, in that finance has not yet declined as a share of U.S. GDP. That may however be about to change. (Incidentally, the massive Wall Street contributions to Obama’s 2008 campaign surely represent in its purest form the adage, supposedly coined by Lenin, that capitalists will sell you the rope with which to hang them!)
Once the current period of artificially low interest rates ends, its stimulus to asset prices and leverage will also end. At that point, many of the products and services that have pushed up finance’s salience will become unprofitable.
One such product that has already declined from its peak is securitization. In its initial incarnation, securitization seemed a useful way to remove excess home mortgage assets from bank balance sheets and transfer them to investors who would welcome this new low-risk asset class. The business was greatly facilitated by the availability of quasi- government guarantees from Fannie Mae and Freddie Mac. However after the subprime debacle it became clear that securitization could be used by unscrupulous operators to originate mortgage loans that should never have been made.
Today, much of the demand for securitized products comes from mortgage REITs, leveraged up the eyeballs and gambling on the spread between short-term and long-term rates. Once that spread disappears, there will be a gigantic glut of this paper on the market as the mortgage REIT losses wipe out their capital bases. The home mortgage market will be disrupted, and will operate only at considerably higher interest rates in relation to Treasuries. Finance’s intermediation profits will be correspondingly diminished, or wiped out altogether. Fannie Mae and Freddie Mac will report losses so large that they may prompt even a spineless Congress to put those useless behemoths out of business.
The derivatives sector is largely responsible for the financial services growth of the last three decades. One of the changes that have boosted derivatives’ salience has been the practice by industrial companies to treat their finance departments as profit centers, thereby encouraging speculative game playing by finance staff claiming to “hedge” exposures. As innumerable investors can attest, the principal effect of such hedging is to make financial statements completely impenetrable, so that hedged oil companies, for example declare huge profits when prices fall, the reverse of their economic reality. A little shareholder pressure and reformed corporate governance should eliminate much of this activity.
While it seems likely that interest rate swaps, currency swaps and their associated options will remain a modest part of the financier’s toolkit, the same cannot be said of their eldritch cousin credit default swaps. The principles of the Life Assurance Act of 1774, which forbade taking out policies on unrelated lives and then arranging accidents, must be applied to this market, so that counterparties cannot take large naked short positions on credit. The legal and payment uncertainties surrounding these instruments in any case make them almost pure gambling contracts. There will doubtless be another financial crash shortly, in which CDS are heavily implicated; it is to be hoped that regulators don’t neglect this area after the next crash as they did after the last one.
Fast trading, whereby institutions position their machines at the stock exchange in order to get earlier information of trading flows, on the basis of which they trade, is pure rent-seeking and a form of insider trading. The various Tobin tax proposals being mooted, while they may do other damage, should at least cut off this illicit source of financial services revenue.
Hedge funds and private equity funds have been major beneficiaries of loose money, attracting institutional capital by promising superior investment returns unlinked to the conventional equity market. It should already be clear, and is becoming increasingly so to the dumbest state pension fund and even to the Harvard endowment, that both these claims are untrue. In the long run, the returns of hedge funds and private equity funds are not superior, especially net of their excessive fees. Second, those returns are highly correlated to the stock market, since they depend crucially on the readily available and excessively cheap money on which all bubbles are built.
Finally, in Europe especially, financial services companies have sought to be universal dumpsters for government debt. While the pre-2008 belief that government debt was risk-free was nonsense, in general financial services entities (unlike some unleveraged global manufacturing companies) are not better credit risks than the governments under which they operate. Hence it makes no sense for them to hold government debt, other than as part of their underwriting function. They have been encouraged to do so by the spuriously steep yield curves of recent years, which have encouraged them to invest in long-term paper, while funding it in the short-term market. Like the unfortunate First Pennsylvania Bank in 1980, some of them will pay the ultimate price for this folly, while others will merely suffer large losses and be forced to sell off operations and fire staff in order to survive.
However, the principal factor cutting back financial services’ share of the economy is the tsunami of regulation that has been and is being imposed on the industry as a result of the 2008 crash. This also happened in the 1930s: the SEC and the Glass-Steagall Act deflated financial services inordinately, doing great economic damage thereby. It is now clear that the damage from Dodd-Frank’s 848 pages arises not from the Act itself, which was fairly anodyne and missed many of the better legitimate targets among the industry’s bad practices, but the regulations it encouraged, which contain a large multiple of the complexities of the Act itself. Much of the financial services industry will be engaged in battling those regulators every inch of the way, while other parts of its business will be severely hampered by the rules they produce.
There are thus three factors cutting back financial services’ share of the economy. First, there is a natural reaction against the excesses of recent decades, in which some of their more egregious business practices will no longer work and will be abandoned. Second, an end to the current excessively loose monetary policy will result in a dampening of speculation and a reduction (much of it the hard way, through bankruptcy) in systemic leverage. Finally, the surge of regulation through Dodd-Frank and the equivalent EU regulations will itself dampen activity in the sector, forbidding some practices and making others uneconomic. Just as deregulation from the 1970s encouraged the growth of the financial services sector so new regulations, imposed ineptly, will cut it back as they did in the 1930s.
The financial services sector may not fall back to the 2.4% of GDP it represented in 1947, but it could easily fall back to the 4% or so of GDP it represented in the 1970s, about half the current size in terms of the overall economy. The moral is thus clear: don’t put too much money in bank stocks, and above all, don’t waste the lives of your intelligent offspring by encouraging them to enter this currently overblown sector, prone to parasitism in bull markets.
(Originally appeared in The Bear's Lair.)
Martin Hutchinson is the author of "Great Conservatives" (Academica Press, 2005)—details can be found on the Web site —and co-author with Professor Kevin Dowd of “Alchemists of Loss” (Wiley – 2010). Both now available on Amazon.com, “Great Conservatives” only in a Kindle edition, “Alchemists of Loss” in both Kindle and print editions.
Genesis 1-26: And he said: Let us make man to our image and likeness: and let him have dominion over the fishes of the sea, and the fowls of the air, and the beasts, and the whole earth, and every creeping creature that moveth upon the earth.
Boy, God sure made it plain and clear that man is more important to Him than trees, dirt, birds, seals, and all things Environmental Wackos (a person(s) who is/are regarded as crazy, eccentric or mad), along with President Obama tend to pay homage to. The world and what one finds in it are more important to environmentalists than the needs of mankind. It seems to me that they worship the things and creatures of the world than what is better to improve and ensure the well being of humans. I’ll never forget some years ago when some wacko woman lived in a tree to protect it from being cut down. She despised the harvesting of trees and was protesting so tree loggers would stop cutting down trees without realizing that the wood from the trees is most often used to build homes and other wood related products to better serve humans. The foolish woman didn’t realize that as trees are cut down, new ones are replanted to replenish the forest. And forest fires caused by lightning destroy millions of trees yearly. Is this woman going to try to stop lightning from striking forests?
In another incident a baby seal that was saved in the Exxon Valdez oil spill that occurred in Alaska in 1989 was released back into the ocean with much news coverage and fanfare to the delight of environmentalists. As the TV cameras covered the release of the seal, the happy atmosphere of the crowd sudden turned into horror. As the seal swam out into the ocean a killer whale plucked the seal, tossed into the air and had itself a great meal. Now folks you just can’t make that up!
I guess you can say that those of my generation (40s, 50s, 60s) were indeed environmental wackos and didn’t even know it. “Why James?” some might ask. My dad never owned a car. Thus, mom and I walked weekly to go buy groceries. I was the gopher of the house and daily I had to go buy bread and milk. Thus, we didn’t spend one nickel on gas. When mom and I walked to the store we’d returned our empty soda and milk bottles, otherwise mom would be charge for the cost of new milk and soda bottles. Stores back then would return the empty bottles to their respective plant to be washed, sterilized and refilled. Now folks that is what you call recycling! Dad never owned a gas-powered lawn more. He’d cut the yard with a push mower. Again, he didn’t use any gas nor did he pollute the air. Mom, along with my wife for years hung the wash on a clothesline. I didn’t buy my wife a dryer until I had to battle it out with a bunch of women on a rainy weekend as I tried to dry my daughter’s diapers in the 70s. Also, my sis and I walked to school until we graduated in 1956.
Today, Americans are spoiled. Most households have a dryer/washer, freezers, ac/heat units, 2 to 5 TVs, 2 cars or more in the garage. Kids in school today are picked up by a school bus or driven to school by car. Heaven forbid that they would have to walk to school or have to wait for a city bus like most of us did in the 50s. For some reason I can’t envision women today walking to the grocery store like mom and I did. Most, I suspect, as I do, drive to the store, work, post office, bank, etc. With all the comforts most of us enjoy we have to shell out more of our hard earned money on water, electricity, natural gas and for the last 3 years under the Obama Administration, gas for our vehicles. When Obama took office in 2008 gas was a little over $1.80 a gallon. Today, it is $3.65 here in Fort Worth and many states are reporting over $5 a gallon. “Why so James?” some might ask. My friends, Obama, and his environmental wacko friends, hate fossil fuels (oil, petroleum, coal, etc.). Obama has been quoted as wishing gas would creep up so Americans would embrace electric cars like the Chevy Volt, which by the way has been a total disaster! Throughout July of last year, a whopping 125 Chevy Volts were sold ($46,000 per car). The sticker price for electric cars is astronomical, as car shoppers would actually save money purchasing a Mercedes-Benz over a Chevy Volt. Car buyers are simply not ready to drop $40,000 for a smaller, slower, and less attractive vehicle at twice the expense. And, as per car analysts, electric cars are not cheap to operate; they cost more to operate than gas engine cars.
I find it comical that this past Sunday Senator Schumer stated in a letter to Secretary of State Hillary Clinton to urge the Saudi government to increase production to full capacity of 12.5 million barrels per day to make up for lost Iranian oil. “What’s so funny about that James?” some might wonder. Folks, just recently President Obama stated that Republicans only solution to lower gas prices is to drill, drill, and drill. And here you have Senator Schumer begging Saudi Arabia to drill to lower the price of gas while President Obama wants us to be less dependent on foreign oil. Something here just doesn’t make sense.
When President George W. Bush was president and gas rose over $3 dollars a gallon Democrats and the media blasted the president saying he was in bed with oil producers. After President Bush opened up drilling in the East and WestCoasts the barrel of oil went down to 38 dollars lowering significantly the price of gas at the pump. Meanwhile Obama has stopped the Keystone Pipeline from being built even though his union buddies want it, which by the way will create millions of jobs. However, Obama serves at the altar of the environmentalists.
I hope that poor people and those on Welfare who love Obama are enjoying the high price of gas and remind them that there’s no free gas at the pump for them. They, like the rest of us, have to pay up and like it
The First President George Washington was born 22 February, albeit we’ll observe his Birthday on Monday the 20th this year. The day will serve to round out a nice long weekend for many folks, welcome time off during the hardest month of winter. Federal employees too will enjoy the day: time to enjoy with family and friends; time to rest or catch up on projects around the house. The average citizen will enjoy the day the same way, and only hope most Government employees pause long enough to remember the man whom the nation honors with its respite.
Historians now openly talk about the way America has left her Constitution behind. Certainly there is a cumulative case to be drawn, probably starting with the War Between the States. Most accounts of government growth and the accretion of power in Washington , D.C. , prominently involve the Progressive Era, and of course the New Deal. Damage was done and also accumulated, but it was not until sometime after World War II when lawmakers actually stopped consulting the Founding Document, when public debates waned concerning the Constitution’s relevant meaning to contemporary public policy. Since the 1950s the Government simply uses political mandate to do whatever the Government wants to do.
Regulations and taxes pile up on people in the name of the People, imposed however by Government through a kind of modern virtual representation, which the Colonists utterly rejected of Great Britain . Just as the Constitution no longer acts as a parameter on what the Government does, neither can it be said of George Washington that he still informs young people and adults of what constitutes the ideal masculine character or responsible republican citizenship. Washington was a preeminent role model for these things until the middle of the Twentieth Century, when the study of biography receded in education and pop celebrity displaced historic heroes.
Washington might have been King but he chose elective office instead, and then he chose to leave that office after just two terms. He had more than the good judgment to quit while he was ahead! He indeed knew what was most important in his own life: his home Mount Vernon ; family and personal obligations; fellowship with friends; reflection, and the study of Scripture. He also knew the nature of power and the temptations attendant to power. He knew the crucial impact that leadership can have, but he valued civil liberties and freedom in society much more. Freedom had been the object of the Revolution, not dynasty or empire.
Washington was esteemed a very wise man, but he eschewed the power to impose his wisdom on everyone else. Washington esteemed the prerogative inherent to liberty, as something more important than either physical wellbeing or scientific certainty in a particular. People run their own lives, some successfully and some not—but it is after all the peoples’ lives and theirs to run. Various environments might be comparatively cruel or limited, chimerical or privileged. An asteroid might hit the earth someday, and the sky is always falling or liable to fall to the Chicken Littles amongst us. Still, families are natural institutions that govern even before the Government does. Government didn’t give a person life or sanction the marriage between the man and woman who had the baby. Indeed, the Church never asked nor asks permission to marry two people. The legal conventions are not always the same as religious ones, albeit for most of our history they have overlapped almost completely, mainly because of the approach to Government the Founders, George Washington included, took.
It bears repeating: It is the peoples’ lives—and so it should be their private choices that govern in nearly all particulars that pertain. This is true whether the individuals choose wisely or not, whether they are wrong or right; and whether they are brilliant or certifiably stupid, handicapped or studs. Individuals possess a prerogative to live according to their lights, regardless and irrespective of circumstances so long as they do not harm anyone else! Individuals possess natural rights according to natural law, and Government must have a compelling interest to intervene and mess with things. If Government does intervene, it does so by exception; further, it should be at the level of the State where a person lives and for some good reason, i.e., to protect others or to promote the general welfare, not necessarily the convenience of society. States are dual sovereign political entities alongside the Federal Government in the construct of Washington ’s Constitution and ours.
Imagine: Washington ’s Constitution, the Founding Document in light of his and the Founders’ worldview—a Restoration of the Republic. This is how I shall be remembering Washington , and how Government better start remembering if I read the Tea Party through to its logical potential conclusion. Remembering Washington means a dedication to the future and to a very similar project to that which he faced in his day. As freemen and freewomen we must choose to remember him and the Revolution, as well as the Constitution, which was its crowning achievement. Heroes did and do exist. Sometimes they are celebrities, but most of the time they are people proud to call themselves American, men and women of character and uncompromising determination to be free—free to dream and succeed, free to dream and fail on their own terms and God’s. Government is not God. The Constitution as amended, is not subject to the whim of the President or the Congress, not today anymore than it was in Washington ’s day. It is not subject either to the Supreme Court, in terms of decisions it has made based upon unconstitutional precedents entered in, which break the moral compact and implicit structure of federalism upon which our Union is entirely based. Government has made carrion of the so-called “living” Constitution and given us a Dead Constitution Walking. Political Revolution is in the air, or should we say brewing?
Wesley Allen Riddle is a retired military officer with degrees and honors from West Point and Oxford . Widely published in the academic and opinion press, he serves as State Director of the Republican Freedom Coalition (RFC) and is currently running for U.S. Congress (TX-District 25) in the Republican Primary. He is also author of two books, Horse Sense for the New Millennium (2011), and The Nexus of Faith and Freedom (2012). Both books are available on-line at
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I have a confession to make.I don’t eat, sleep, and breathe the practice of law.In what passes for spare time, I teach, I write articles and books, and I lecture.But every now and then, my gaze drifts over to that Mexican wrestling mask I brought back from a trip to Cancún, and I think “What if . . . ?”Could I battle it out in courtrooms by day, and by night enter a wrestling ring as “El Abogado Luchando” (The Fighting Lawyer) in the lucha libre?Okay; actually, I don’t have that pipe dream.But Chicago lawyer Tom Benno does, and he’s actually turned his dream into reality.
To casual observers, the 57 year-old Benno is your typical suburban Chicago trial lawyer.But a couple of years ago, the former high school wrestler and longtime wrestling fan had an itch he wanted to scratch. He learned of Carlos Robles, a real estate agent/wrestling promoter who was running an independent wrestling league, GALLI—Gladiator Aztecs Lucha Libre International—patterned after the “lucha libre” Mexican wrestling, complete with capes, masks, and fast-paced athletic moves.Benno and Robles became business partners, and the league started taking on some of the characteristics of American professional wrestling, featuring heroes and villains and storylines.Shortly after Benno got involved on the business end and provided legal advice, another idea struck him—why not wrestle as well?
Benno began training—losing 40 pounds, building a wrestling ring behind his wood-paneled law office and perfecting his moves.Equally important, he developed his wrestling alter ego: “Apocalypto,” a character who “plays the mediator, staying neither good nor bad, leaving audiences uncertain.”Befitting this new persona, Benno-as-Apocalypto wears a mask with one side depicting a grin, and the other a frown.Apocalypto made his wrestling debut last November, entering the ring at the AddisonParkCommunityRecCenter to the Darth Vader “Imperial March” from Star Wars.After some flying leaps off the turnbuckle, and a few more well-choreographed moves, Apocalypto had his first “victory.”
Friends and family have been mostly supportive of Benno’s masked moonlighting.While his wife Terri appreciates the fact that he has an outlet that’s gotten him into better shape—she says “there are worse things he could be doing than wrestling”—she is not completely sold on “Apocalypto.”She says “I know Tom is a lone ranger and he doesn’t fit into boxes too well . . . . I guess I just hoped this whole thing would be a like a fleeting fancy.Except obviously, it’s really not.”Benno himself knows that, at 57, his days in the wrestling ring are numbered.But he’s thoroughly enjoying it while he can, and even finds similarities between his profession and his avocation.Practicing law and wrestling, he says, both require you to “be dramatic, have presence and be spontaneous and always think on your feet.”
Tom Benno is not the only lawyer who moonlights by slamming into people.Amy Dinn is a 36 year-old civil litigator by day with the Gardere Wynne Sewell law firm’s Houston office.But at night, she becomes “The Prosecutor,” competing with a roller derby team in Houston.Dinn competes in 3–4 games a month at the local and national level.Dinn notes that “The roller derby of today is not the same as it was in the Seventies.It is an empowering sport for female athletes.It’s also a sisterhood.”It’s also a painful one; the 5’10” Dinn works out at least 3 times a week, in addition to 3–4 team practices each week that can last up to 3 hours, and she’s endured reconstructive knee surgery and back surgery.Dinn says that co-workers were surprised at first about her unusual hobby, but that the physical demands of it made keeping her roller derby competition impossible.“The first time you get hurt the cat’s out of the bag at work.I come in bruised or walking funny and co-workers ask questions.”Like Tom Benno, Amy Dinn also observes that her chosen sport has much in common with her day job.“Litigation is a high-stress profession,” Dinn notes.“Sometimes you have to be aggressive and stand your ground on your position.”
Young lawyer Emeka Onyejekwe took a less painful path to moonlighting and, eventually, a career change.The attorney seemingly had everything he wanted after graduating from NYU School of Law in 2006, taking a job as an associate with one of the most prestigious law firms in the country.But something was missing; Onyejekwe had a deep, abiding interest in music since the age of 8, and had even been in a band during college.After toiling less than a year in the legal trenches, the lawyer embarked upon a different path.He became hip hop artist “Mekka Don”—“the Legal Hustler.”“Mekka Don” proclaims “Music is my calling.God spoke to me and I listened.”
And, really, isn’t that what it’s all about?A law degree affords a person many opportunities, but sometimes it’s just not enough.So, even if you don’t quit your day job, you don’t have to abandon your passion—whether it’s wrestling, roller derby, rapping, or even writing.I’m sure John Grisham doesn’t regret following his dreams after long days at the courthouse.