Who’s in Charge?
Recent history as reported in mainstream media might bring a person to question “Who’s in Charge”.
CNBC Reported on Apr 13, 2012.
“Earlier Friday, JPMorgan first-quarter profit that beat analyst expectations on higher revenue. The company said it issued more mortgage loans in the first three months of the year.”
May 11, 2012 headline.
JPMorgan Loses $2 Billion on Unit’s ‘Egregious Mistakes’
May 11, 2012 Jamie Dimon was quoted as saying:
“There were many errors, sloppiness and bad judgment. These were egregious mistakes, they were self-inflicted.”
JP Morgan’s share price has declined from a high of over $46.00 in March 2012 to a low in May of approximately $33.00. During the same period the market capitalization has declined by about 28% to $126 billion.
Wikipedia states.
“Sarbanes–Oxley Section 302: Disclosure controls
Section 302 of the Act mandates a set of internal procedures designed to ensure accurate financial disclosure. The signing officers must certify that they are “responsible for establishing and maintaining internal controls” and “have designed such internal controls to ensure that material information relating to the company and its consolidated subsidiaries is made known to such officers by others within those entities, particularly during the period in which the periodic reports are being prepared.” 15 U.S.C. § 7241(a)(4). The officers must “have evaluated the effectiveness of the company’s internal controls as of a date within 90 days prior to the report” and “have presented in the report their conclusions about the effectiveness of their internal controls based on their evaluation as of that date.””
From the New York Times May 26, 2012.
“Roughly 40 examiners from the Federal Reserve Bank of New York and 70 staff members from the Office of the Comptroller of the Currency are embedded in the nation’s largest bank. They are typically assigned to the departments undertaking the greatest risks, like the structured products trading desk.”
When Jamie Dimon and Doug Braunstein signed off, as required by Section 302 of SOX relative to the first quarter results what had they done to ensure that JP Morgan Chase had “designed such internal controls to ensure that material information relating to the company and its consolidated subsidiaries is made known to such officers by others within those entities, particularly during the period in which the periodic reports are being prepared.”
More from Wikipedia.
“Sarbanes–Oxley Section 404: Assessment of internal control
Further information: SOX 404 top-down risk assessment
The most contentious aspect of SOX is Section 404, which requires management and the external auditor to report on the adequacy of the company's internal control on financial reporting (ICFR). This is the most costly aspect of the legislation for companies to implement, as documenting and testing important financial manual and automated controls requires enormous effort.[31]
Under Section 404 of the Act, management is required to produce an “internal control report” as part of each annual Exchange Act report. See 15 U.S.C. § 7262. The report must affirm “the responsibility of management for establishing and maintaining an adequate internal control structure and procedures for financial reporting.” 15 U.S.C. § 7262(a). The report must also “contain an assessment, as of the end of the most recent fiscal year of the Company, of the effectiveness of the internal control structure and procedures of the issuer for financial reporting.” To do this, managers are generally adopting an internal control framework such as that described in COSO.”
More from the press reports:
“The troubles at the group, called the Chief Investment Office, which makes trades to balance the bank’s assets and liabilities, were expected to weigh on the bank’s broader earnings.
Within days of the disclosure, Ina Drew, the unit’s top executive, resigned, and two other executives were expected to step down.”
If the buck stops with Jamie Dimon, as anticipated by SOX, why did he not step down? Since he didn’t step down, why didn’t his Board of Directors fire him? Since they didn’t get rid of Dimon, why didn’t the shareholders fire the Board?
Did JP Morgan Chase and their external auditors and management produce the required reports when the previous year’s results were released? If not, did anyone check to find out why not or impose any sanctions for not doing so?
Did anyone in either the auditor’s office or at JP Morgan have any idea what type and size of trades were being made by the “London Whale”?
Did any of the 110 bureaucrats from the Federal Reserve and /or the Office of the Comptroller of Currency who were embedded in JP Morgan’s offices have any responsibility or authority under SOX and/or Dodd-Frank that would have addressed the trading activities of the London office of JP Morgan?
Did anyone involved with JP Morgan, the external auditors or the regulatory agencies have any knowledge that Boaz Weinstein of Saba Capital Management of New York was making trades that took the contrary position to those being done by JP Morgan? Did anyone at JP Morgan or the regulators notice the contrary trades and wonder what was happening?
Back to the original question. Who’s in Charge?
Would a return to the provisions of the Glass –Stegall Act of 1933 which separated investment banking and deposit taking not sound like a better way to prevent the pain that shareholders and depositors in JP Morgan have suffered and simplify the task of regulators and legislators? Again, I ask Who’s in charge? Apparently, none of the owners and depositors of JP Morgan nor the regulators and legislators are in control.
The house and the Senate continue to pass regulatory legislation followed by legislation/budgets that strip regulators of the funding they need to do the job they have been legislated to do. Who’s in charge?
Fred McCreath
Nanaimo, BC
© FJM Financial Inc. May 2012
Euro fiddles while
Nero fiddled while Rome burned. Now Europe is fiddling while Italy (and Greece, Ireland, Spain, and Portugal) burns.
The bigger question is will they continue to fiddle while the rest of the world starts to burn.
One of the only good things about having the world focus its attention on the European Union is that is isn't paying much attention to the United States. The US debt clock suggests that the national debt has passed 15 trillion dollars and US debt has now passed 100% of GDP. In the US state and local debt has passed 3 trillion dollars.
While Europe has given itself some breathing room by suggesting it will have a proposal to update the European agreement between countries (their constitution) by March 2012 it is not clear that some event will not take place between now and March that won't reignite the flames that are burning in the region.
The IMF has indicated that Greece needs to reduce the size of its public sector payroll and make other “adjustments” on the expenditure side or the deficit will stay at 10% of GDP. The US deficit is presently between 8.5 and 9% of GDP. A significant portion of the US deficit is structural in nature.
In the US attention is turning to the various Republican caucuses and primaries and will be focused more on the 2012 election than on economic matters until November 2012.
Unfortunately, the US debt clock will be closer to $16 by November. Depending on how the US votes, the ability of the country to face the kind of tough choices that are presently being forced on Greece will not improve in the near term.
In the meantime, Europe will continue to take a few steps forward coupled with a number of lurches backward until they finally face the reality that providing bailouts to countries at the same time they require major banks to increase their capital is roughly equivalent to nationalizing the banks using a painfully circuitous route.
If they force a default or significant write down of sovereign debt (isn't this what Greece has done already) on the debt holders (many of whom are the large banks) they are simply eliminating the new capital the banks are supposed to raise before they raise it.
If the banks find that equity markets do not welcome new share issues designed to raise their capital they will be forced to sell assets to get the job done. In the real world this will force them to sell good assets because they will raise relatively more money than the sale of bad or marginal assets would.
It will be a good thing if they have the increased equity because they will have a bit of room to take the hit when they are forced to write off sovereign debt of the deadbeat countries in the EU or elsewhere, for that matter.
At the end of the day they will be back to roughly where they started but minus the best assets they were forced to sell to raise capital. Their shareholders will have taken the hit for them. Their share valuations will suffer until they are able to rebuild their asset base. The rebuilding could take a long time in a sketchy economy.
Would it not have been much simpler and quicker for the banks to write off a portion of their holdings at the beginning?
I can hear the fiddler and see the fire burning today in Europe.
In my view, it would have been easier to let them all fail in 2008. Iceland is already starting to show(at least modest ones) signs of a recovery from their default. At least the rebuilding process would have been 3 years further along than it is now.
Fred McCreath
Nanaimo, BC
© FJM Financial Inc. 2011
Going in Circles
First Iceland. European countries and their banks bailed Iceland out of $85 billion in international debt by agreeing to the default by Iceland's three largest banks. Iceland has been able to return to international debt markets less than 3 years after the default. By this date, in late 2011, it has been all but forgotten, except within Iceland where the economy shrunk at well over 5% per year in 2009.
The cause of Iceland's problem was the huge debt run up by its banks in international markets. The result was that Iceland saw its currency drop by 80% and it has been gripped by a severe recession. While the main cost of the defaults was born by international banks, mainly in Europe. A large portion of the Icelandic debt was held by individuals in Europe and their deposits were, in many cases, protected by deposit insurance underwritten by the Governments of the countries where the investors lived.
The result was that between 2007 and 2010 Iceland's Public debt has increased from 29.3% of GDP to 96.6% and it is projected to hit 103.2% in 2011 by the IMF (International Monetary Fund). The annual surplus in 2007 went into deficit of .5% in 2008, 12.6% in 2009, and 9.2% in 2010 (the IMF estimates 5.6% for 2011). Inflation was at 12.4% in 2008 when the crisis hit and is expected to decline to 2.6% in 2011.
Iceland didn't bail out their banks but their public debt shot up after the crash of 2008. I can only assume it was stimulus spending trying to spur a sagging economy.
Then Ireland. In Ireland's case there was a rapidly expanding economy from 1997 to 2007 during which the significant expansion of credit helped fuel a real estate bubble that exploded during the 2008 global financial meltdown. As a result of the September 2008 world crisis and related budgetary difficulties that befell Ireland, the Government, on September 29, 2008, provided an unlimited guarantee in support of six banks. Eventually one of the banks, the Anglo Irish Bank was nationalized and two, the Allied Irish Bank and the Bank of Ireland were recapitalized under terms dictated by the Government.
The end result was that Ireland's public debt skyrocketed from 25% of GDP in 2007 to 96.1% in 2010 and it is projected to reach 114.1% in 2011 by the IMF . The nominal surplus of 2007 has become an annual deficit that has climbed from 7.3% of GDP in 2008 to 17.7% in 2010 (2011 estimate from IMF is 11.2%). After experiencing inflation of 3.1% in 2008, Ireland went through a period of deflation in 2009 and 2010 before returning to a very modest inflationary level estimated for 2011.
Then Greece. Greece was already in trouble when the crisis of 2008 arrived. Their public debt was 95.6% of GDP in 2007 and is projected to rise to 152.3% in 2011, despite all the efforts at austerity that have been taken since the bailout process started in earnest in 2010 with a $146 billion package from the rest of Europe. The Greek deficit was 3.7% of GDP in 2007 and after rising to 13.6% in 2009 is forecast (by the IMF) to decline to 7.3% in 2011. 40% of total Greece's economic output comes from the public sector.
During the whole 2008 to 2011 period Greece has been experiencing inflation, although the level dipped in 2009.
As a part of the Greek ”rescue” package European banks agreed (did they jump or were they pushed!) to accept a write down of the Greek debt they held of 21% (now being revised to at least 50%). At the same time the European Union was discussing the need to recapitalize their banks. This was before the Greek problem became acute in October 2011.
I may be wrong but I have a feeling that all of the events that are part of the unfolding disaster that started in the US in 2008 are simply leading us around in circles.
The Icelanders didn't bail out their banks and end up with a huge increase in public debt, the Irish bailed out their banks and ended up with a huge increase in public debt, The Greeks have a huge debt (as do the Italians) because, among other things, international banks were prepared to loan them huge sums of money to support their spending addiction (isn't this what happened to the US?). The international banks and the rest of the Eurozone countries will likely be asked to take a “haircut” on Italian debt before their crisis is over.
When it is all over the debt loads of the profligate spending countries as well as those who experienced asset “bubbles” of varying types may be reduced by amounts deemed acceptable by the international financial community and the pain will have been borne by the countries that were better off financially to start with. Further pain is supposed to be borne by banks that are being required to increase their reserves by central bankers and international pressures.
In a perfect world (only economists seem to live in one) the pain of the banks will ultimately be borne by their shareholders. If the shareholders do not pony up the required amounts of additional capital, Governments may be forced to step into the breach. In my view, the shareholders of the banks and the taxpayers of the various countries involved are the same person.
The New York Times Oct 23, 2011 “Despite resistance from Spain and Italy, agreement seemed close on a plan worth around 100 billion euros, or $138 billion, to recapitalize European banks. The measure is intended to help banks better withstand turmoil in the markets.
“We have laid down foundations for an agreement on the banking side,” said Anders Borg, Sweden’s finance minister.”
Did Spain and Italy resist because they knew that the package wouldn't be large enough to rescue their banks and they might have to print more money to backstop their banks? Or did they resist because they knew the more selfish members of their Governments believed they could continue to spend beyond their means and look to others to pay the bill?
That would close the circle. The same group, the taxpayers, who are still bearing the pain of the 2008 financial meltdown will again pick up the tab for countries and banks that were deemed “too big to fail”. Maybe the “Occupy” protesters are on to something.
Fred
McCreath
Nanaimo, BC
© FJM Financial Inc. 2011
I blew It!
I was wrong!
Little did I know that it would take until 2011 for the dysfunctional government in the USA to have its credit rating downgraded and that the equally dysfunctional euro zone would muddle through and delay the inevitable crash resulting from the earlier fiscal imprudence of the PIIGS. In case you forgot the PIIGS; Portugal, Ireland, Italy, Greece and Spain were all suffering from staggering public debt and deficit problems. The recent downgrades of the Spanish debt together with indication by Moody's on October 7, 2011 that Belguim (not a PIIG or anything like one) was on negative watch.
As a person living in North America I underestimated the potential damage that could flow from some seemingly smaller European countries and how they were simply indicators of the greater malaise that was out there. The fact that the 440 billion European Financial Stability Fund (EFSF) has been projected as being short by between 1.6 billion and 5.6 billion Euros by two widely recognized economic consulting groups suggests that the “contagion “ will definitely spread and, perhaps, lead to a collapse of the common currency.
While Eurpoe struggles with the inevitable collapse of one or more countries' financial system the US dawdles along, locked in partisan wrangling, hoping its massive debt will go away.
The Greek tragedy is unfolding more like a decathlon than a one act play. Stumbling from “crisis” to “crisis” has taken well over a year and the finish line still appears to be out of site. While Athens burns the rest of Europe is fiddling with their financial system.
Is now clear to me that it will take at least until 2013 to sort out the problems in Europe, including those that have not yet emerged.
There seemed, in 2008, to be some optimism that the US would face the reality of the staggering debt load and take steps to deal with it. To date all that has been done is the appointment of a “Super Committee” of political wranglers whose recent history suggests a greater likelihood of the “bull” winning the day than a real solution being proposed.
That suggests to me that the US will not “hit the wall” until some time later. If it takes Europe two years to acknowledge that a default is the only real solution in Greece it will take the US at least two years of fumbling to admit to their problem. I'm guessing that will occur in 2015 or 2016. Only the dysfunctional, confrontational, system can drag out dealing with the obvious until a crisis, real or imagined, forces the country to address real solutions to its self-inflicted problems.
If my imprecise timing is at least reasonably accurate; I'll predict that the world will not come out of the ensuing depression for at least 10 years. This would mirror quite closely the experience of the Great Depression where the first crash in 1929 was followed by a second decline in 1932. The recovery did not really start until after the end of the war in 1945.
Now,
in September and October of 2011 the 'Occupy Wall Street” movement
in the Untied States has started. The objectives of this movement
seem to be the polar opposite of the Tea Party that started in 2009. If the two groups got together and talked rationally they might conclude that the best steps to take to fix things would be bringing back the Glass-Stegal Bank Act of 1933 combined with an instruction to the Commodity Futures Trading Commission that credit default swaps and some other derivatives are insurance products and should be managed accordingly. At the same time, the Dodd-Frank Act, Sarbanes-Oxley and few other unnecessarily complex pieces of regulatory legislation should be scrapped.
I've recently read a very interesting article from the November 2011 Vanity Fair (http://www.vanityfair.com/business/features/2011/11/michael-lewis-201111#gotopage6). It chronicles the financial woes facing two municipalities in California as well as the financial straight jacket the State of California finds itself in. This article made me realize that the US will not “Hit the Wall” until a few more municipal level governments experience actual bankruptcy proceedings like Vallejo, California and Central Falls R.I. or narrowly avoid it as Jefferson County, Alabama did in September 2011. If I am right; the real crisis will start when a city much larger than San Jose succumbs to an impossible debt load. Until then, the US will manage to lurch from panic to panic until 2015 or 2016.
If the “Come to Jesus” moment happens in 2015 or 2016 as I predict, I'm then predicting the ensuing Depression ( there are many who feel the US has been in one since 2008 ) will last at least 10 years.
I have changed the header on my blog to read “Depression 2008 – 2025”.
Fred McCreath
Nanaimo, BC
October 2011
© FJM Financial Inc.
The Politics of “We” and “They”
The
following are thoughts from a concerned Canadian observer of the side
show presently taking place in Washington. My concerns are real because over 60% of Canadian exports are sold to the United States and my economic survival is dependent on what happens in the US.
The political system of the soon to be second largest economy in the world is being forced into a worldwide spotlight and the light is highlighting much of what is wrong with the United States of America.
The two old line parties are busy campaigning for the 2012 elections, clearly demonstrating the fact (one that all involved conveniently ignore) that during the last 18 months of each 4 year Presidential term very little is done in terms of actually governing the United States of America.
Those who claim to be in charge of the world's leading economy are spending all of their time acting like first grade students in the playground fighting over who gets to use the playground equipment and when as they campaign for the next election.
Back to to the “We's” and “They's”:
“We” (average Joe/Jane citizen) want the members of Congress, the Senate and the administration to do something to break the impasse over the debt ceiling and fiscal reform.
“We” (read GOP, Democrats, Tea Party, Gang of Six, etc.) are coming up with proposals and accusing “they” (same people as “we”) of sabotaging them.
“We” say that “they” caused all of the fiscal problems the country is now in when “they” were in power. Again, “they” and 'we” are the same people.
“We” want to create new bi-partizan committees as part of the solution to the current stalemate, ignoring the fact that the bi-partizan “Gang of Six” hasn't worked to date.
“We” are the current group of politicians in Washington who will be most embarrassed (but likely re-elected in 2012) if nothing is done by August 2 and there is a default. The embarrassment will be worse if the “they” in financial markets who chose to bet, via credit default swaps, actually earn $4.8 billion if the deadline passes and a default actually takes place.
“We” (politicians) are more concerned with our strategic posturing before the 2012 elections and our own re-election than we are about solving the country's huge economic problem.
“They” (politicians, again) are the ones who have overspent the contents of the cookie jar for at least 40 years and left the country owing an astronomical amount on “our” credit card.
“They” are the agencies created by all of the past “we's” and “they's” that permitted the crash in 2008 and have allowed the US debt to grow to almost 15 trillion dollars.
Once all the games are finished and the “We's “ and “They's” come to the conclusion that the real enemy is the “They” represented by financial rating agencies such as Moody's, Fitch,and Standard and Poor as well as the international financial markets that are already penalizing the US for its inability to deal with the self-inflicted crisis. The US dollar has already dropped in relation to a number of currencies, particularly the Swiss Franc, that is seen as benchmark for many world currencies. It is becoming more obvious that international financial markets are penalizing the US economy regardless of what the politicians do between July 27 and August 2, 2011.
Once the “We” and “They” who are frozen in inaction in Washington realize that there is another “they” that has already taken control of the situation in international financial markets it is possible that the Washington “they” will collectively rally and actually do something.
It is clear that the finger pointing going on in 2011 regarding how the US got itself into such dire straights does not change the fact that the present circumstance “is what it is”. It will take considerable courage and foresight to find a solution to the problem that will work for more than a year or two and deal with the solution to a problem that took over 40 years to create.
Perhaps some of the Presidents who will be recognized as being partly responsible for the problem left some insights that today's leaders might consider.
Lyndon Johnson, taken from an address to the nation in November 1963 said, “yesterday is not ours to recover, but tomorrow is ours to win or lose.”
Ronald Reagan said “ Politics is supposed to be the second oldest profession. I have come to realize that it bears a very close resemblance to the first.” Perhaps a message for today's leadership, also from Mr. Reagan “If you're afraid of the future, then get out of the way, stand aside, the people of this country are ready to move again.”
I have been predicting, since the crash in 2008, that the current Depression would last until 2015 and would tend to mirror the 1930s Depression. Now it looks as though the second down phase the world is about to experience will be caused by the dysfunction of the US political system and the politicians who created the dysfunction. Even if the debt limit is raised, world markets and/or rating agencies will punish the US economy because the root of the problem is the unwillingness to address the crushing US national debt. International markets will, as they have done in Greece and will do in Ireland, Portugal, Spain and Italy if they don't make real changes in their fiscal situations, force US interest rate up to a level that could, and most likely will, cripple the US domestic economy.
A relatively minor change in interest rates in the US could bring the economy to a virtual stop. The real estate crash that started well prior to 2008 will experience huge difficulties in sustaining whatever momentum it has to date and unemployment will certainly increase well above the current levels if new investment in the economy slows.
If the resolution to the current situation comes from a short term measure, interest rates will rise and the US economy will stall and return to recession sooner, rather than later.
As soon as "we " and "they" realize that there is only "us" a solution may be found. In the meantime, the world holds its breath.
- Fred McCreath
- Nanaimo, BC
- July 27, 2011
Are entitlements a problem?
A Google search finds the following when searching for a definition of: ”Entitlements”:
“Entitlement is a guarantee of access to benefits because of rights or by agreement through law. It also refers, in a more casual sense, to someone's belief that one is deserving of some particular reward or benefit. It is often used pejoratively in common parlance (e.g. a "sense of entitlement").
en.wikipedia.org/wiki/Entitlements”
“payments made to a person or government which meets the requirements enumerated in the law. Social Security benefits, military pensions, and Aid to Families with Dependent Children (AFDC) are all entitlements.
www.historycentral.com/civics/E.html”
“entitlement - Government funds issued to certain individuals because of a prescribed need. Social Security, Medicare, veterans' benefits and food stamps are examples of entitlement programs.
www.cnn.com/2009/LIVING/studentnews/03/15/financial.glossary/index.html”
The Government describes Medicare and Medicaid as follows:
“Medicare is financed by a portion of the payroll taxes paid by workers and their employers. It also is financed in part by monthly premiums deducted from Social Security checks. www.ssa.gov/pgm/medicare.htm “
What is Medicaid?
“Medicaid is a jointly funded, Federal-State health insurance program for low-income and needy people. It covers children, the aged, blind, and/or disabled and other people who are eligible to receive federally assisted income maintenance payments.
Thirty-two states and the District of Columbia provide Medicaid eligibility to people eligible for Supplemental Security Income (SSI ) benefits. In these States, the SSI application is also the Medicaid application. Medicaid eligibility starts the same months as SSI eligibility.
The following jurisdictions use the same rules to decide eligibility for Medicaid as SSA uses for SSI, but require the filing of a separate application: Alaska, Idaho, Kansas, Nebraska, Nevada, Oregon, Utah, Northern Mariana Islands
The following States use their own eligibility rules for Medicaid, which are different from SSA`s SSI rules. In these States a separate application for Medicaid must be filed: Connecticut, Hawaii, Illinois, Indiana, Minnesota, Missouri, New Hampshire, North Dakota, Ohio, Oklahoma, Virginia. http://www.ssa.gov/disabilityresearch/wi/medicaid.htm”
The current disputes in Wisconsin, Ohio and other states where Republican Governors are attempting to “break” the unions who represent government employees at both a state and local level also appear to be a battle over “entitlements”.
From Fox news:
“self-employment tax
People who have salaried jobs pay 7.65% in Social Security and Medicare taxes, and their employers pay a like amount. But self-employed workers pay both halves — a total of 15.3% — in what is called the self-employment tax. In all other years, they have been able to deduct their health insurance from their net income, but not until after the self-employment tax is calculated. So, a consultant earning $100,000 and paying $15,000 for health insurance would owe the self-employment tax on the full $100,000, and then be able to deduct $15,000 before the income tax is calculated. (Half of the self-employment tax is then deductible.) That would leave her with a $15,300 self employment tax, and a taxable income of $77,400.
Read more: http://www.foxbusiness.com/personal-finance/2011/02/25/new-tax-breaks-self-employed/#ixzz1FOU3wh7p”
One of the major issues frequently raised when dealing with the causes of the US Government’s current deficit and debt problems is that the ‘Entitlement” programs are not sufficiently funded and are, or shortly will be, creating a permanent “structural” deficit federal Government finances.
Another issue frequently raised when talking about the state of public finances (governments at all levels) is the unfunded liabilities for pensions and all other employee related costs not due to be paid until some time in the future, as well as future Medicare and Medicaid costs.
The main reason for these budget problems appears to stem from the fact that they are partly financed by current taxation but the costs that have to be paid in the future, are generally, if not always, higher than the up front revenue stream can fully fund.
There are two reasons why the current revenue isn’t sufficient to meet future costs:
Demographics are working against the structure of the system. The number of older people who are seeking to collect the benefits is increasing at a faster rate than the smaller number of currently contributing taxpayers ability to fund; and the cost of the programs is significantly higher than expected when the laws creating the “entitlements“ were passed.
The funding model is seriously flawed. Besides the shortfall resulting from the taxation levels being too low to fund the future costs that were committed to in the past; there is the problem arising from the fact that the revenues are not dedicated to the programs. The tax revenues are invested in Treasury Bills issued by the Government as opposed to “real” money investments. It is somewhat like trying to pay for actual costs with Monopoly money by having the Monopoly bank print more bills.
The problems with benefits included in union contracts were highlighted when General Motors’ and Chrysler’s union contracts were altered substantially during the restructuring process in 2009. The significant changes made during the restructuring of the automotive industry would appear to be, at least in part, the reason behind the desire of some states to force the unions who represent their employees to accept legislated changes to the bargaining process.
Rather than admit they are, for all intents and purposes, bankrupt the states are trying to use their ability to make or change laws to force a restructuring on their employees. In many ways this process is very similar to the “negotiated bankruptcy” that was forced on GM and Chrysler and their employees.
Governments have acted irresponsibly to date because they have not paid much attention and often only lip service to their fiscal obligations as legislators on behalf of the public. The stories referenced below illustrate the point.
Washington Post Headline Feb 22, 2011
“Illinois seeks to borrow $3.7 billion to shore up pension shortfall”
Stltoday.com Headline Feb 23, 2011
“Illinois finds plenty of buyers for $3.7 billion in bonds”
The message appears to be that Governments can’t be trusted to fulfill their financial obligations to taxpayers and /or employees.
The solution might be relatively simple if two principles were adopted.
First, treat the taxes collected as trust funds. If governments were forced to treat the funds collected by taxation to fund entitlement programs as “trust” funds they would maintain separate accounts that could only be used to fund the costs associated with the revenue they collect up front.
Second, convert all of the entitlement programs to (using the definitions of the pension/insurance industry) money purchase programs from the current defined benefit structure.
At present the benefits from Social Security and Medicare are defined in the legislation. Thus, the term “entitlement”. In a money purchase situation, the funds collected for the purpose would be invested by trustees (private money managers, investment counsel, etc.), who would be completely independent and, where possible, chosen by the beneficiary as with a 401k, until the beneficiary became eligible to receive the benefit. The beneficiary would then be obligated to purchase an annuity or other form of income stream to fund retirement. In the case of medical related benefits the beneficiary (or the agency holding the funds) would purchase an insurance policy to provide the benefits.
This type of system transfers the future risk to two parties, the investment agency that is charged with investment of the funds (a manager like Bill Gross of PIMCO, chosen by the beneficiary), and the beneficiary who has to purchase a health insurance policy and a pension income investment when the funds are paid out.
Individuals would have the ability and, in fact, an obligation to ensure that the funds being set aside were sufficient to provide the benefits they require/expect when the qualifying period ended (at retirement age, etc.). In cases where employers provide contributions those contributions should be mandated by legislation and periodically subject to a mandatory review to make sure levels of contribution were reasonable in light of changing circumstances. In order to help minimize the amounts being set aside for the purposes of these programs the benefits (other than pensions) would not be subject to income or other taxation.
While the system isn’t perfect it is a basis for discussion that would help to take the uncertainties caused by politicians playing political games out of the system as much as possible.
Fred McCreath
Nanaimo, B.C.
©FJM Financial Inc. 2011
A tale of Two Countries
This tale is not to be confused with the Dickens classic written in 1859 and set in the time of the French Revolution in Paris and London. Nothing in it should ever be confused with famous literature.
This story is set in 2011 and deals with the differences between two of the world’s largest trading partners who trade along the longest border in the world.
One country is the “big brother”, the United States, with a population of more than ten times that of the “little brother”, Canada, and the world’s strongest currency and economy. Recently the “big brother” country has fallen on difficult financial times and is being forced to take desperate measures to deal with the difficulties it has placed itself in.
During the early 1990s Wall Street Journa in the US wagged its finger at Canada and suggested it was in danger of becoming a “third world banana republic” due to the size of its national debt and continuing annual budget deficits.
Canada took drastic steps to put its fiscal house in order. It slashed spending virtually across the board and kept taxes relatively low. By the time the world economy crashed in 2008 it was held up as the star of the developed world. It had is fiscal house in order and its banking system was touted throughout the world as a model of what should be done to fix the ailing banks in other countries after the 2008 crash.
Fast forward to 2011 the big brother, US, has added to its already staggering annual budget deficits with huge amounts of stimulus funds in an attempt to revive an economy that cratered in 2008. The national debt has ballooned to levels previously thought to be unsustainable. States and cities are teetering on bankruptcy. Unemployment remains stubbornly high and there are no prospects of it showing real improvement for a number of years. The real estate market has tanked and the number of foreclosure actions by lenders is at unprecedented heights. States are so desperate they are threatening to decimate existing contracts with their workers. One state, at least, is floating a bond issue to make the payments it is obligated to make to its employees’ pension fund.
Since 1960 in the US, only six years have resulted in an annual surplus in government finances. Projections by the government and anyone else who looks at the economy suggest that the federal government will be facing annual deficits at least until 2030. By that time the country will have experienced over 60 years of annual deficits (with only 4 years of surpluses) and a national debt that could force the once great country to its economic knees.
Welcome to the “Third World Banana Republic”.
Meanwhile in Canada, the deficits that were used to attempt to bring the country out of the 2008 recession (depression?) will be curtailed between 2012 and, if things go according to plan, eliminated by 2015.
Why are these to countries going in opposite directions? When Canada was accused by the Wall Street Journal of being a “Third world banana republic”.In 1993 the Canadian Government reacted by introducing measures to reduce the national debt from 68% of GDP in 1995-96 and eliminate annual deficits between 1993 and 1996. By 2004 Canada had 8 consecutive years of annual surpluses and the national debt was reduced from 565 Billion to 499 billion. The result was that total debt had been lowered from the 68% level to under 40%.
Canadians have paid a higher price for oil and gas, due to higher taxation, for at least 20 years. In 2011 the equivalent price for a gallon of gas in Canada is over $4.00 and consumers in the United States are apoplectic when the price goes over $3.00. Canada has also had higher “sin” taxes on alcohol and tobacco. Canada has the ability to be self sufficient in oil, the US does not. Perhaps the US needs to look at Canada and Europe for elevating gasoline taxes to levels that will really drive the crusade for automobile fuel economy.
Citizens of the United States have personally and collectively been living on their credit card since 1980 (the years from 1998 to 2001 being a minor exception as far as government is concerned).
While the US economy has outperformed the Canadian economy by a significant margin during most of the last 60 years much of the recent better performance has been financed with personal and public debt.
The United States, the world’s dominant economy and de facto world currency, has been living a dream since the late 1960s. Since long before it weathered the storm caused by the Savings and Loan meltdown in the late 1980s and early 1990s the economy of the former manufacturing superpower started to change completely. As was evidenced by the near complete collapse of the auto industry in 2008 and 2009 the manufacturing sector is no longer the engine of the US economy. With the exception of 4 years the United States has had a deficit budget every year since 1970.Canadians have long been the butt of jokes about their conservative, (not politically, a Conservative Canadian government is likely to the left of US Democrats in many ways) cautious nature. This natural caution resulted in taking the steps necessary during the 1990s to put their fiscal house in order. This was accomplished with a cost to annual economic growth and by an acceptance (usually grudgingly) of the need to accept the government cuts and pay the taxes necessary to solve the debt/deficit problem. The cautious approach to finances also helped create a banking system that was not likely to take the kind of risks associated with the financial meltdown in 2008.
Today, the Canadian Government is warning Canadians that personal debt levels are reaching critical proportions and savings rates are in decline. In early 2011 steps were taken to place more stringent underwriting limits on new mortgages. In the United States, there is no end in sight to either the foreclosure problem or the effects of the excessive personal and government debt levels that helped to fuel the economic growth of the 1990s to 2006. No substantive changes to the US mortgage finance system have been proposed or implemented to date.
Recently, in President Obama’s 2012 budget proposals, there appeared a proposal to tax Canadians when they travel by air or ship to the US. To many Canadians this sounds like the 350 million Americans, who loudly argue against any tax increases, want the 33 million Canadians to help solve their 15 to 20 trillion debt problem. While this proposal and parallel ones to tax Canadian companies selling products in the US to help pay for road upgrades in some northern US states are being floated are unlikely to see the light of day. However, some Canadians will, no doubt, suggest that some of the pipelines taking oil and gas south be shut down before they, even grudgingly, contribute to in the solving of the US debt problems by being taxed by the United States. The US did not come to Canada’s aid when Canada was a “third world banana republic”, nor did Canada try to force US citizens to help.
At the end of the day, only the citizens of the United States can deal with the crushing reality of the fiscal woes spreading throughout the country. Regardless of political leanings US citizens, including the protesting teachers and state employees in Michigan and Ohio, have to come together to meet challenges to the nation. With annual deficits hovering in the 10% of GDP range and the national debt poised to pass 100% of GDP during 2011, the United States is in significantly worse shape than Canada was in 1993 when the wake up call was sounded.
The only way the current fiscal disaster the United States is in can be resolved is to increase taxes or implement new ones and immediately make significant reductions in spending at all levels of government across the whole country. It is likely that neither taxes (especially on Canadians traveling to the US) nor spending reductions alone can solve the problem.
The ultimate cost will likely be a lengthening of the period during which unemployment remains above acceptable levels and slower economic growth for a considerable period of time. Canada developed a roadmap (let’s hope they haven’t lost it); all that’s required now in the US is to follow it.
Fred McCreath
Nanaimo, BC
© FJM Financial 2011
“New” Brave New World of 2011
“New” Brave New World of 2011
This is not the “Brave New World” of Aldous Huxley’s 1932 book. It is the Brave New World of Facebook and Twitter, ushered in with the evolution of the internet and instant communications.
It burst upon the world on January 25, 2011 when the citizens of Egypt followed the lead of citizens in Tunis that started mass protests to overthrow a totalitarian government.
It is possible to argue that it actually started earlier in January when, on the 13th, protesters filled the streets of Tunis to protest in an effort which eventually toppled the Government.
It is also possible to trace the roots of this “new” brave new world to the emergence of the Tea Party Movement in the United States in early 2009.
Others may claim that the emergence of Flash Mobs is a sign that the new order has begun. Connecting on Facebook has made it possible to mobilize huge groups or “Flash Mobs” for a variety of purposes. In April 2010 a group of 700 “Flash Dancers” assembled in Vilnus, Lithuania to dance together. Over the Christmas season in 2010 there were numerous stories of spontaneous singing of Christmas carols by groups of singers who connected on Facebook and Twitter.
Wikipedia suggests that the first Flash Mob was attempted in May 2003 and the first successful one was a group that assembled at Macy’s department store in New York in June 2003. It attributes the founding of them to a Harper’s Magazine editor named Bill Wasik.
Perhaps the recent problems experienced by Blackberry in the United Arab Emirates, Saudi Arabia and India indicate that some countries were concerned that Blackberry devices could be used to spread the Flash Mob phenomenon to their countries. China has also been known to try to control and limit internet communications with the outside world.
It will be interesting, in the aftermath of the upheaval in Tunisia and Egypt, to see if any other totalitarian countries shut down their communication networks both internally and externally.
So what is this “brave” new world going to look like?
It is impossible to tell, at this stage, if the old regimes in Tunisia and Egypt (I’m assuming Mubarak’s is an old regime) will be replaced by democratically elected governments or governments controlled by radical Muslim groups as happened in Iran when the Shah was replaced.
On the other hand, the current upheavals in Tunisia and Egypt may just be harbingers of the start of a series of changes countries will experience until the true will of the people to control their collective political destiny is realized. What is happening today may only be the first step of many that will ultimately happen in this age of instant communication.
What is presently unclear is whether democracy will come to these countries immediately after the current protests end or there will be a descent into an autocratic regime dominated by hard line Muslim groups such as the Muslim Brotherhood in Eqypt.
The sooner the protesters get some semblance of organization to prepare to assume political power and create a situation where democratic reforms can be followed by honest elections that are run fairly the better things will be. Unfortunately, some of the more radical groups appear to have won the organization race by simply existing. In Tunisia the exiled Muslim leader, Bouazza Ben Bouazza returned recently and his return indicates the possibility of a radical Muslim government.
Tunisia is a much smaller player than Egypt and also a less of central part of the overall political dynamic in the region. For that reason, there is much greater concern around the nature of the new Government that emerges in Egypt.
From an economic standpoint Egypt is a great concern because of the amount of trade, including oil, which moves through the Suez Canal or pipelines over Egyptian land. Concern over the future of Egypt’s economy has already resulted in a downgrading of their debt by Moody’s.
Moody’s downgrading of Egyptian bonds raises another possibility. If the Muslim Brotherhood or some other radical Muslim group seizes power in Egypt there are a few possible outcomes and all of them are bad.
First, the Suez canal could be shut down or the rates to ship through it could be come very expensive. Second, a hard line Muslim regime could decide to repudiate all debt owed to western “infidels” and otherwise close the Egyptian economy to the rest of the world.
Back to the “Brave” part of this new world. The people, primarily young, who were mobilized to protest in both Tunisia and Egypt using instant communication technology such as Twitter and Facebook and text messaging on cell phones certainly qualify as “brave” for their willingness to risk their lives in pursuit of a better one.
Unfortunately, they may be forced repeat their brave action in a few years if the result of their actions is a new extremist Muslim Government rather than the democracy they seek.
In the context of the United States, the Flash Mob phenomenon has only been used to get groups to sing Christmas Carols in malls and, perhaps, attend Tea Party rallies all over the country.
Once many of the groups in the US are able to reconcile the conflict (many don’t believe there is one) between demanding lower taxes, eliminating both the annual deficit and national debt, and the desire to maintain services provided by their Governments at all levels; it may be possible for them to use the miracles of instant communication to bring the real changes needed before the US economy collapses.
In the context of the world as a whole, the message from Tunisia and Egypt to the parts of the world where there are totalitarian regimes is that average citizens have amazing power to mobilize for change and it can’t be ignored. While Egypt was able to significantly reduce assess to communication systems during the recent demonstrations; it is quite clear that all communication can’t be shut down.
Before the ability to make actual changes can be acknowledged as a success it will take some time to see how the results of the protests on both Tunisia and Egypt actually unfold. It will also be interesting to see if the new communication tools can be mobilized to effect real change in a functioning(barely) democracy such as the United States or the European Union.
The one thing that is certain about this “brave new world” is that governments will need to react more quickly to the wishes of citizens.
Fred McCreath
Nanaimo, BC
©FJM Financial Inc. 2011Fannie and Freddie
What to do with Fannie and Freddie
Since the two Government Sponsored Enterprises (GSE) were put under Federal Government conservatorship in 2008 media reports in the New York Times and Bloomberg have chronicled the tale of woe.
New York Times Jan 24/11
“Government support for legal fees in support of the GSEs and their former top executives $160 Million….
Government support of losses since 2008 $150 million….
Government committed to support Fannie Mae and Freddie Mac up to $200 million in capital each.”
Bloomberg June 13/10
Headline “Fannie-Freddie Fix at $160 Billion With $1 Trillion Worst Case”
The Congressional Budget Office estimated in 2009 that costs through 2019 would be $389 million. The White House’s estimate was $160 million.
The Bloomberg article also quoted two politicians:
“We need to have a housing-financing system in place,” Senate Banking Committee Chairman Christopher Dodd said last month. “If you pull that rug out at this particular juncture, I don’t know what the particular result would be. We’re caught in this quandary.” ….
Representative Scott Garrett, a New Jersey Republican and co-sponsor of the phase-out amendment, said eliminating Fannie and Freddie would force the government and the housing market to confront the issue. “
As usual, there is no agreement among the opposing political parties but it may be that Representative Garrett’s suggestion that the Government and the Housing market should confront the issue is the start of the road to a real solution.
The banks and numerous other major players in the financial sector, including a major insurance company, have all benefited from Government bailouts that appear, based on recent earnings reports, to have returned them to financial health. The Government (read taxpayers) will still end up bearing a cost of between $300 million and $1 trillion, depending on which costs you include, as the ultimate cost of Fannie and Freddie. So far, the tally of costs ignores all of the individuals who are, or have been, underwater in mortgage debt or subject to foreclosure actions due to debt problems that fall, at least in part, on the doorstep of the White House as well a the financial industry.
Rather than point fingers at those responsible (I don’t have enough hands, much less fingers) it is more constructive to suggest a better system to be adopted for the future.
Some parties have suggested that part of the solution to the problems with the GSEs (Fannie and Freddie) would be to divide them each into two entities based on the quality of their assets. When the Savings and Loan crisis was sorted out the same “good bank, bad bank” process was used.
Once the “good” assets of Fannie and Freddie are transferred to a new entity the Government, in their only involvement in the process, should require the banks, insurers and other players, including rating agencies, who were involved in the debacle leading up to 2008 to purchase equity in the “good” GSE taking the government out of the equation, except for a minor shareholding position. Only viable companies continuing to be part of the mortgage business, in any way, would be shareholders in the new entity.
The government should adopt legislation creating the new entity with a structure that can only be changed by Congress. It would be a public entity with a specific mandate set by Congress. The Government should retain a limited number of seats on the Board of Directors to ensure both good governance and common sense (often an oxymoron where governments are involved) prevail. The majority of the Board would be elected by the shareholders. All future participants in the mortgage and finance markets would be obligated to become shareholders of the entity based on their mortgage market activity.
Its mandate would be to set mortgage underwriting rules based on it being a mortgage insurer with an additional capability and mandate to purchase, sell and securitize mortgages. It would have to apply underwriting standards that would make the insurance role function based on conventional, market driven, reserve requirements prevalent in the private mortgage insurance market. The mortgage insurance would be subject to the same regulatory regime as any federally chartered mortgage insurer currently operating.
It would also be both a buyer and seller of securitized of mortgage loans. This would mean that it would be heavily involved in the evaluation of the risks inherent in mortgage pools underwritten both by lenders whose mortgages it insures and other mortgage pools, insured or otherwise. The extent to which it could hold mortgage pools would depend on the availability of capital to meet its insurance regulatory obligations and other market based operating constraints.
It would be this new entity that would establish its own contractual arrangements for transactions involving mortgage pools. Clearly, the shareholders would not want to experience losses from bad underwriting of either mortgage insurance or mortgage investment pools. By ensuring it has recourse against mortgage originators and rating agencies involved in the initiation of mortgage pools it could protect itself against the disaster that emerged in September 2008.
While this “new” company would not provide any assistance to borrowers who are currently in great difficulty it could insure and hold mortgages granted to purchasers of homes currently either subject to foreclosure or being sold to qualified purchasers.
An advantage of the creation of this new entity would be that it would not be affected buy the numerous legal issues between Fannie, Freddie, their former senior executives and the government or lenders and rating agencies that will plague the “bad GSE” until it is finally wound up.
Another advantage would be the psychological one of sending a message to the taxpaying public that a new day has dawned and, in future, a system to avoid the errors of the past has been put into operation.
Finally, it would also help to assure the public that the banking and financial services sector that has a well deserved reputation for being bloated fat cats are coming to the table as part of the solution to a problem they helped to create.
Fred McCreath
Nanaimo, BC
© FJM Financial Inc., 2011
Conspiracy or Control?
The Real Conspiracy
Recently CSIS (Canada's Security Intelligence Service) director Richard Fadden, cautioned Canadians about “spies” from China and other countries. He suggested that the purpose of the spies was not cold war type espionage but to establish relationships with local, provincial, and federal politicians for the purpose influencing them to take action and or/support policies that were deemed to be in the best interests of the Peoples Republic of China.
While he did not name any names or provide any details the long term impact of activities of this nature are abundantly clear.
Since Chinese companies have, in recent years, acquired a significant presence in Canada's oil sands and more broadly in the resource sector it is clearly the intent of the Chinese Government to be able to influence governments in Canada to make decisions that will benefit China's objectives.
The following quote from
www.asianpacificpost.com indicates that the US is also at risk.
“As former FBI analyst Paul D. Moore puts it; “In China’s model, anyone and everyone is a potential intelligence asset.""
The trading relationship that has evolved in the past couple of decades between China and the United States, dubbed “Chimerica” by historian Niall Ferguson, would also be served well from the Chinese perspective by increasing the Chinese influence in the US. Doubtless, efforts by “spies” in the US would be at least as important to China's long term objectives in the huge economic relationship that “Chimerica” represents as those singled out by the head of CSIS would be in the China/Canada relationship.
In addition to their trading relationship with the US China currently holds (as of August 2010) approximately 21% of the US treasuries held by foreign interests. Slightly more than 50% of the US debt used to finance deficits is held by foreigners. Recently much media attention has been focused on the “sovereign debt” issue in Greece and the rest of Europe. It is not beyond reason to assume that China has concerns about both the total of the US debt and the long term prospects for repayment as the Congressional Budget Office, the Concord Coalition and others continue to express alarm regarding the mounting US debt and mounting annual budget deficits that are predicted to continue indefinitely.
China has made it quite clear, since the start of the Recession (Depression?) in late 2008 that they do not believe the US dollar should continue to be the world's reserve currency. The have suggested a new reserve currency that would be supported by a number of currencies, including emerging economies like their own, Brazil, Russia and India as well as the US and Europe.
In the last few months there have been indications that China will soon start trading with other emerging economies using the Chinese Yuan or Renminbi. The same reports that brought up this possibility indicated that 55% of China’s exports are to the emerging countries.
China has also resisted all efforts by the US and other nations let their currency float to a market based level. The US believes it is undervalued and should be permitted to rise. China argued recently, prior to the G20 November meetings, that the US was devaluing their currency by the proposal to print an additional 600 Billion dollars as part of the second round of “Qualitative Easing”, the QE2 process. Many of the developed countries in the world are nervous about any possible currency war.
What would happen if China proposed starting the new reserve currency by contributing a significant amount on the US Treasuries they hold to the fund needed to start the new reserve currency? Would Japan and other countries that hold significant amounts of US debt join the party? Would an action of this type undermine confidence in the safety of the US dollar?
Since 2008 and the restructuring of GM it has become apparent that GM's operations in China and other emerging economies are at least as important to their long term survival as their domestic US operations. How many other large US companies are increasingly dependent on emerging economies for their continued success?
How does this represent a conspiracy?
First, it raises the possibility of China gaining such huge influence due to their spying” and economic actions that they might have the ability to force the US to do their bidding or face an economic collapse that would make the 2008 crash and the Great Depression seem like minor incidents. The Chinese have already brought pressure to bear on the US because of their disagreement with printing US$ as part of QE2.
Second, it raises the possibility that, for all practical purposes, China will effectively take over the US without firing a shot. If the US continues to follow the self destructive economic track it is on China may take the controls of the engine and force the US to take action to reduce deficits and debt.
Third, it also raises the possibility that as the Chinese economy continues to grow from second largest in the world to largest, it will impose it's will on the world using economic power rather than nuclear weapons or other forms of force.
China has always demonstrated patience well beyond that applicable to America which, increasingly, is driven by instant gratification. It may be that this patience, as demonstrated by the 50 year wait to regain control of Hong Kong, is part of a plan to dominate the world by economic means.
Since 2008 there has been much attention devoted to perceived conspiracies such as the Democrats plan to turn the country into a European style welfare state as a result of the reform of medical care adopted in 2010 .
In the past, whenever major challenges have presented themselves, the US has demonstrated the collective will and determination to overcome and whatever sacrifices were required were willingly made.
The current threat is economic and for many US citizens very personal because it affects their day to day economic well being and that of their families. Are the American people prepared to accept the reduction in their standard of living required in order to meet the challenges presented by the economic threat posed by China and the other emerging economies?
While the Canadian Government officially denies reports about spying, infiltration and influence being exerted by China The Congressional Research Service has prepared a report dated June 30,2009 entitled ”China’s Holdings of U.S. Securities: Implications for the U.S. Economy”. The report indicates that China is the largest holder of foreign Currency reserves in the world, holding $1.2 trillion in US Securities as of June 2008.
The wielding of power by USA since it became the worlds’ only superpower at the end of the cold war and the demise of the USSR appears to have won more enemies than friends for the US.
If the Chinese conspiracy results in the end ofn the superpower status, both militarily and economically, the US will require significant changes to survive in the new world order that emerges. The end of the US$ as the worlds’ reserve currency will not only affect how the rest of the world sees the US, it will limit the ability of the US to dictate terms in many of its trading relationships.
Call it a conspiracy or refer to it by any other name but there is little doubt that China will soon have a much greater influence over the economy of the US and much of the rest of the world than most democracies are comfortable with.
Fred McCreath
© FJM Financial Inc. 2010
Nanaimo, BC
November 2010