Will Planned Bank Taxes Go Far Enough?

The UK emergency budget, which will impose a £2billion tax on banks, both domestic and foreign bank operations domiciled there, along with the upcoming G20 meetings, is pushing a contentious issue to the fore: how and how much to tax banks.

There are two motivations at work. First, with most advanced economies keen to narrow fiscal deficits that blew out as a result of the global financial crisis, the perps are a logical target. Second, taxes are a way to discourage certain types of behavior.

George Osborne, the UK chancellor, said that France and Germany had pledged to implement similar levies. The Financial Times summarized the new taxes:

Mr Osborne said the new UK levy would be calculated on the basis of its total liabilities less core capital and insured deposits. So-called repo funding, liquid funds guaranteed with government bonds, would also be exempt. In a move to encourage banks to lengthen funding terms, the levy will be charged at half the rate on financing longer than a year.

Treasury documents suggested that the levy would raise £1.2bn next year, with the levy pitched at 0.04 per cent of targeted liabilities, rising to 0.07 per cent the following year, generating more than £2bn in 2012.

Mr Osborne said he would separately pursue a globally co-ordinated tax on bank profits or remuneration, as recommended by the International Monetary Fund.

Yves here. The biggest risk of banking is simultaneously their raison d’etre. They take short term funding and make longer term loans. When they screw up (either due to making too many bad loans or by having liquidity problems by going too far with the classic “borrow short-lend long” formula), the state has to rescue big banks. Since we haven’t solved the big bank problem, and banks seem constitutionally incapable of reforming themselves, the next best idea appears to be to nudge them in the direction of operating with bigger safety buffers. One of them, per the formula above, is to reward banks for relying more on deposits (which even though they technically can be withdrawn at will, from a practical standpoint are pretty sticky) and, when they borrow, for relying on longer-term funding.

The problem is that the UK bank levy appears to be a bit of sleight of hand, and may do little to change behavior. Even though, per the Financial Times, Osborne contended, “the new levy ‘far outweighs’ any tax benefits extended to the corporate sector as a whole, analysts disagreed. From the Guardian:

Deutsche Bank analysts noted the significance of the corporation tax change. “Taking 2% off the 2012 tax rate for the five banks listed in the UK would increase profit by £1.16bn, that it is should almost offset all of the banks tax. Overall a good outcome for the banks.”

But even with that sop, international banks are threatening to shift assets into Japan or Switzerland (note: I wouldn’t bet on Japan as a safe haven if the US, UK, and EU manage to act in a coordinated manner). Political and budget commentators in the UK noted that the banks got off easy. Unions in particular were unhappy both about the level of the levy, less than half of what had been anticipated, and worse, the failure to impose effective taxes on bonuses. Bank shares rose even as industry executives howled.

Unfortunately, there is not assurance that even this modest move to tax an industry that just wrecked the global economy will get much traction. As the Wall Street Journal noted:

Bank levies will be on the agenda at the Toronto summit, according to G-20 officials, as its leaders seek to maintain a united front on tax and regulatory changes to avoid a repeat of the recent meltdown. Officials are expected to agree in principle, as they have in the past, that citizens shouldn’t pay for the sins of their countries’ banks.

But in the details, leaders are likely to agree to disagree, say people close to the matter. The countries that have footed the bill to bail out their financial sectors—including the U.K., U.S., Germany and France—are backing various levies on bank balance sheets. Countries such as Canada and Australia see such levies as punishment for their banks, which were left relatively unscathed by the credit crisis.

Yves here. Cynics might say that the reason Canada and Australia have done well so far is first, their overheated residential real estate markets haven’t crashed yet. Second, as commodities-driven economies, they have been the biggest beneficiaries of China’s pumping a trillion dollars of liquidity into its economy during the crisis. Third, as as countries that are not capital exporters (as in they do not have high domestic savings rates) their financial institutions were not investors in foreign assets, and hence did not load up on toxic US paper. But don’t expect those arguments to carry much weight with politicians in those countries.

And in any event, these holdouts may not make much difference if the G20 members are successful in agreeing to implement measures to prevent banks from moving to avoid taxed. Presumably, that would include shifting assets or exposures. But it will take a real show of unity, plus some tenacity, to make even a modest measure like this stick.

Geithner Yet Again Misrepresents TARP “Performance”

The problem with propaganda is that it is generally effective. Utter the Big Lie often enough and most people will come to believe it.

The Obama Administration has engaged in persistent misrepresentation of the outcome of the TARP equity injections, which is a manifestation of its early decision to reconstitute as much as possible, the banking industry that had just driven itself and the global economy off the cliff. Albert Einstein defined insanity as “doing the same thing over and over again and expecting different results.” The decision of the new Administration to cast its lot with an unreformed banking industry locked it into a course of action. As we noted earlier,

Thus Obama’s incentives are to come up with “solutions” that paper over problems, avoid meaningful conflict with the industry, minimize complaints, and restore the old practice of using leverage and investment gains to cover up stagnation in worker incomes. Potemkin reforms dovetail with the financial service industry’s goal of forestalling any measures that would interfere with its looting.

Yves here. One place that frequent repetitions of the Big Lie might not work so well is relative to the TARP, where the overwhelming majority of Americans were so opposed to bank bailouts with no pain inflicted on the recipients that any attempts to call the effort a success might simply serve to reopen a festering wound. But let’s not take any chances.

Today, a New York Times headline extols, “Banks Have Repaid 75% Of Bailout, Geithner Says.” Their summary:

The Treasury secretary, Timothy F. Geithner, said on Tuesday that taxpayers were recovering their investment from the financial bailouts as the program was wound down. But he acknowledged there would probably be a loss from the rescue of the insurer American International Group.

From his testimony:

We closed the Capital Purchase Program, under which the bulk of support to banks has been provided. To date, banks have repaid approximately 75 percent of TARP funds they received, and TARP investments in banks have generated taxpayers $21 billion in income from dividends, sales of warrants and stock, and fees from cancelled guarantees. We expect TARP investments in banks to generate a positive return on the whole

Yves here. Let’s debunk the two overarching messages:

1. Taxpayers got a good deal

2. “Paying back” the TARP is a sign of success of the program

Start with the “good deal” myth. Note that while Geithner does use the word “investment” from time to time, he and Obama when talking about the TARP have most often used the turn of phrase “pay back.”

Some members of the public might hear the “pay back” and assume the funding had been via debt. Instead, the Capital Purchase Program program was senior preferred stock plus equity warrants. The Treasury did build in some mechanisms to encourage return of the funds (preferred dividends increased from 5% to 9% after year 5, for instance). But there was no immediate pressure in the deal terms to lead a quick return of the funds to necessarily be a good thing.

Most important, the key metric as to whether the deal was a good deal is not the speed of repayment, as the Adminstration’s boosterism implies, but whether the deal was a good one given market conditions as of October 2008. Answer: not at all. The deal was lousy on its face, and it did NOT serve to advance what should have been the overarching objective, namely, putting the industry on sounder terms, say by using the leverage to extract key concessions. Instead, this was another manifestation that the officialdom has adopted through the entire crisis: patch the system up with duct tape and baling wire, and if it looks even remotely operational, tout it as tremendous success. We noted at the time the equity injections were announced:

But here we go, virtually no restrictions (the Bloomberg article mentions executive comp limits, but given Paulson’s stance, expect this to be cosmetic), no (a la Sweden) having a disciplined process to figure out who was worth salvaging and concentrating rescue dollars on them, and having a strategy (consolidation, liquidation, spinning bad assets off into an Resolution Trust type “bad bank” vehicle) for the ones that didn’t make the cut.

For those who may forget the details, Paulson hauled what were to be the main TARP recipients, hectored them for nearly two hours about how they were gonna take the money, then after this faux show of force, unveiled attractive terms. Not surprisingly, the banks fell into line.

But let’s turn to the even bigger issue: was it a good idea for the banks to be so quick to pay back their TARP funds? Marshall Auerback shredded that idea:

This whole line about “taxpayers to recover bailout money” is based on an accounting fraud, because accounting abuses are the primary means by which TARP recipients have repaid bailout money — putting us at greater risk. That may seem paradoxical, but the rush to repay is driven by a desire to have unrestrained executive bonuses (a very bad thing associated with far greater accounting fraud and failures — requiring future, larger taxpayer bailouts) and accounting abuses produce the (fictional) ability to repay the United States (primarily by failing to recognize existing losses). The TARP recipients weakened their financial condition, and increased moral hazard, when they rushed to repay the TARP funds. Both factors increase the risk of making more expensive future bailouts more likely.

Yves here. Technically, the accounting isn’t fraudulent, since the banks have gotten so many variances (it’s called regulatory forebearance). But the profits and equity levels banks are reporting are more than a tad misleading.

Extend and pretend is rampant. Not only are asset values inflated by super cheap funding, which is not going to be with us forever, but there is considerable evidence that banks are making assets at utterly indefensible levels. We’ve pointed repeatedly to Mike Konczal’s quick and dirty analysis of second mortgages, which suggests the four biggest banks are overstating their equity by roughly $150 billion. We have also had readers who work at dealer banks tell us of wildly unrealistic marks on CMBS. And the big banks, per Chris Whalen, are reporting unrealistic earnings and equity levels due to taking insufficiently low loan loss reserves.

But Geithner would have you believe all is well in bank-land. Paulson discovered he could not kick the can down the road to the next Adminsitration. Team Obama believes he will be re-elected, and it presumably does not think it can paper over problems for another six years. Thus it appears they are unable to distinguish between mere cosmetics and real progress. Scary indeed.

Gonzalo Lira: Is the U.S. a Fascist Police-State?

By Gonzalo Lira, a novelist and filmmaker (and economist) currently living in Chile and writing at Gonzalo Lira

I lived in Chile during the Pinochet dictatorship—I can spot a fascist police-state when I see one.

The United States is a fascist police-state.

Harsh words—incendiary, even. And none too clever of me, to use such language: Time was, the crazies and reactionaries wearing tin-foil hats who flung around such a characterization of the United States were disqualified by sensible people as being hysterical nutters—rightfully so.

But with yesterday’s Holder v. Humanitarian Law Project decision (No. 08-1498, also 09-89) of the Supreme Court, coupled with last week’s Arar v. Ashcroft denial of certiorari (No. 09-923), the case for claiming that the U.S. is a fascist police-state just got a whole lot stronger.

First of all, what is a “fascist police-state”?

A police-state uses the law as a mechanism to control any challenges to its power by the citizenry, rather than as a mechanism to insure a civil society among the individuals. The state decides the laws, is the sole arbiter of the law, and can selectively (and capriciously) decide to enforce the law to the benefit or detriment of one individual or group or another.

In a police-state, the citizens are “free” only so long as their actions remain within the confines of the law as dictated by the state. If the individual’s claims of rights or freedoms conflict with the state, or if the individual acts in ways deemed detrimental to the state, then the state will repress the citizenry, by force if necessary. (And in the end, it’s always necessary.)

What’s key to the definition of a police-state is the lack of redress: If there is no justice system which can compel the state to cede to the citizenry, then there is a police-state. If there exists a pro forma justice system, but which in practice is unavailable to the ordinary citizen because of systemic obstacles (for instance, cost or bureaucratic hindrance), or which against all logic or reason consistently finds in favor of the state—even in the most egregious and obviously contradictory cases—then that pro forma judiciary system is nothing but a sham: A tool of the state’s repression against its citizens. Consider the Soviet court system the classic example.

A police-state is not necessarily a dictatorship. On the contrary, it can even take the form of a representative democracy. A police-state is not defined by its leadership structure, but rather, by its self-protection against the individual.

A definition of “fascism” is tougher to come by—it’s almost as tough to come up with as a definition of “pornography”.

The sloppy definition is simply totalitarianism of the Right, “communism” being the sloppy definition of totalitarianism of the Left. But that doesn’t help much.

For our purposes, I think we should use the syndicalist-corporatist definition as practiced by Mussolini: Society as a collection of corporate and union interests, where the state is one more competing interest among many, albeit the most powerful of them all, and thus as a virtue of its size and power, taking precedence over all other factions. In other words, society is a “street-gang” model that I discussed before. The individual has power only as derived from his belonging to a particular faction or group—individuals do not have inherent worth, value or standing.

Now then! Having gotten that out of the way, where were we?

Holder v. Humanitarian Law Project: The Humanitarian Law Project was advising groups deemed “terrorists” on how to negotiate non-violently with various political agencies, including the UN. In this 6-3 decision by the U.S. Supreme Court, the Court ruled that that speech constituted “aiding and abetting” a terrorist organization, as the Court determined that speech was “material support”. Therefore, the Executive and/or Congress had the right to prohibit anyone from speaking to any terrorist organization if that speech embodied “material support” to the terrorist organization.

The decision is being noted by the New York Times as a Freedom of Speech issue; other commentators seem to be viewing it in those terms as well.

My own take is, Holder v. Humanitarian Law Project is not about limiting free speech—it’s about the state expanding it power to repress. The decision limits free speech in passing, because what it is really doing is expanding the state’s power to repress whomever it unilaterally determines is a terrorist.

In the decision, the Court explicitly ruled that “Congress and the Executive are uniquely positioned to make principled distinctions between activities that will further terrorist conduct and undermine United States foreign policy, and those that will not.” In other words, the Court makes it clear that Congress and/or the Executive can solely and unilaterally determine who is a “terrorist threat”, and who is not—without recourse to judicial review of this decision. And if the Executive and/or Congress determines that this group here or that group there is a “terrorist organization”, then their free speech is curtailed—as is the free speech of anyone associating with them, no matter how demonstrably peaceful that speech or interaction is.

For example, if the Executive—in the form of the Secretary of State—decides that, say, WikiLeaks or Amnesty International is a terrorist organization, well then by golly, it is a terrorist organization. It no longer has any right to free speech—nor can anyone else speak to them or associate with them, for risk of being charged with providing “material support” to this heinous terrorist organization known as Amnesty International.

But furthermore, as per Holder v. Humanitarian Law Project, anyone associating with WikiLeaks—including, presumably, those who read it, and most certainly those who give it information about government abuses—would be guilty of aiding and abetting terrorism. In other words, giving WikiLeaks “material support” by providing primary evidence of government abuse would render one a terrorist.

This form of repression does seem to fit the above definition of a police-state. The state determines—unilaterally—who is detrimental to its interests. The state then represses that person or group.

By a 6-3 majority, the Supreme Court has explicitly stated that Congress and/or the Executive is “uniquely positioned” to determine who is a terrorist and who is not—and therefore has the right to silence not just the terrorist organization, but anyone trying to speak to them, or hear them.

And let’s just say that, after jumping through years of judicial hoops, one finally manages to prove that one wasn’t then and isn’t now a terrorist, the Arar denial of certiorari makes it irrelevant. Even if it turns out that a person is definitely and unequivocally not a terrorist, he cannot get legal redress for this mistake by the state.

So! To sum up: The U.S. government can decide unilaterally who is a terrorist organization and who is not. Anyone speaking to such a designated terrorist group is “providing material support” to the terrorists—and is therefore subject to prosecution at the discretion of the U.S. government. And if, in the end, it turns out that one definitely was not involved in terrorist activities, there is no way to receive redress by the state.

Sounds like a fascist police-state to me.

Links 6/22/10

Your blogger has a baaaaad cold! Posts may be thin the next few days.

Monsanto GM seed ban is overturned by US Supreme Court BBC. Just about every Supreme Court decision these days is an advertisement for becoming an expat.

A Bruise on the First Amendment New York Times

40,000 deaths a year due to junk food, says health watchdog Nice Telegraph

EU sees solar power imported from Sahara in 5 years Reuters

Life in the Gas Lane: Living with Drilling, Part II-c Corrente

A Colossal Fracking Mess Vanity Fair (hat tip reader Crocodile Chuck). You need to read this. This process uses a lot of water and worse, contaminates aquifers….and fresh water is the MOST scarce resource globally. We are due to run out of it before all others. This is monstrously short-sighted.

That’s all, spokes: Colorado town of Black Hawk bans cyclists Guardian (hat tip reader John D)

Human race ‘will be extinct within 100 years’, claims leading scientist Daily Mail (hat tip reader Toby). Yes, it’s the Daily Mail…but the flip side is humans underestimate tail risk.

Are We Going Down Like the Soviets? Tom Englehardt (ht tip reader Gonzalo Lira)

Merchants Win Debit-Card Fee Battle Wall Street Journal

Freight fright *alert* FT Alphaville

As Law Takes Effect, Obama Gives Insurers a Warning New York Times

A Health Insurer Pays More to Save New York Times

Chinese Yuan Spencer, Angry Bear. Note that contrary to hyperventilating in the media, China announced its peg v. dollar Monday at same level as the Friday before its announcement. The currency movement during day (touted hysterically at Bloomberg) was within permitted band (the move was .42%, when the maximum allowed in a day is .5%, and the announcement stated that the bands would not be widened). China may be playing games. It did move the reference rate up by almost exactly amount of the market increase yesterday, but the market rate today is lower. And while the PBoC isn’t intervening today, this reversal is looking orchestrated nevertheless (China state-owned banks buying dollars heavily: traders Reuters) While even this tiny move is more than I anticipated, I’m still not convinced that what so far is a rise so small as to be cosmetic will get any follow through after the G20 meetings.

Rising China Wages Prompt Nissan, Foxconn to Boost Automation Bloomberg

SP Futures and Gold Daily Charts at 2:30 EDT: Smoke and Mirrors Jesse

Stress tests results likely to be broadened Eurointelligence

Meredith Whitney Comments on Housing Double Dip Ed Harrison

Old Wall Street Discusses the New Floyd Norris, New York Times (hat tip reader Steve S)

Profit-Margin Outlook for U.S. Is ‘Extremely Bad’: Chart of Day Bloomberg

Antidote du jour:

Picture 65

Afghanistan: Pentagon Payments to Warlords Undermine Central Government

The Pentagon, to secure supply lines, is effectively making payments to warlords in Afghanistan. Not only is that undermining the central government (as in by reinforcing competing centers of power), but it also appears to be helping to fund the insurgents.

Now before you put that overview in the “You cannot make this stuff up” category, actually, it’s the reverse. This is a completely predictable outcome given the situation in Afghanistan, which is that the US, like the Soviets before us, controls only the cities, and is in completely hostile territory elsewhere.

Remember, for all practical purposes, there is no infrastructure in Afghanistan. As reader Crocodile Chuck pointed out, “The entire military supply chain is flown in: equipment, materiel, food, fuel. It’s like staging a war on the moon.” So if you want to secure passage across the countryside, say to move munitions or troops, you need the cooperation of the not so friendly locals. The warlords aren’t above taking bribes, but the officialdom has somehow managed to harbor the illusion that paying money to people who are hostile to our occupation is likely to result in the funds being used against us. Bloomberg gives an overview:

Contractors on a $2.1 billion job trucking U.S. supplies into Afghanistan are paying millions of dollars in protection money to warlords controlling their routes, according to a congressional report.

Contractors told congressional investigators they believe that, in turn, “the highway warlords make protection payments to insurgents” who are fighting the U.S., though there wasn’t direct evidence backing that claim..

Yves here. That “wasn’t direct evidence” looks like someone desperately trying to find a fig leaf. Back to the piece:

The eight contractors who carry food, fuel, ammunition and other goods under the Afghan Host-Nation Trucking Contract are expected to provide for their own security without U.S. military escorts.

This has led to an ad-hoc system where the principal private security subcontractors are “warlords, strongmen, commanders and militia leaders who compete with the Afghan central government for power and authority,” the report said…

The trucking contracts cover 70 percent of the U.S. overland supply chain that typically starts in Pakistan, moving in convoys of as many as 300 trucks through Pashtun tribal lands to U.S.-controlled distribution hubs near Bagram Airfield and Kandahar Airfield.

Yves here. The Associated Press reported that the Afghan “security firms” could be getting as much as $4 million a week from the trucking contractors for protection.

The part that is a wee bit misleading is the suggestion that military escorts would end the need for payoffs. It is going to be interesting to see what happens if this inquiry does indeed put an end to the bribes, because the result may well be much more serious problems with resupply. An article in the Boston Globe noted:

“While is it important that we continue to do all we can to combat illicit financial flows, setting up an alternative to Afghan private security contracts — such as having US troops escort the goods — would be costly and entail additional dangers,’’ said Jeremy Pam, guest scholar at US Institute of Peace.

As we pointed out in an earlier post, the sudden touting of the presence of a lotta minerals in Afghanistan (which it turns out was not news, except maybe to the chump American public) appeared to be an effort to bolster a military campaign that is going not at all well. We cited our sometimes guest poster Richard Kline, who pointed to an unintentionally damning piece in the Christian Science Monitor and provided this take:

Here are a few points in takeaway, directly from statements of joes in the 12th infantry a few miles outside Kandahar.

1) They absolutely do _not_ control the countryside.

2) The Taliban engage them—when they want to, where they want to, as they want to—not the other way around.

3) The occupiers are engaged in an attritional contest where everywhere they go is now mined and they lose a steady, bloody drip of casualties anytime they move.

4) The Taliban have received heavy reinforcements from outside the region which the occupiers are unable in any meaningful way to interdict.

5) The Taliban can, and do, kill anyone who cooperates in any remote way with the occupation, and neither the occupation nor its regime can do anything about this whatsoever.

6) The operational objective of this particular unit was, in effect, to ‘inconvenience the manueverability’ of the Taliban units.

7) The operational objective of their regional command (in Kandahar) was ‘to control the big cities so that they (the Taliban) would have to come to terms with us.’

And keep in mind, this is all taking place at the height of The Surge II in the region with maximum deployment of assets declared as the primary objective of the present occupation campaigning season.

There is a word for this configuration of conditions: defeat. This is why Stan McChrystal is re-polishing his shiny balls: he and his are completely immobilized, have lost any operational initiative that they may have had, can’t do a damn thing about it, and are now trying to keep the large population centers hostage to some kind of settlement. This looks highly like the Soviet occupation of Afghanistan, minus the saturation bombing but with far more boots on the ground. This looks amazingly like the Indochina dumb-a-thon; even the kind of rhetoric used by the guys in the article I mention would be entirely in place, trying to paint a picture of failure as one where the occupation is ‘in control and on plan’ by milspeak fuzziness and omission, much of it the unintentional result of what is left when candor is excluded.

The problem, as Kline pointed out later in comments, is that the US has chosen not to understand the nature of this engagement:

….this is a Pashtun war against a widely detested occupation. We’re not fighting the largely mythical al-Qaida, imperialist talking points nothwithstanding: we’re fighting the people who live on the ground, and their immediate cousins who live over the crestline….

The Taliban has demonstrated, deep support from a plurality of the Pashtuns of Afghanistan on its worst day. That day is behind us. They likely have majority support now, and have backing in areas where one never would have expected that in a generation such as the North Slope. All most as importantly, the Taliban completely dominate the security of the countryside: no one whom they dislike survives, at this point. No one turns them in and survives. No one takes $29 of wampum and an iPod from the occupiers and survives. Sure, the Taliban would rather make nice and have strong support, but the demonstrated fact, in _multiple current reports_ is that the insurgency dominates the locals totally. The US can do nothing about this. Stan McChrystal thought he had a sepoy army and collaborationist bureaucracy read to roll to handle the countryside once he ‘manhandled’ Those People’ out of the way; he has now been disabused of that notion; nothing of the sort exists, OR WILL EXIST…

The war is lost, I said. Now, ‘lost’ is a relative term….The Taliban cannot, yet, eject the occupation; it may be that they never can on their own, as they are now. The occupation cannot defeat the Taliban, and the cost for staying in the Great Game only gets higher as the insurgency gets better and broader. I mentioned several analogous conflicts for the present state of conditions describing the war in the Stans. I left out the best one, though: South Lebanon. Israel had all the air one could ever want, vast ‘technological superiority,’ held every town, had a better force ratio _by far_ than the occupation has or will ever have in the Stans, and operated in terrain generally more favorable to an occupier than that of Afghanistan, and snatch-and-grabbed ‘leaders’ profusely—and left with their tails between their legs. The tactics used by the insurgency in South Lebanon are those exactly being used in Afghanistan, and that is 100% no coincidence, and not simply because they worked there. The Israelis couldn’t win in Lebanon anymore than we can win in Afghanistan, and got tired of the expense of non-losing, not least because the insurgency there were gradually getting better weapons, raising the costs, and had generally outfought the occupiers huddled in their iron coffins…

Strategically,the situation is exactly the same [as the Soviet occupation of Afghanistan]: the Soviets held the cities, but not the countryside, not ever. The present Taliban-led insurgency is far more effective than the mujahideen ever were, and operationally active in more of the countryside, this despite the fact that the US has significantly more ground in place than the Soviets ever did.

Yves here. Other factoids strongly suggest our little adventure (actually, technically a NATO operation, as reader aet pointed out) is not going swimmingly. The UK wants out. A story last week in Der Spiegel (hat tip reader Swedish Lex) similarly indicated that Germany is thinking about exiting:

The belief that things will end well in Afghanistan is dwindling in Germany. An increasing number of security experts recommend an orderly withdrawal and even those who were involved in sending the Bundeswehr on the mission are now voicing doubts about ultimate success….

Asked if everything is going well in Afghanistan, [former Defense Minister Peter] Struck bursts out with, “No!” Asked if the German Armed Forces, the Bundeswehr, are where they had hoped to be, he exclaims, “No, of course not!” He can clearly remember the days following Sept. 11, 2001. Struck was chairman of the SPD’s parliamentary group when then-Chancellor Gerhard Schröder declared Germany’s full solidarity with the United States. This statement effectively meant Germany would be going to Afghanistan. “One year, then we’d be back out, that’s what we thought back then,” Struck says, poking at his fish, before adding, “We thoroughly deceived ourselves.”…

The price is soaring higher and higher, in terms of both human lives and finances. Officially, the mission costs Germany €1 billion ($1.2 billion) per year, but experts place the true costs at three times that amount, which would make it 10 percent of the country’s defense budget. Official data has the war in Afghanistan costing Germany over €6 billion so far.

Yves here. I wonder how long the drip drip drip of lack of progress in Afghanistan, plus continuing budget pressures in the US, will lead us to find a graceful exit. Unfortunately, having put our prestige on the lines, I suspect it will not be soon.

Guest Post: Experts Say BP Lowballing Size of Leaking Oil Reservoir

Washington’s Blog

On May 1st, I warned that the amount of oil spilling into the Gulf was much higher than either the government or BP were admitting:

As a story in the Christian Science Monitor shows, the Gulf oil spill is much worse than we’ve been told:

It’s now likely that the actual amount of the oil spill dwarfs the Coast Guard’s figure of 5,000 barrels, or 210,000 gallons, a day.

Independent scientists estimate that the renegade wellhead at the bottom of the Gulf could be spewing up to 25,000 barrels a day. If chokeholds on the riser pipe break down further, up to 50,000 barrels a day could be released, according to a National Oceanic and Atmospheric Administration memo obtained by the Mobile, Ala., Press-Register.

As estimates of the spill increase, questions about the government’s honesty in assessing the spill are emerging.


“The following is not public,” reads National Oceanic and Atmospheric Administration’s Emergency Response document dated April 28, according to the Press-Register [see this]. “Two additional release points were found today. If the riser pipe deteriorates further, the flow could become unchecked resulting in a release volume an order of magnitude higher than previously thought.”
An order of magnitude is a factor of 10.

The Wall Street Journal reported Friday that John Amos, an oil industry consultant, said that NOAA revised its original estimate of 1,000 barrels after he published calculations based on satellite data that showed a larger flow.

The 5,000 barrels a day is the “extremely low end” of estimates, Mr. Amos told the Journal.

CNN quotes the lead government official responding to the spill – the commandant of the Coast Guard, Admiral Thad Allen – as stating:

If we lost a total well head, it could be 100,000 barrels or more a day.

Indeed, an environmental document filed by BP estimates the maximum as 162,000 barrels a day:

In an exploration plan and environmental impact analysis filed with the federal government in February 2009, BP said it had the capability to handle a “worst-case scenario” at the Deepwater Horizon site, which the document described as a leak of 162,000 barrels per day from an uncontrolled blowout — 6.8 million gallons each day.

Now, I am warning that the amount of oil still in the reservoir might be much bigger than BP is admitting.

Specifically, BP claims that there are 50 million barrels worth of oil in the reservoir underneath the leaking spill site.

But the Guardian noted Friday:

But the 50m figure cited by Hayward took some industry insiders by surprise. There have been reports the reservoir held up to 500m barrels – the figure quoted by Hayward’s questioner, Joe Barton, a Republican from Texas.

“I would assume that 500m barrels would be a more likely estimate,” said Tadeusz Patzek, the chairman of the department of petroleum and geosystems engineering at the University of Texas at Austin. “I don’t think you would be going after a 50mbarrel reservoir so quickly. This is just simply not enough oil to go after.”

Indeed, Wolf Blitzer said:

One — one expert said to me — and I don’t know if this is overblown or not — that they’re still really concerned about the structural base of this whole operation, if the rocks get moved, this thing could really explode and they’re sitting, what, on — on a billion potential barrels of oil at the bottom of the Gulf of Mexico.

Bloomberg notes:

The ruptured well may hold as much as 1 billion barrels, the Times reported, citing Rick Mueller, an analyst at Energy Security Analysis in Massachusetts.

Oil industry expert Matthew Simmons also puts the number above one billion barrels (see this Bloomberg interview, for example, where he says that – unless stopped – 120,000 barrels a day will leak for 25-30 years; that adds up to 1,095,000,000 to 1,314,000,000 barrels).

And Rob Kall claims that a source inside BP tells him:

Size of reservoir – estimated by BP and its partner, Andarko to be between 2.5B and 10B bbl. (that’s 100,000,000,000 gallons and 400,000,000,000 gallons).

Yes – all of those numbers are BILLIONS.

Given that BP’s nearby Tiber and Kaskida wells each contain at least 3 billion barrels of oil (see this, this, this and this), estimates of more than a billion barrels for the leaking Macondo reservoir are not unreasonable.

Why the Size of the Reservoir Matters

The size of the reservoir is important for several reasons. Specifically, the more oil in the Macondo reservoir, the longer the oil leak will flow if the efforts to cap it fail.

Moreover, higher volumes of oil and gas might change the pressure of materials gushing out of the leaking well. As CBS notes:

The oil emanating from the seafloor contains about 40 percent methane, compared with about 5 percent found in typical oil deposits, said John Kessler, a Texas A&M University oceanographer who is studying the impact of methane from the spill.

I will leave it to the scientists to calculate what a larger volume of oil (with 40% methane) would mean for pressure. Higher pressure may make it harder to cap the leak, and may wear out the casing quicker by speeding up the rate at which sand and other small particles in the oil abrade the metal. Lower pressure would ease both problems.

Finally, the more oil and gas in the reservoir, the higher a priority the government may consider it to produce the well at all costs. See this and this.

Guest Post: The Second Energy Revolution

By Wallace C. Turbrville, the former CEO of VMAC LLC who writes at New Deal 2.0

In the 1930s, a great many Southerners had no access to electricity. The Roosevelt administration perceived an enormous opportunity to restructure the region’s economy. By building facilities to bring power to the rural South, jobs would be created from thin air to mitigate the unemployment of the Great Depression. More importantly for the long run, commercially vibrant communities would replace subsistence farms. For the people directly affected, lives of toil and sweat would be a thing of the past; for the nation, large populations would be integrated into the economy for the first time, helping to assure sustainable and diverse growth in the post-depression era.

The political effects were dramatic. Robert Caro, in his epic biography of Lyndon Johnson, described the brutal life of West Texas before the creation of the Lower Colorado River Authority. He pointed out that the dramatic life-changing effect of rural electrification spawned a fierce loyalty to New Dealers like Johnson. This persisted throughout the South for three decades until, ironically, Johnson’s Civil Rights legislation snuffed it out.

For those 30 years, electrification and other tangible benefits of the New Deal drove political discourse in this country. For the next three decades (and still), the Civil Rights legislation animated politics. The issue morphed from overt racism to resentment of the federal government telling people what to do. We must remember to thank Rand Paul for reminding us of the connection between race and the radical right.

Today, the federal government is considering a second revolution in energy. The issues are more abstract than those of the 1930s. We no longer have insufficient energy infrastructure. We have the wrong infrastructure. Instead of a backwards region dragging on an economy already in dire straits, the concerns today are threats to our future well-being: climate change and dependence on foreign sources of fuel. A comparison of the 30s and today is like the difference between treatment of a bleeding artery and a wellness program. Both will save your life, but the wellness program can be started next week.

It will be necessary to overcome both parochial regional opposition and ideological opposition by the Republican right. The right has a general aversion to federal expenditures to secure a promised benefit in the future. The aversion is strongest in regions whose economies depend disproportionately on coal. Their upfront cost is disproportionately large and the anticipated benefits are spread over the whole society.

The key to success is to articulate an urgency to act on concerns that are somewhat intangible. Energy reform addresses two distinct concerns. Climate change constitutes a catastrophic threat while energy independence is a national security matter, a defense against economic tactics in the conflict with Islamic extremism. A portion of the public is susceptible to both concerns. However, on the extremes, representing the most politically active people, there is much less overlap. In particular, the people who are most attached to the national security rationale are unlikely to be motivated by environmental risks. For example, despite the tragedy of the BP oil spill, many on the right are resistant to a drilling moratorium. The winning strategy is to keep as many individuals from these two groups together as possible. This is a treacherous endeavor.

The task of the proponents for a new energy revolution can be framed by an analysis of the opponents’ strategy. The most direct strategy, obfuscation, was signaled by Lamar Alexander in his response to the President’s Oval Office speech on energy and the oil spill. He characterized the proposed Climate Change legislation as an “energy tax.” He proposed as an alternative simply replacing half of our vehicles with electric powered cars, trucks and buses.

For those who thought that the legislation was about the environment, this alternative proposal sounds like nonsense. The new vehicles will still require energy, just not gasoline as fuel. Transportation represents about 33% of total carbon emissions in the US. Power generation accounts for about 42%. Simple logic suggests that the 16.5% reduction in transportation sources would be transferred to power generation which would then constitute 58.5%. Almost certainly this is imprecise, but, as they say in Tennessee where Senator Alexander and I grew up, “it’s close enough for gov’ment work.”

Alexander’s proposal is not about the environment. It is designed to separate the national security advocates from the environmentalists. It is unlikely that Republicans view it as a realistic alternative. It echoes the tactics employed in the health care debate. In health care, they attempted to carve back the scope of the bill by advocating an incremental approach, knowing full well that the only way to benefit poorer people was comprehensive legislation. Their purpose was to separate middle income people interested in insurance reform from those also interested in the plight of the poor. The Democrats were tentative about advocating benefits of helping poor people and the opponents achieved significant success. If the same tentativeness is used regarding the environmental benefits of the Climate Change legislation, we can expect the same type of result or much worse.

The second strategy of the opponents is de-legitimization. The far right has turned this into a socio-political movement, encompassing everything from the Birthers to the Tea Party enthusiasts dressed in Revolutionary War costumes. They embrace the position that scientific proof of climate change caused by human activity is untrue. To explain these beliefs in the face of concrete evidence they resort to pseudo science and preposterous conspiracy theories. (This is a remarkable echo of the religious right’s reliance on literal readings of the Bible to counter scientific facts like evolution.)

Republican leaders have seized on this anti-intellectual movement. It is hard to believe that politicians who are able to ascend to positions of leadership and commentators able to construct and manage media empires are unpersuaded by the scientific consensus on climate change. The only alternative is that they are driven by cynical opportunism and venality. Their motives are known only to them. The practical problem is that the movement is a useful weapon for ideological opponents of Climate Change legislation.

Of the two opposition strategies, obfuscation will only be successful if de-legitimization works to undercut the threat of climate change. The message of de-legitimization is particularly powerful in America today. The American public is insecure and feels as if leadership of all kinds has failed it. Being normal humans, they are unlikely to blame themselves for bad decisions. It is easier to de-legitimize the people and institutions in which they formerly chose to believe. The President and other leaders must not allow themselves to be ridiculed and bullied by know-nothings.

If the climate debate becomes an argument over competing beliefs through de-legitimization of proponents, the cause is lost. Opponents would not advertise their real intent to kill the whole effort. They would offer easier incremental options designed to appeal to those most interested in national security, hoping to smother the environmental elements of the legislation.

The proponents cannot succeed by relying on compellingly logical proofs. The problem is not that people doubt the data and the algorithms; it’s that they doubt the messengers. The first step in bolstering legitimacy is to demonstrate sincerity of the messengers. Sincere people are more legitimate. The President is the dominant messenger in our system so it must start with him.

Climate change threatens future generations. It would be powerful if the President conveyed with sincerity that addressing climate change now is important to him because of concern for his family and that he shares this concern with all American parents. The threat to the future must made concrete and personal and that means families. Political agendas must be secondary to sincere and shared concern for future generations. If the public believes that the single leader elected by all of us sincerely is concerned for their children’s well-being, de-legitimization will lose its bite. Science can then make the case for prompt action.

Mirabile Dictu! The Fed Criticizes Wall Street Pay Practices

The normally bank-friendly Fed fired an unexpected shot across the industry’s bow today, taking issue with its failure to take sufficiently tough measures to curb undue risk-taking. Per the Washington Post:

The Federal Reserve has completed an initial review of compensation policies at 28 large banks it oversees and has been giving them confidential feedback on areas where they must change. On Monday, the Fed and other federal regulators issued final guidelines, stressing the need for policies that do not give executives, traders, and other bank employees incentives to make overly risky investments that might earn them huge bonuses in the short run while leaving the bank exposed to losses in the long term.

The press release detailed the areas in which, ahem, improvement was necessary:

* Many firms need better ways to identify which employees, either individually or as a group, can expose banking organizations to material risk;
* While many firms are using or are considering various methods to make incentive compensation more risk sensitive, many are not fully capturing the risks involved and are not applying such methods to enough employees;
* Many firms are using deferral arrangements to adjust for risk, but they are taking a “one-size-fits-all” approach and are not tailoring these deferral arrangements according to the type or duration of risk; and
* Many firms do not have adequate mechanisms to evaluate whether established practices are successful in balancing risk.

Yves here. This emphasis on better calibration of risk, and more differentiation among incentive comp payout structures, would indeed help discourage the industry’s fondness for complex, opaque deals that produce profits now but have hidden risks that can blow up clients and even the firm, later. It might serve to restore the recently-fallen standing of investment banking businesses. If you do an M&A transaction or a corporate underwriting, the risk that the deal team did Something Awful that will leave wreckage in it wake is limited (not zero, mind you, but limited). By contrast, if you are a derivatives salesman, if you sell the sort of complex products that produce juicy profits (and those are opaque to the client), they typically don’t go sour right away.

But one of the problems is I am not certain how you improve the industry’s ability to judge risk ex ante. Pretty much no one at the big firms judged AAA CDO tranches to be risky until it was too late. They had been acceptable collateral for repo and the haircuts were a mere 2-4%. Even after the Bear Stearns hedge funds blew up (July 2007) repo haircuts didn’t start widening (and then only a very small amount) until Sept 2007 (and recall, that was the first acute phase of the credit crisis, when subprime paper was suddenly tainted). Anyone in senior management up through and including the 2006 bonus year would no doubt have contended that CDOs weren’t that risky (80% of the deal was rated AAA, the rest was sold to “sophisticated” buyers). And 2006 was the peak year for CDO issuance, and the overwhelming majority of deals burned investors, and the banks, badly.

The Financial Times focused on the politics:

In response to the backlash against big bonuses, most banks have announced provisions to “claw back” part of traders’ and bankers’ bonuses if their deals cost money in later years…

However, many banks have remained adamant that star traders and bankers would still be rewarded with big pay packages, arguing that a large cut in salary and bonuses would lead to a brain drain from the industry to less regulated entities such as hedge funds and private equity groups.

A senior Wall Street banker said on Monday that the Fed’s moves would compound the political pressure on compensation but added that, in private, the authorities had been more flexible in vetting pay practices and bonuses.

Banks are now bracing for a possible new salvo from Kenneth Feinberg, special master on pay at the Treasury, who will announce soon whether he intends to name and shame banks over specific pay-outs made at the height of the crisis.

Yves here. “Bracing”? Banks have been remarkably impervious to criticism from officials and the media. But the Fed could actually force some changes if it kept the heat on. Given its track record, I would not be terribly optimistic, but then again, I am surprised it has gone even this far. It would be great if it surprised me again.

George Magnus on China’s Renminbi Move

George Magnus, senior economic advisor at UBS, provided a reading of the Chinese central bank’s announcement on its currency policy over the past weekend. He sees it as political, “symbolic rather than substantive.” He also contends that China needs to make significant policy changes.

From the Financial Times:

It would be churlish not to acknowledge that a more flexible renmbini is unequivocally a good thing. But China is not really interested in meaningful changes in the currency regime. As I argued on this page earlier this year, an excessive and politicised focus on the exchange rate deflects attention from three areas where enduring changes are needed.

First, China’s creditor status necessitates that it also takes responsibility for fixing global imbalances, especially as the west has been increasing its savings. Creditor countries that back away – such as the US in the 1920s or Japan in the 1980s – do the world, and themselves, no favours.

Second, imbalances will not go away so long as China has an entrenched savings excess – the product of an unreformed rural sector, the urban citizen registration system, immature social security and financial systems, and the one-child policy.

Third, the renminbi regime matters not so much because of any particular degree of undervaluation, but because it sustains an economy wedded to underpriced capital, excessive credit growth and artificially low interest rates. It is not inconceivable that the inflation genie is already out of the bottle and will have to be put back with a more assertive credit tightening that may be incompatible with a tightly controlled exchange rate.

I doubt that this smart, diplomatic renminbi policy shift is anything more than that. Certainly, it should not be taken as a sign that reforms to lift domestic demand are imminent. The one thing it might reflect, however, is that amid economic hubris China can also show some political humility – and that is worth nurturing in a fractious global economy.

Links Summer Solstice

I assume those of a pagan persuasion will be out celebrating….

Solstice at Stonehenge Telegraph

The Real Science Gap Miller McCune (hat tip reader Kendall)

A Best Friend? You Must Be Kidding New York Times. This appears in the “Fashion & Style” section. Gonzalo Lira notes, “The NY Times is reporting how great it is that school administrators are forbidding children from having best friends, deeming it “exclusive”. I’m not kidding—I wish I were.” I hope Vinny will weigh in on this one.

UN Africa corruption case buried Washington Pos.t UN Staffer writes, “I see it all as part of the larger failures by many institutions to take fraud seriously. TWO YEARS without a head of investigations? (Where’s the US on this one, you might ask?)”

BP was told of oil safety fault ‘weeks before blast‘ BBC

BP estimates spill up to 100,000 bpd in document Reuters

The Agony of the Liberals Ross Douthat, New York Times. Read this only if you want to raise your blood pressure.

The Stealth Attack on America’s Best-Loved Program Robert Knutter, New Deal 2.0 (hat tip reader bill). You must read this to find out who really saved Social Security during the Clinton Administration.

Rahm Emanuel expected to quit White House Telegraph (hat tip reader Marshall). We can only hope…

China Moves. Or Not. Tim Duy. There is some very disparate reporting going on right now. The Journal, as Duy pointed out, said that the PBoC set the dollar-RMB parity rate at the same level as Friday. 6.8275. The Financial Times weighs in with, “Renminbi unchanged despite policy shift.” Bloomberg, by contrast, is wildly cheerleading the fact that the currency has moved in intra-day trading to 6.803. Given that the RMB is allowed to move .5% a day v. the dollar, this is still within the permitted band, and thus inconclusive. I am sure the Chinese authorities are delighted at the reception in the market and media around the world, however.

As China Aids Labor, Unrest Is Still Rising New York Times. Cynically, I wonder whether the authorities are allowing labor protests to proceed at foreign employers and discouraging them at Chinese ones.

Dealers Pushed Aside by Private Collectors as Art Prices Surge Bloomberg (hat tip reader Buzz Potamkin)

Sleight of hand is not the best reform Clive Crook, Financial Times

A (timely) bank crisis management critique FT Alphaville. Today’s must read.

Antidote du jour:

Picture 64

Eurobank “Stress Test” Disclosure Likely to Increase Jitters

As we noted last week, Spain has forced the hand of other Eurozone bank regulators by declaring it will release the results of recent ECB stress tests, which earlier were to be published only on an aggregated basis, not bank by bank.

There is still a good bit of confusion as to what happens next. The flurry of announcements by other eurozone leaders is that they will also release the results of stress tests, but it is clear that these will be new stress tests, not the ones already completed (note this story by Reuters, for instance, which refers to past as well as prospective stress test results).

We said we did not expect this movie to end well, even though the euro rallied impressively on the news. First, the data was to be released only on an aggregated basis before precisely because French and German authorities had not liked the idea of showing bank by bank results. Not only are French and German banks rather heavily exposed to Club Med sovereign debt, but they are likely to have dodgy exposures from the 2007-2008 crisis that are still marked very generously (even though the US is the land of “extend and pretend”, the eurozone banks have marked down less of their dodgy debt than their US peers).

Those concerns are already being reflected in the marketplace. From the Financial Times:

Fears are rising over French and German banks’ exposure to weaker economies in the eurozone such as Greece, Portugal and Spain after moves to publish bank stress tests in Europe.

Investors warn the tests could expose the European banking system’s interdependence and spread contagion, which started with Greece, to the continent’s two biggest economies.

Elisabeth Afseth, fixed-income strategist at Evolution, said: “The stress tests have focused some investors’ minds on the exposure of France and Germany to the peripheral economies. This could put the French and German bond markets under pressure.”

The Bank for International Settlements published figures last week showing that French and German banks were particularly exposed to Greece, Ireland, Portugal and Spain…..The BIS said German and French banks had combined exposures of $958bn to Greece, Ireland, Portugal and Spain at the end of 2009 in its quarterly report published on June 14.

So we have problem one sorta confirmed, that publishing credible stress test results will make some banks look bad, which is precisely what the authorities want to avoid (hold that thought, we will come back to it in due course).

But recall….the reason the Spanish (and now the eurozone members who have been forced to fall into line) wanted the stress tests to be published was to restore confidence in their banks.

The problem was that confidence created by the stress tests was not simply the result of publishing a report card with As, or at least nothing worse than a B-, but having a credible process (at least as far as the not-always discerning media, analysts, and investors were concerned).

John Hempton provided a useful reminder last week (hat tip Richard Smith):

The Scandinavian banking crisis was solved in the following manner

(a). The banks were guaranteed

(b). Someone independent of the banks was invited in to reassess bank capital.

(c). The banks were then told how much capital they had to raise. They had a fixed period of time to raise it.

(d). If they could raise it – well and good – and they kept operating. If they could not the Government injected capital cancelling existing equity as it went and where it could ultimately wind up with 100 percent ownership. They were not afraid of the “n-word” (ie nationalisation).

The American solution worked almost identically except for step (d). In America

(a). The government told us that there would be “no more Lehmans” and they kept telling us and giving banks access to additional funds until we all knew the banks were effectively guaranteed,

(b). They had a “stress test” to assess how much capital to raise.

(c). The banks were told how much capital to raise and given a time. They raised it in common equity.

(d). If the banks could not raise the capital the government injected capital as common shares until they had enough. Note that the US process could not wind up with 100 percent ownership of a bank – and the “n-word” was not used. If the US had run on the Scandianvian formula Citigroup would be entirely government property.

Yves here. Hempton leaves out a few key steps in the US process, namely a well orchestrated PR campaign to talk up the banks, plus lots of theater during the stress test process, which enhanced perceptions that the tests were tough (here the propensity of bankers to fight tooth and nail over every perceived indignity was a huge plus).

The part that Hempton finesses is that the “no “n” word in the US meant the stress tests were inadequate, but that was very adeptly camouflaged. As we detailed on this blog ad nauseum while the tests were on, they were a joke. There was no effort to validate the banks’ data (by contrast, normal protocol for a troubled bank is to sample loan files). The banks were asked to run various scenarios on their own risk models, the very ones that had performed so well during the crisis. The exam was also skewed towards the lending side of the business, when the banks all had large, and potentially deadly, toxic assets and problematic liabilities via derivatives in their trading operations.

Moreover, the “adverse” scenario in the stress tests as far the performance of the economy was concerned, was far too optimistic. And it was also vastly too generous in its treatment of second mortgages exposures. The stress tests called for assuming only 13-14% losses (except for Citi, which was told to assume 20%). As Mike Konczal pointed out this year, House Financial Services Committee chairman Barney Frank has deemed seconds to have “no economic value”. The four biggest banks hold $477 billion of seconds. Even assuming, charitably, as Konczal did, that they are worth somewhere between 40 and 60 cents on the dollar, that means losses of between $190 billion and $285 billion. That in turn implies that the banks have hole in their balance sheets roughly $150 billion larger than what the stress tests showed, and that in turns implies their capital raising was $150 billion short of what was necessary.

Oh, and these banks were all allowed to pay back TARP funds because they were supposedly healthy. And the big reason for their anxiety to escape the TARP? Not because it was good for their enterprise, but to free themselves of executive pay restrictions.

So why did the stress tests work? Team Obama is great at propaganda. The media fell completely into line. One indicator: about midway through the two-month process, Bill Black appeared on the widely watched Bill Moyers show and pronounced them a sham. Not a single journalist contacted Black about the stress tests. USA Today did ask him to run an op-ed on the stress tests, then turned it down when he took his usual candid stance.

Of course, impressive-looking first and second quarter 2009 earnings didn’t hurt (leading bank analyst Meredith Whitney deemed them to be “manufactured” but also conceded the banks could keep it up for a bit) as did concerted squeezes of short interests in bank stocks.

So let us consider the obstacles to the Europeans conducting “successful” (meaning convincing to the market) stress tests:

1. Lack of a mechanism to credibly inject serious amounts of capital should that be shown to be needed. Revealingly, Merkel assured the press that the banks could rely on the eurozone rescue facilities, the same ones that are already seen as inadequate to deal with looming sovereign debt problems. As John Hempton noted:

This solution [the Scandanavian style stress test process] works provided you have sovereign solvency. A sovereign can do this if it can print money (I will go into mechanics later) but cannot do it on a gold-standard or Euro standard. The Scandinavians needed to de-peg their currency from Europe to achieve their solution and to this day there is a Swedish, Norwegian and Danish Kroner. Finland alone took up the Euro – but Finland has no large domestically owned banks.

The solution will work in Europe too provided the currency of the PIGS is separated from the Euro. It will not work otherwise because step (a) above – the Government guarantee of the banks – is not possible.

2. The various banking regulators will need to agree on the scenarios. One of the reasons that the US tests charade worked was because Treasury and the Fed had worked closely together during the crisis (remember, Geithner had just come over from the New York Fed). So with the exception of possible complications coming from Shiela Bair at the FDIC, they key players were working together and even if they had private differences, always presented a unified front in public. By contrast, every step of the eurozone crisis has shown friction and conflict, with agreement being reached painfully, at the 11th hours.

Banking regulators being less colorful and public sorts, the disarray may not be visible, but the most likely result instead is “adverse” scenarios so generous as to be unconvincing to the markets.

3. Adequate disclosure needs to be made of the scenarios and the bank-level results. Again, if national bank regulators worry that their banks will be exposed as being weak, they will fight for less disclosure than the market will deem adequate. This would put the eurozone officials back where they started, perhaps even worse off, since the failure to reveal enough will be seen as confirmation that there is indeed something to hide.

The problem at its root appears to be that the Spanish wanted to release the stress test results to prove that their banks are adequately capitalized. Even if that is true, it is certain not to be true for all the major Eurobanks. Eurozone officials, lacking a credible mechanism to shore up weak bank, have recklessly committed to showing the dirty laundry of weak banks, or more likely, engage in finesses which will simply confirm, if not heighten, existing doubts.

Update: FT Alphaville is also on a stress test kick today, see “Some stresstestimates” and ”

Why is No One Willing to Say Wall Street is Overpaid?

The New York Times yesterday featured an article by Yale economist Robert Shiller in which he discussed how financial reform had fallen short of addressing the conditions that caused the crisis. He focused on the failure to implement effective pay reform at the large financial firms that too big or otherwise too crucial to fail:

The issues facing us are complex. Let’s look at just one of them: the provisions in the Congressional bills on executive compensation.

Certainly, executive pay has grown enormously in recent decades, and there has been much suspicion that it contributed to the crisis. But it’s not the high level of executive salaries that helped cause the financial collapse. Efforts to reduce executive salaries have perversely created the wrong incentives. A 1993 law discouraging companies from paying their chief executives more than $1 million a year appears to have led to a de-emphasis of salaries and an increase in stock options.

So here is one of those epiphanies: Those stock options didn’t lower total compensation. And they probably encouraged C.E.O.’s to expose their companies to more risk, because options’ value grows as risk does. In fact, legislators’ misunderstanding of the law’s true incentives may have contributed to the severity of the crisis.

Yves here. Um, so how exactly does this little discussion disprove Shiller’s aside, that the level of pay did not contribute to the crisis? Answer: it doesn’t. He instead shows that not-fully-thought out reform created results the reverse of what was intended: it allowed pay levels to escalate when the level of executive compensation had already become worrisome, and worse, in a way that encouraged undue risk taking.

Now some readers will argue that financial services industry pay is market determined and therefore virtuous. That’s a misconstruction. Compensation in the financial services is a classic example of market failure.

The big banks and broker dealers ALL went into the crisis badly undercapitalized. Why? Because the industry engaged in a variety of practices that allowed them to rely on what amounted to fictive capital. For instance, credit default swaps allowed them to hedge risk with undercapitalized counterparties like AIG and the monolines. When the hedges failed, the banks showed spectacular losses. Similarly, banks shifted assets into structured investment vehicles and other off balance sheet entities, but earned fees both for setting them up and providing services to them. When these entities started showing serious losses, the banks discovered they weren’t so “off balance sheet” and tool losses.

If the banks had accounted for these risks properly, they would have had to carry higher capital levels and would therefore have had to retain more in the way of earnings and pay less to employees. And the idea that escalating pay levels was needed to retain “talent” was dubious. The threat was that the best staffers would leave for hedge funds. But let’s face it, they did regardless, and hedge funds employ comparatively few people in comparison to the banks and broker dealers.

Another reason compensation across the firms was excessive was that earnings are what economists call pro-cyclical. Banks and broker dealers are structurally long. Even Goldman, which endeavored to short subprime, was still long mortgages and credit instruments generally. When interest rates fall and risk spreads narrow, banks and brokers will show profits if they do absolutely nothing. They will show profits on the rise in the value of their assets. This has nothing to do with employee actions, yet they were paid bonuses on profits that would have shown up regardless. And those profits turned quickly to losses when risk spreads widened, but no one was forced to disgorge what amounted to undeserved compensation.

In 2007, John Whitehead, former co-chairman of Goldman, debunked the idea that the current levels of pay were warranted (mind you, 2006 bonus were dwarfed by 2007 and 2009 levels):

“I’m appalled at the salaries,” the retired co-chairman of the securities industry’s most profitable firm said in an interview this week. At Goldman, which paid Chairman and Chief Executive Officer Lloyd Blankfein $54 million last year, compensation levels are “shocking,” Whitehead said. “They’re the leaders in this outrageous increase.”

Whitehead, who left the firm in 1984 and now chairs its charitable foundation, said Goldman should be courageous enough to curb bonuses, even if the effort to return a sense of restraint to Wall Street costs it some valued employees. No securities firm can match the pay available in a good year at the top hedge funds.

“I would take the chance of losing a lot of them and let them see what happens when the hedge fund bubble, as I see it, ends.”

More support comes from Andrew Haldane of the BIS, who in a March 2010 paper compared the banking industry to the auto industry, in that they both produced pollutants: for cars, exhaust fumes; for bank, systemic risk. While economists were claiming that the losses to the US government on various rescues would be $100 billion (ahem, must have left out Freddie and Fannie in that tally), it ignores the broader costs (unemployment, business failures, reduced government services, particularly at the state and municipal level). His calculation of the world wide costs:

….these losses are multiples of the static costs, lying anywhere between one and
five times annual GDP. Put in money terms, that is an output loss equivalent to between $60
trillion and $200 trillion for the world economy and between £1.8 trillion and £7.4 trillion for the
UK. As Nobel-prize winning physicist Richard Feynman observed, to call these numbers
“astronomical” would be to do astronomy a disservice: there are only hundreds of billions of
stars in the galaxy. “Economical” might be a better description.

It is clear that banks would not have deep enough pockets to foot this bill. Assuming that a crisis
occurs every 20 years, the systemic levy needed to recoup these crisis costs would be in excess of
$1.5 trillion per year. The total market capitalisation of the largest global banks is currently only
around $1.2 trillion. Fully internalising the output costs of financial crises would risk putting
banks on the same trajectory as the dinosaurs, with the levy playing the role of the meteorite.

Yves here. So a banking industry that creates global crises is negative value added from a societal standpoint. It is purely extractive. Even though we have described its activities as looting (as in paying themselves so much that they bankrupt the business), the wider consequences are vastly worse than in textbook looting.

Yet its incumbents tout their ‘talent” and insist on their right to mind-numbing pay because their services are allegedly so valuable to the economy.

Yet after applying a wrecking ball to the global economy, the banks got big handouts, and like Fannie and Freddie pre crisis, the banks get to borrow at cheaper rates than would otherwise apply because investors understand full well that governments stand behind big financial firms. Haldane again:

It is possible to go one step further and translate these average ratings differences into a monetary measure of the implied fiscal subsidy to banks…The resulting money amount is an estimate of the reduction in banks’ funding costs which arises from the perceived government subsidy..

For UK banks, the average annual subsidy for the top five banks over these years was over £50 billion – roughly equal to UK banks’ annual profits prior to the crisis. At the height of the crisis, the subsidy was larger still. For the sample of global banks, the average annual subsidy for the top five banks was just less than $60 billion per year. These are not small sums…

On these metrics, the too-big-to-fail problem results in a real and on-going cost to the taxpayer and a
real and on-going windfall for the banks.

Barry Ritholtz in a post today, correctly takes apart Shiller’s recommendation (deferring a substantial portion of pay, which would be forefit if a company were bailed out or failed) and recommends a superficially appealing solution, returning to a partnership model:

The thought process behind this is that risky corporate activities should also become a risk to the firm’s executives…The hope is that “this will transform executives’ thinking about risks — and may help prevent another disaster.”

I sincerely doubt it. Similar disincentives were already in place — and they failed miserably.

At each and every one of the companies that went bust due to their excessively risky speculations — from AIG to Bear to Citi to Fannie Mae to Lehman to WAMU — every executive had huge amounts of stock, stock options, and future salaries at risk. Lehman’s Dick Fuld reputedly lost over $500 million dollars in stock value, and a few of Bear Stearns execs lost close to a $ 1 billion dollars each in asset value.

The mere threat of future losses has already proven insufficient to moderate behavior. Holding back $100s of 1000s of dollars — or even millions of dollars — is a meaningless inconvenience to the people whose net worth is measured $100s of millions or billions of dollars.

Barry then offers partnerships as a model:

I did discover one group of Wall Street firms whose senior management took a very measured approach to managing risk..

The group? Wall Street partnerships…

Partners have “joint and several liability.” Every partner is fully liable, up to the full amount of the relevant obligation, for the actions of every other partner. This has the effect of focusing the minds of management on exactly what the worst case scenario of their behavior can wreak….the creditors can proceed to recover losses from the personal assets of every partner. Bank accounts, Houses, boats, vacation property, 401ks, cars, jewelery, watches, etc. are all fair game for creditors.

Not surprisingly, none of the Wall Street partnerships got into trouble…

Yves here. While I agree 100% that Barry’s proposal is superior to Shiller’s it’s not the panacea he makes it out to be. First, partnerships were reckless in the 1920s and many failed in wake of the Great Crash. Ironically, Barry cites Brown Brothers as an example of a modern partnership that has behaved prudently, but the current Brown Brothers was born of the merger of the teetering Brown Brothers & Co. into the stronger Harriman & Co. in 1931. There was another large wave of partnership failures and mergers in the wake of the 1960s back office crisis, but because these firms got into trouble as the result of operational problems, as opposed to the misuse of borrowed money, it did not have wider economic fallout.

Second, there are a lot of ways that executives can slip the leash, from putting assets in countries where it would be hard to repatriate, or even locate them (there is a reason Jews fleeing persecution used to sew diamonds into their clothing, it is a compact and portable form of wealth) to quitting at the first sign of business troubles, to only taking risk in very long-dated exposures (again, to shift responsibility for any blowups on to successor management) And who would want to take on that sort of liability unless he could an exhaustive audit of the banks’ exposures? Thus, if someone were to turn down a high level position, rumors could easily start that the bank was in trouble, which in a worst-case scenario would precipitate a run.

Third, how would you draft regulation to deal with sales of severely weakened firms? Look at the sale of Merrill to Bank of America, which was lauded as a coup by John Thain (in terms of the value received by Merrill shareholders). It sure was, Bank of America later cut a deal with the government to cover Merrill losses. And this sort of partnership liability concept would lead the authorities to write waivers to firms like JP Morgan that step in to buy troubled firms like Bear.

One of the reasons that Barry forgets that partnerships led to more caution wasn’t simply the prospect of unlimited losses. It was also that partners had most of their wealth tied up in the firm, and could withdraw it only gradually after they retired. This led them to take a long-term perspective and also prevented the pursuit of a lavish lifestyle. And it further lessened mobility among junior staff. Partners would only take people into the partnership that they had observed over long periods of time. Unless he was exceptionally talented, someone who came in mid-career to a firm would be at a disadvantage relative to those who had spent their career there.

But the focus on executive pay divers attention from the fact that pay levels across the big players is wildly out of line, given their ever-growing government guarantees. n a paper by Piergiorgio Alessandri and Haldane, “Banking on the State” (hat tip reader Scott), they describe how support to the financial system has ratcheted up in the wake of crises, which only makes it more attractive for banks to gamble. They note:

This is a repeated game. State support stokes future risk-taking incentives, as owners of banks adapt their strategies to maximise expected profits….the latest incarnation of efforts by the banking system to boost shareholder returns and, whether by accident or design, game the state. For the authorities, it poses a dilemma. Ex-ante, they may well say “never again”. But the ex-post costs of crisis mean such a statement lacks credibility. Knowing this, the rational response by market participants is to double their bets. This adds to the cost of future crises. And the larger these costs, the lower the credibility of “never again” announcements. This is a doom loop.

The “St Petersburg paradox” explains how a gambling strategy which starts small but then doubles-up in the event of a loss can yield positive (indeed, potentially infinite) expected returns. Provided, that is, the gambler has the resources to double-up in the face of a losing streak. The St Petersburg lottery has many similarities with the game played between the state and the banks over the past century or so. The banks have repeatedly doubled-up. And the state has underwritten any losing streak.

Yves here. In other words, given the inability of bankers to avoid crises, this destructive pattern will continue until the banks break their backers, meaning the state, or we find a way to stop the game. Loudly contesting the idea that the pay levels at the major capital markets players are in any way warranted is part of the process of bringing the industry to heel.

Guest Post: Oil Coating Seafloor and Killing Fish, Crabs … and the American Dream

Irish-Canadian journalist Alex Kearns, who now lives in St. Mary’s Georgia posted this image on her website today, along with the following description:

A researcher captured this image. A discarded flag (or one that has fallen from one of the many vessels in the area) rests on the ocean floor amid the oil and the bodies of dead crabs.

A two-inch layer of submerged oil is coating portions of the Gulf seafloor off the Bon Secour National Wildlife Refuge: a week after a smothering layer of floating crude washed ashore there. This scenario is being played out all along the Gulf shoreline.

Collecting in pockets and troughs in waist-deep water, the underwater oil is looser and stickier than the tarballs that cover the beach. The consistency is more like a thick liquid, albeit one made up of thousands of small globs. Unlike tarballs, which can often be picked up out of the water without staining the fingers, the submerged oil stains everything that it touches. If you passed your hand through the material it would emerge covered in oily smears.

There are a number of patches of submerged oil 40 to 100 feet off the beach, apparently collecting along rip currents and sandbars. The carcasses of sand fleas, speckled crabs, ghost crabs, and leopard crabs are spread throughout the oil, a thick layer of the material caking the bodies of the larger crabs – their claws looking as if they been turned into clubs made of oil.


Huge schools of bait fish are hugging the shore, attracting large numbers of birds. King mackerel, Spanish mackerel, mullet, ladyfish, speckled trout, and other fish are congregating in massive numbers amid the sharks.

The Dauphin Island Sea Lab measured large areas of low oxygen water just off the beach at Fort Morgan last week, beginning in water around 20 feet deep. Monty Graham, a University of South Alabama scientist, theorized that the population of oil-consuming microbes had swelled. Sea life begins to die if oxygen levels drop below 2 parts per million. “We saw some very low oxygen levels, some below 1,” said Graham, of testing he conducted aboard a Dauphin Island Sea Lab research vessel. He said that the layer of low-oxygen water closest to shore off Fort Morgan began at the bottom and rose up 30 feet.

Graham said he believed that the low oxygen levels were responsible for reports of strange behavior among fish: “The low oxygen explains things we’ve been hearing, like reports of flounder swimming on the surface.”

The low-oxygen levels offshore may also explain the dense aggregations of fish seen in the surf zone. The turbulent area near shore is naturally high in oxygen due to the influence of the breaking waves.

There are numerous reports that suggest that oil is moving beneath the surface in Alabama waters. State officials conducting shrimp trawls in the Mississippi Sound two weeks ago found oil on their nets when they pulled them. More recently, BP contractors working around Dauphin Island reported oil coming up on their anchors.

Gulf Coast Residents Hit Hard

It’s not just the sealife.

Gulf coast residents are being hit hard as well.

David Kotok of Cumberland Advisors estimates that one million jobs will be lost permanently in the Gulf coast oil services and supporting industries.

The House Judiciary Committee has found:

  • As of … Tuesday, June 15th, BP had paid less than 12 percent ($71 million dollars out of an estimated $600 million) of outstanding claims submitted by individuals and businesses.
  • Two weeks after the disaster, BP had not paid a single dollar to the individuals or businesses harmed by the explosion and the oil spill. As of May 18th (four weeks post-disaster), BP had only paid $11,673,616.
  • In apparent response to congressional oversight and the efforts of the federal government, BP began increasing their payments to affected individuals and businesses in the past few weeks.
  • Although the oil spill disaster occurred on April 20th, BP has only begun to compensate individuals for their full loss of income in the past two weeks. We understand individuals continue to experience delays in the receipt of full income awards.
  • BP has not paid a single bodily injury claim. As of Friday, June 18th, there were 717 claims submitted for bodily injury, including claims for respiratory issues, headaches, and skin irritation.
  • BP has not paid a single claim for the diminishment in value of homes in the affected areas of the Gulf South, out of a total 175 claims submitted.
  • Out of the 267 claims submitted, BP has paid only $169,371 in loss of income claims for affected restaurants. However, the lack of data from BP on the damage amounts requested by the affected restaurants or the number of claims paid makes it impossible for the Committee to determine if restaurants and other Gulf Coast businesses are being properly compensated.

“I remain concerned that BP is stiffing too many victims and short-changing others,” [Committee Chairman John] Conyers said.

Reuters notes that BP is paying only a fraction of what the fishermen think they’re entitled to.

CNBC points out that BP is only paying fishermen one month’s pay – pegged to pay from their slowest season.

USA Today notes:

State officials in Louisiana and Florida say the payouts, so far, have been small and often too slow and that BP hasn’t given them the data they need to adequately monitor the process.

WDSU reports:

Some people claim the payout process is unorganized, and other said there is no system in place to account for how many days the fishermen have worked and no clear time frame for when they’ll see the money they’ve earned.

CBS notes:

Some businesses have been asked to file 1,700 pages of documents before they can get a check.

The L.A. Times notes that:

BP’s request for tax records poses a problem for some residents of fishing communities in southeastern Louisiana — the nonconformists who haven’t kept records or reported their cash income.

Time Magazine makes a similar point:

Fishing can bring in a lot of money in a very short period of time during the right season, but fishermen might be hard-pressed to provide evidence — bank statements, pay stubs — that can back that up. The same goes for many other businesses: if receipts are dwindling at a restaurant, or guests are cancelling at a resort, how is it possible to prove that the spill alone is responsible? “We’re stuck in the middle,” says Chris Camardelle, whose seafood restaurant in Grand Isle has been badly hurt by the oil spill. “So it’s a tricky situation.”

Jane Hamsher notes that fishermen harmed by the Exxon Valdez oil spill have had to wait 20 years to see any money, and – for many fishermen – all of that money was been swallowed up by government fees and taxes.

But as bad as it is for fishermen, it’s worse for everyone else. For example, AP notes:

BP PLC says 90 percent of the compensation checks it has issued so far have gone to fishermen.

Those who provide goods and services to fishermen are receiving next to no compensation.

Given that the oil spill is killing not only fish and crabs – but the American dream for millions of Gulf Coast fishermen, shrimpers, tourist industry workers and others – the image in the photograph above is very powerful indeed.

Washington’s Blog

Alford: Structural Remedies Necessary to Tame Global Imbalances

By Richard Alford, a former economist at the New York Fed. Since then, he has worked in the financial industry as a trading floor economist and strategist on both the sell side and the buy side.

Calls for global rebalancing are back in vogue, while the debate about the appropriate stance of domestic policy heats up again. While there is disagreement about the exact role the global imbalances played in the run up to the financial crisis and the crisis itself, there is general agreement that a rebalancing of the global economy is necessary if we are to enjoy a return to sustainable growth. There is less than full agreement on the net benefits of further monetary and fiscal stimulus.

China is in the hot seat and the Yuan exchange rate remains the focus, even as the US is placing greater weight on continued Chinese fiscal stimulus. In addition, US-based macroeconomists and policymakers are now focusing on and criticizing proposed fiscal austerity in Europe. Their concern is not solely with European economic performance per se. Among their concerns is the perceived impact that European austerity would have on US economic performance. They view demand and income growth in Europe as the means by which the US will reduce its current account deficit. There is little or no mention of any need for the Euro, the Dollar, or any currency other than the Yuan to adjust to promote or support the rebalancing.

These positions reflect interesting wrinkles in US economists’ and policymakers’ mind sets. They are a variant on the old US policy position first espoused by the then Secretary of the Treasury John Connolly: It’s our currency, but it’s your problem. The current version is: It’s our current account deficit, but it’s your problem. Alternative wording of the revised up dated Connolly doctrine: If the rest of the world will just pursue expansionary fiscal monetary policies, then the US can avoid having to choose between austerity and unemployment on the one hand or further increasing unsustainable deficits on the other.

However, the idea that given global counter-cyclical stimulus and “Bob’s your uncle”, the US will return to sustainable noninflationary trend growth does not stand up to analysis. It is unlikely that counter-cyclical expansionary policy abroad will correct the US current account deficit or help restore trend growth. In fact, the idea that the solution to the current US economic woes lies in traditional counter-cyclical policy is being questioned. Recently, in the FT, Jeffrey Sachs wrote:

• Now, against a backdrop of a widening sovereign debt crisis we need to abandon short-term thinking in favour of the long-term investments needed for sustained recovery
• .. Certain countercyclical spending is vital on social grounds. But stimulus measures …reflected a hope that a temporary fiscal bridge could carry us back to consumption and housing led growth — a dubious proposition since the old “normal” had been this financially unsustainable.

Sachs offered a number of guidelines for economic policy consistent, in his view, with restoring sustainable trend growth. They included:

• government should work with a medium-term budget framework of five years and within a decade-long strategy on economic transformation.
• governments should steer their economies towards needed long-term structural transformation. External deficit countries such as the US and UK will need to promote exports over the next five years …
• we need, in sum, to reset our macro timetables. There are no short-term miracles, only the threat of more bubbles if we pursue economic illusions…

Sachs cites the need for the US to promote export growth and not simply expand domestic demand. The language suggests that he believes that the US external position reflects a structural problem that has to be addressed if the US is to achieve sustainable trend growth. Furthermore, Sachs is not alone in his beliefs that inappropriate economic policy can contribute to the growth of the economic imbalances. For example, Edwin Truman writes:

“Instead, the imbalances and the crisis were jointly caused by flaws in the design and implementation of macroeconomic policies and the resulting global credit boom.”

If a return to external balance or at least a trade deficit of a sustainable size is required for the US to achieve sustainable growth and avoid future crises, is it reasonable to assume that demand stimulus abroad alone would bring about the required structural transformation in the US economy? There are numerous reasons to believe that is not the case. Returning to Truman:

Current account balances are endogenous to the economics of the overall economic and financial system. A country’s recorded, ex-post current account position must simultaneously satisfy three relationships: the difference between net domestic savings and net domestic investment, the difference between domestic production (output) and domestic demand (often referred to as absorption), and the difference between the net change in the demand for domestic assets by the rest of the world and the supply of those assets…

It follows that external adjustments also require parallel domestic adjustments in order to succeed. Calling on our trading partners to increase demand and their imports from the US will not narrow the trade deficit unless there is a narrowing of “the difference between net domestic savings and net domestic investment…”, but US domestic economic policy is not supportive of the required domestic adjustment. Continued deficit financing of stimulus packages widens the difference between net savings and investment. Monetary policy is also geared towards increasing consumption and reducing private savings. To the extent that a significant fraction of the consumer basket is comprised of imported goods and the US income elasticity of demand for imports is high, stimulating consumer demand increases domestic demand (often referred to as “absorption”) relative to domestic output. In short, US domestic economic policy is inconsistent with an effort to achieve external balance and hence a return to sustainable growth. Back to Truman for a moment:

It also follows that a large country has the capacity through the application its own policies to achieve, within a reasonable range, is preferred current account position….

Given that US macroeconomic policy remains inconsistent with reducing the external deficit (in fact, it is just the opposite), our trading partners might very well ask why they should deviate from their chosen policy stances to help the US reduce its external deficit when it is unwilling to adjust its own domestic policies to achieve that end.

The relative downplaying of the importance of exchange rate adjustment in addressing the US trade imbalance is also troubling. If the US is to correct its external imbalance, resources (capital and labor) are going to have to be reallocated to the production of tradable goods and services. In the absence of Dollar exchange rate adjustments, it is difficult to see reasons why the US economic agents would move into the tradable sector. In recent years, if anything, US resources have been moving in the opposite direction. It is unlikely that economic agents in the US will return to the tradable goods and services sector solely on the basis of promises by our own policymakers or other policymakers that demand for US exports will increase.

While exchange rate adjustments will not alone correct the imbalance, it is difficult to see a solution without some exchange rate adjustment. It is virtually impossible to see it given the absence of exchange rate adjustment coupled with fiscal and monetary policies which are inconsistent with a narrowing of the imbalance.

Returning to the principle point, the US faces structural and not just cyclical economic problems. The structural problems are reflected in mutually determined unsustainable current account and fiscal deficits, as well as depressed saving rates. It is easy to see evidence of structural problems in economic performance, All one has to do is look at recent economic performance (e.g. growth rates, growth in real wages, the number of workers who have joined the long-term unemployed etc.) relative to earlier periods and recognize that those less than satisfactory outcomes were only achieved with virtually constant economic policy stimulus (e.g. the cyclically adjusted Federal fiscal deficit) and asset-price-bubble-induced unsustainable increases in consumption relative to income. (See Brenner for evidence of the structural dimension of the current crisis.)

Once one recognizes that the US is contending with structural as well as cyclical problems, then it is clear that a move to sustainable trend growth requires something other than the standard countercyclical stimulus. In order to achieve balanced sustainable growth the US will have to increase savings (relative to income and consumption), increase investment relative to income, and increase the production of tradable goods versus nontradable goods. However current US policy has consisted of efforts to stimulate private consumption (decrease savings), increase public dis-saving, subsidize consumption of nontradable goods (housing) all coupled with perfunctory calls for exports to double.

Unfortunately, the US does not face a simple choice between lower fiscal deficits and idle resources on the one hand, and temporarily higher deficits and trend growth with full employment on the other. Or, as Sachs put it: “There are no short-term miracles…” The US also faces a choice between addressing the causes of structural imbalances now, perhaps at the expense of idle resources, or addressing the same problems in the future when the costs of adjustment will undoubtedly be higher. The costs of addressing the global imbalances now are higher than they would have been had they been addressed in 1996 or 2001.

Economic stimulus, which is not accompanied by steps to address the underlying structural problems, is a pernicious palliative. It will mask the costs of the structural problems; reduce any incentive politicians and policymakers have to pursue short-term costly, but longer-term higher payoff policies; and at the same time allow for the costs to resolve imbalances to fester.

Links 6/20/10

Cornish ferry stowaway shrew flown home BBC

Potatoes May Power The Batteries Of The Future Hot Hardware

Anxious monitoring near Florida coral reefs for oil spill PhysOrg

Lottery Winner Taps Geffen on Risk-Sharing Secret to Make Films Bloomberg (hat tip reader Buzz Potamkin)

What Many Liberals Don’t Understand About Health-Care Reform Maggie Mahar (hat tip reader Francois T)

Shocking True Tales of Immigration Enforcement Matthew Yglesias

Verizon To Reprimand, Fire Employees Who Try To Save Customers Money Consumerist

Fox pundit: AZ law needed because ‘Middle Easterners coming across that border’ Raw Story

Summers cautious about recovery Calculated Risk. This is a serious change in stance, he was cheerleading not at all long ago.

Cost of Seizing Fannie and Freddie Surges for Taxpayers New York Times

The Inflatable Loan Pool Gretchen Morgenson, New York Times

Why It’s Different This Time for Housing Barron’s (hat tip reader Doug Smith, via Barry Ritholtz)

How Much Oil Will Be Wasted In The Deepwater Spill? io9 (hat tip reader Richard R)

Deepwater oil spill victims, from waitresses to cabbies and strippers, plead for BP payouts Guardian

Antidote du jour. From reader John M:

These pics were taken last Sunday at Yellowstone National Park. The canyon shots were right at 12:04 PM and the bison were 6:09-6:15 PM Mountain Time (MDT). The second mother bison was wearing a radio collar, but it can’t be seen in these shots.

Video 99 0 00 03-17 Closeups

China’s Renminbi Announcement: A Big Headfake

The Chinese central bank made a vague announcement about its currency policy on its website today, which the officialdom, on cue, treated as a major move (to wit: “China vows increased currency flexibility” at the Financial Times, “Chinese say they intend to free up their currency,” Washington Post).)

As we describe below, this “announcement” is basically a non-statement to silence Westerners calling for a revaluation in the runup to the Toronto G-20 meeting later this month.

This is the full text of its English version:

In view of the recent economic situation and financial market developments at home and abroad, and the balance of payments (BOP) situation in China, the People´s Bank of China has decided to proceed further with reform of the RMB exchange rate regime and to enhance the RMB exchange rate flexibility.

Starting from July 21, 2005, China has moved into a managed floating exchange rate regime based on market supply and demand with reference to a basket of currencies. Since then, the reform of the RMB exchange rate regime has been making steady progress, producing the anticipated results and playing a positive role.

When the current round of international financial crisis was at its worst, the exchange rate of a number of sovereign currencies to the U.S. dollar depreciated by varying margins. The stability of the RMB exchange rate has played an important role in mitigating the crisis´ impact, contributing significantly to Asian and global recovery, and demonstrating China´s efforts in promoting global rebalancing.

The global economy is gradually recovering. The recovery and upturn of the Chinese economy has become more solid with the enhanced economic stability. It is desirable to proceed further with reform of the RMB exchange rate regime and increase the RMB exchange rate flexibility.

In further proceeding with reform of the RMB exchange rate regime, continued emphasis would be placed to reflecting market supply and demand with reference to a basket of currencies. The exchange rate floating bands will remain the same as previously announced in the inter-bank foreign exchange market.

China´s external trade is steadily becoming more balanced. The ratio of current account surplus to GDP, after a notable reduction in 2009, has been declining since the beginning of 2010. With the BOP account moving closer to equilibrium, the basis for large-scale appreciation of the RMB exchange rate does not exist. The People´s Bank of China will further enable market to play a fundamental role in resource allocation, promote a more balanced BOP account, maintain the RMB exchange rate basically stable at an adaptive and equilibrium level, and achieve the macroeconomic and financial stability in China.

Yves here. There are some real internal inconsistencies. While this does represent an announcement of an intent to liberalize, it lacks any particulars as to timing and mechanisms. Moreover, it specifically rejects the idea of widening the bands in which the RMB trades, which is the litmus test of a move to a market-based exchange rate (you’d expect gradual widening of the permitted band as a precursor to abandoning currency intervention).

Instead, what this appears to signal is a shift of the basis for managing the currency to:

1. Use of a basket of reference currencies, rather than just the dollar. China is contending that that is what it has been doing since 2005, but the language allows for the possibility for a change in the mix. Thus this signals China’s intent to move away from a dollar reserve currency regime (it has taken other measures along these lines, for instance, encouraging invoicing in currencies other than the dollar). The problem is that a permitted trading band vs. a basket of currencies is what China supposedly implemented in 2007, and the results have looked an awful lot like a dirty float against the dollar.

2. Arguing for the balance of payments as the metric of the appropriateness of the exchange rates. China contends that because its balance of payments is improving (as in its trade surplus is weakening) it really does not need to do much (as in it has ruled out a meaningful revaluation). This is essentially an argument that the large trade deficit for March means critics need to lay off, a posture it took in April. The problem, however, was the March deficit appears to have been the result of one-off factors. China’s exports in May were larger than expected, due to more robust export growth. And note Chinese officials had expected exports to rise 50% over 2009.

The fact is, as Michael Pettis pointed out in his latest post, no country in modern times has ever run a trade surplus as a percent of GDP as large as China does. That means even if it does decide to extricate itself from this position, it will want to do so gradually. As Pettis noted:

As a share of global GDP China’s recent trade surpluses (roughly 0.6-0.7% of global GDP) are easily the highest recorded in the last 100 years.

This is all the more striking when you consider that the two previous record holders, the US in the late 1920s (with a trade surplus equal roughly to 0.4% of global GDP) and Japan in the late 1980s (0.5% of global GDP), were relatively much larger economies. The US represented more than 30% of global GDP in the late 1920s, and Japan represented 15% of global GDP in the late 1980s. By contrast China represents only 8% of global GDP today.

In the same post, he also rejected the idea that China’s trade balance is moderating:

In other words the cost of capital for China’s already too-capital-intensive and overinvesting economy is declining, and so worsening the domestic imbalances, and all but assuring that China’s trade surplus excluding Europe will surge (and maybe even including Europe it will still rise). In fact one of the least surprising of the “surprises” of recent months was China’s May trade figures. Here is what an article on Thursday in the South China Morning Post says:

Mainland’s exports rose 48.5 per cent in May from a year earlier and imports were up 48.3 per cent, the General Administration of Customs said on Thursday, giving the country a trade surplus of US$19.53 billion, up from just US$1.7 billion in April. The median forecast of 32 economists polled by Reuters was for exports to rise 32 per cent and imports to climb 45 per cent, with a projected trade surplus of US$8.8 billion.

Sources said on Wednesday that export growth was up about 50 per cent from a year ago, giving a boost to global financial markets as investors expressed relief that the country’s fast growing economy did not appear to be juddering to a sharp halt.

Some surprise, although I should add that I have a worrying feeling that the subsequent applause by the global stock markets may have got it exactly backwards. Net exports had to surge after the temporary contraction earlier this year, and in fact if you exclude the impact of commodity stockpiling, which overstates outflows due to consumption imports and understates outflows due to investment, China’s trade surplus would have probably been much higher. It is being artificially reduced by commodity stockpiling, which of course must be reversed at some point in the future. I expect that Chinese net exports will continue very strong this year, perhaps even taking into account the effect of the European crisis, which should be excluded from the number. And of course I expect US net imports, and with it US unemployment, will surge to politically unacceptable levels throughout this year and next, thanks in large part the European crisis and the unwillingness of anyone else to absorb it.

Yves again. With this as background, there is a completely different way to read the China announcement. Start from the top:

Starting from July 21, 2005, China has moved into a managed floating exchange rate regime based on market supply and demand with reference to a basket of currencies. Since then, the reform of the RMB exchange rate regime has been making steady progress, producing the anticipated results and playing a positive role.

When the current round of international financial crisis was at its worst, the exchange rate of a number of sovereign currencies to the U.S. dollar depreciated by varying margins. The stability of the RMB exchange rate has played an important role in mitigating the crisis´ impact, contributing significantly to Asian and global recovery, and demonstrating China´s efforts in promoting global rebalancing.

Yves here. First, the “basket of currencies” talk is technically accurate but misleading. China allowed for a widening of the band against the dollar and a smidge of appreciation. And the talk on what happened during the crisis is more than a bit of a distortion. China is effectively contending that by keeping its dollar peg during the crisis (when the dollar was rising, which was to China’s disadvantage) it was being a good soldier and “promoting global rebalancing”. Huh? Although China’s trade surplus shrank in early 2009, the big story of trade during the crisis was: 1. Trade volumes plunged and 2. China’s surplus in quite a few months was at record levels. Why? Pretty much every other trade surplus nation saw its surplus collapse (Japan in particular, as its yen soared) and China got a disproportionate share of what trade there was. Calling that an effort to promote global rebalancing is a serious distortion. (By the way, old Asia hands will recall the US unwittingly promoted this construction, that of keeping a dollar peg when other currencies were depreciating as being pro-stability, during the 1997 Asian crisis, when China no doubt considered devaluing the renminbi, but stood pat at the US’s request).

So as I read this announcement, China has committed to do…..absolutely nothing. In fact, this language could just as easily be used to justify shifting its dirty float to be against the dollar (which is now comparatively strong and will continue to be so as long as the eurozone is on its austerity kick) to putting greater weight upon the euro in its basket, which would lead to a devaluation against the dollar. Note I am not saying that will happen, but the announcement does not preclude that idea if China’s trade surplus were to deteriorate.

Notice the goals the PBoC commits itself to meet:

….further enable market to play a fundamental role in resource allocation, promote a more balanced BOP account, maintain the RMB exchange rate basically stable at an adaptive and equilibrium level, and achieve the macroeconomic and financial stability in China.

Yves here. Note the contradictions: you can’t have the market play a “fundamental role” in setting FX rates, and “maintain the RMB exchange rate basically stable.” And China is not going to make any moves that compromise “macroeconomic and financial stability in China.”

I’m not the only observer to read this announcement cynically. From the Wall Street Journal:

Beijing’s move may not, however, result in a large appreciation of the yuan. Cornell University economist Eswar Prasad, former head of the International Monetary Fund’s China division, cautioned that Beijing is returning to a policy of linking the yuan to a basket of currencies, without identifying the composition of the basket.

About a quarter of China’s trade is in euros, a currency that has been in a steep slide against the dollar recently. If the euro composes a large share of China’s invisible basket, the yuan could actually weaken relative to the dollar, Mr. Prasad warned.

“If the world now says, ‘Let your currency float against the dollar,’ the Chinese could say, ‘Do you really want it to depreciate?’ ” Mr. Prasad said, describing Beijing’s move as “canny.”

Mr. Prasad said China’s main concession was therefore not the content of its new policy, a return to the one that was in place before the global financial crisis. Rather, Beijing’s principal shift was in the timing, offering at least a symbolic gesture ahead of the summit in Toronto next weekend of leaders from the Group of 20 major industrialized and emerging economies.

“They’ve actually accomplished two significant objectives,” Mr. Prasad said. “They”re taking away the political heat, but without significantly affecting their export competitiveness.”

So what does this announcement really achieve? Buy time. As we noted, there was a firestorm of criticism in Washington over the sharp rise in Chinese exports in May. This announcement comes right before the G20 meeting, where China was sure to come under attack if nothing appeared to have changed. The Administration really does not want a row with China right now; Geithner was clearly reluctant to brand China a currency manipulator (as he was being pushed to do by Congress in April, when China miraculously announced a trade deficit right before the required Treasury semi-annual window) and now has even less reason to want to, given that we are looking for China’s support in the row between North and South Korea over North Korea’s alleged sinking of a South Korean warship and in sanctions against Iran.

So not surprisingly, the Administration is playing along and touting this non-commitment as meaningful. From Bloomberg:

Geithner, in a statement, praised China’s decision and added that “vigorous implementation would make a positive contribution to strong and balanced global growth.” The Obama administration received advance notice of the announcement, U.S. officials said.

And analysts are also talking China’s book while pointing out that this takes the heat off China for now:

“It makes it a lot more difficult for Washington and Congress to do China bashing,” {Goldman Sachs Group Inc. Chief Global Economist Jim] O’Neill said. “The Chinese are increasingly confident they can make this adjustment to a domestic-driven economy rather than the one relying on exporting low-value-added stuff to the rest of the world.”

Yves here. But as Pettis pointed out, China has been increasingly reliant on investment as a source of growth, simply unheard of levels relative to GDP. And he points out another not widely recognized fact: this actually impedes the process of shifting to more consumption, which is necessary for China to become less export oriented (ie, it has plenty of opportunity to sell goods internally if it can increase income levels and consumption rates over time);

More importantly, China’s financial repression is also at the heart of the imbalance in the Chinese economy. By transferring large amounts of wealth from the household sector to net borrowers (perhaps as much as 5-10% of GDP annually, as I explain in an earlier entry), it creates the large growth differential between national GDP and household income that is at the root of China’s very high savings and very low consumption levels.

I should add that if much of this investment is non-economic, as I believe it is, this will exacerbate even further the differential. Why? Because the total economic cost of the investment (which must include the real debt forgiveness implied by excessively low interest rates), and which will be borne over the future as the cost are amortized in the form of debt repayment, exceeds the total economic value of the investment (which must include externalities), which will accrue upfront. This means that we get more investment-driven growth today and less consumption-driven growth tomorrow.

Yves here. The Chinese officialdom clearly can, at any point, announce and implement policies to move the RMB either higher relative to other currencies and/or allow wider trading bands as a way to move towards a less controlled currency regime. But I don’t see any reason to expect it to happen until China gets more pushback from its trading partners. Their enthusiastic responses to this noncommittal announcement seem likely to insure that has been kicked down the road until China’s continuing trade surpluses force politicians to turn the heat back on.

Countries That Support US in Afghanistan Get Preferred Access to Minerals (Updated)

Readers may recall that we highlighted the report last week in the New York Times of an estimated trillion dollars worth of valuable materials, including copper, gold, and lithium. We pointed out that this announcement was awfully convenient, coming on the heels of reports that the efforts to pacify the country weren’t going terribly well. Readers provided further confirmation in comments, observing that the existence of minerals in Afghanistan wasn’t new (the Chinese have been operating a copper mine, or at least trying to) and that the precision of the estimate of the value of the finds was sus.

Tom Ferguson sent us an e-mail with the text of an article from Frankfurter Allgemeine Zeitung, which Richard Smith graciously translated. Tom’s note:

Below I paste in an amazing interview with Richard Holbrooke.
In it explains the second part of the admin case on revealing Afghanistan’s mineral riches.
In simple English, it says that the countries that support the US intervention there get preferred access.
Says it just like that.
This is so crass….

From the Frankfurter Allgemeine Zeitung:

Meanwhile Afghan President Hamid Karzai announced that the major donor countries would have preferential access to mineral resources in the Hindu Kush. “Afghanistan should grant access first to countries, who have supported us massively in recent years,” Karzai said, according to agency reports in Tokyo. Japan, as the second largest donor, was a welcome investment partner. Karzai warned that natural resources would have to be developed in an environmentally friendly and responsible manner, in order to prevent corruption. The proceeds would flow to Afghanistan. “There will be rivalry over these natural resources, especially now that the world knows of their significance.” Afghanistan will promote its iron ore mining to investors in London on Friday.

Yves here. Ain’t imperialism grand?

Update 5:30 PM. I neglected to include this tidbit, from a former Pentagon employee on the original New York Times story on the $1 trillion mineral “find”:

The timing of this release of ancient mining news–especially when floated with Petraeus’ name plastered all over it in a tried-and-true government propaganda outlet like the N.Y. Times–smells to me like a last ditch attempt to invent an economic justification for hanging on many more years in the hopeless Afghani morass.

Note that the now sacrosanct 1980s Russian mineral survey was “stumbled on” six years ago in 2004 by an American reconstruction team foraging in the Afghan Geological Survey Library. Then, according to the Times’ (read Petraeus and DoD) spin, nothing happened until two years later when the U.S. Geological Survey launched a 2006 aerial mineral survey followed by another in 2007, supposedly yielding all-new evidence of astonishing mineral wealth (iron, gold, copper, lithium, supposedly a trillion dollar’s worth) just waiting to be tapped. Supposedly, this astonishing new evidence was then ignored by all until a Pentagon business development task force “rediscovered” the ignored USGS mineral data in 2009.

This spin is quite untrue: in 2005, the Afghan government, quite aware of their mineral resources, opened bidding on copper mining leases in Logar Province, bidding that was won by the Chinese in 2007. As for the reliability of the USGS data, note that they report 1.8 billion tons of potential lithium deposits (lithium is very trendy with the greens these days) but only a puny 111 million tons in proven or probable deposits. But none of this purportedly astonishing USGS aerial survey data has raised much dust in the international mining world, despite the fact that the entire current New York Times scoop was thoroughly covered by Reuters and Mining Exploration News a year ago in April of 2009.

So what turned the ho-hum Reuters news of April, 2009 into a hot Times scoop in June of 2010?

Is there any connection with the desperate need of McChrystal, Petraeus and Gates for a life jacket, now that the Afghan surge they floated is sinking so rapidly?

I think so.

Links 6/19/10

Tea and coffee ‘protect against heart disease’ BBC

The strange and consequential case of Bradley Manning, Adrian Lamo and WikiLeaks Glenn Greenwald. Salon

Hands Across the Sands (hat tip reader Tim S)

BP chief quits role in oil leak response Financial Times. The company is utterly incapable of telling the truth. The chairman said 2/3 of the leak was now being captured. The Coast Guard puts it at 25,000, with a “probable 35,000″ still leaking. Do the math. 25,000/60,000 ain’t very close to 2/3.

BP Used Cheaper Design for More Wells Than Most Peers Wall Street Journal

Anadarko Says BP Should Pay for Oil Spill After Being Reckless Bloomberg

Alan Simpson: Cutting Social Security Benefits to “Take Care of the Lesser People in Society” Jane Hamsher. The video has a lot of entertainment value, in a sick way.

Ridleyed With Errors George Monbiot

New Bank Fees: How to Fight Back Wall Street Journal

Peddling Relief, Industry Puts Debtors in a Deeper Hole New York Times

Clearing up misinformation about Section 716 Economics of Contempt

Study to stir dollar-renminbi debate Financial Times

Eichengreen: China Needs a Service-Sector Revolution Mark Thoma

MAD MEAT! How Securitized Lending Collapsed the Financial System, Eric Von Berg (a commercial property mortgage banker and was the President of the California Mortgage Bankers Association during the heat of the market who has been watching “Regulatory Reform” as a member of the Commercial Board of Governors of the Mortgage Bankers Association of America). This is an absolutely must read! It has a few pages of set up to a fable of sorts, but when you get to page 6 of the slide presentation, it becomes laser sharp and funny. To wit:

The disclosures were typically so numerous and far fetched that the real risks were overlooked…

Sponsor Disclosure. Sponsor has various conflicts of interest. Not printed: We set up a book making operation taking bets on whether you will get sick and die from this product. Are we also making bets? “You betcha!” Which side are we betting on? According to the SEC, we are allowed to tell you, “None of your business!”

Antidote du jour (hat tip reader furzy mouse):


On the Curious and Misguided Defenses of BP

The ongoing disaster in the Gulf has elicited heated responses as the media continues to provide images of dead wildlife, fouled marshes and beaches, losses to owners of employees and small businesses, and continuing reports that BP is putting the health of cleanup workers at risk by continuing to refuse to allow respirators to be used and providing inadequate safety training in the face of evidence of health risks.

In addition, the amount of liabilities that BP will face is not yet known. The public at large is likely not getting an accurate tally of the daily volume of the output. While BP will drill relief wells in August, there is no assurance its initial efforts will be successful (as we pointed out, the last major Gulf oil disaster, the Ixtoc well in 1979, it took ten months to halt the flow of oil from a well at a depth of only 100 feet. Moreover, in addition BP compounding its liability through its inattention to the health of cleanup workers, new information is emerging that suggests the environmental damage could be worse than heretofore thought. The oil leak contains unusually large amounts of methane. As the Associated Press reported:

The oil emanating from the seafloor contains about 40 percent methane, compared with about 5 percent found in typical oil deposits, said John Kessler, a Texas A&M University oceanographer who is studying the impact of methane from the spill.

That means huge quantities of methane have entered the Gulf, scientists say, potentially suffocating marine life and creating “dead zones” where oxygen is so depleted that nothing lives.

“This is the most vigorous methane eruption in modern human history,” Kessler said.

And this is before we consider the issue of culpability: BPs’ simply awful record of safety risks, its failure to do even remotely adequate containment of the oil on the surface even though the safety plans it submitted to regulators said it would (and experts have said it was quite feasible).

With this as backdrop, it has been stunning to see some of the defenses of BP in the wake of the announcement that BP will establish a $20 billion fund as a step in compensating leak victims and Thursday’s House Committee on Energy and Commerce’s grilling of BP CEO Tony Hayward.

The fund has been bizarrely treated as some sort of abuse of power, even though the stock traded up on news. Huh? This came out of a negotiation, and the US has every reason to want to get BP to conserve cash, and BP has never denied that it owes a lot of people a lot of money, and the ultimate amount of damages is unknown. As law professor Bill Black noted, it’s about competence as a creditor. Civil fines alone could be $4300 a barrel. Uncle Sam will presumably be sending a bill for all the Coast Guard resources deployed on behalf of BP. Criminal sanctions could result in the loss of BP’s US drilling licenses and Federal contracts. It isn’t hard to come up with scenarios where the tab from the federal government alone exceeds $20 billion, and if the US does strip BP of some of its US sources of income, its ability to meet those claims would be impaired. As ProPublica noted:

The EPA said in a statement that, according to its regulations, it can consider banning BP from future contracts after weighing “the frequency and pattern of the incidents, corporate attitude both before and after the incidents, changes in policies, procedures, and practices.”

Several former senior EPA debarment attorneys and people close to the BP investigation told ProPublica that means the agency will re-evaluate BP and examine whether the latest incident in the Gulf is evidence of an institutional problem inside BP….

The most serious, sweeping kind of suspension is called “discretionary debarment” and it is applied to an entire company. If this were imposed on BP, it would cancel not only the company’s contracts to sell fuel to the military but prohibit BP from leasing or renewing drilling leases on federal land. In the worst cast, it could also lead to the cancellation of BP’s existing federal leases, worth billions of dollars.

Present and former officials said the crucial question in deciding whether to impose such a sanction is assessing the offending company’s culture and approach: Do its executives display an attitude of non-compliance?….In its negotiations with EPA officials before the Gulf spill, BP had been insisting that it had made far-reaching changes in its approach to safety and maintenance, and that environmental officials could trust its promises that it would commit no further violations of the law.

Yves here. So while some commentators would like to characterize BP’s star turn before Congress and the President as theater (and it is true that Obama in particular desperately needs to re-establish his bona fides here), there is a serious purpose afoot. BP has been a serial miscreant. It has not only amassed a horrid safety record, it has misrepresented its commitment to turning a new leaf (one BP shill in comments here had the gall to blame BP’s poor safety record on its failure to turn around the cultures of its US acquisitions, Amoco and Arco. Those took place more than ten years ago. Any veteran of corporate transactions will tell you how seldom the culture of purchased businesses survives even when the buyer desperately wants to retain it. These sort of arguments illustrate how difficult it is to defend BP’s conduct).

So part of the “theater” is actually deadly serious. Does BP get it, or does understand it at least needs to credibly fake getting it? If the spectacle of eleven figure losses isn’t a “come to Jesus” moment, nothing will be.

Similarly, the House hearings were no ambush; the House sent a detailed letter to BP alerting the company to the topics it intended to cover with a good bit of detail on the decisions and procedures it found troubling.

Was it reasonable to expect much new information from Hayward? No. But there is a tremendous amount already in the public domain. A display of contrition, admitting to things it can’t possibly deny (faux candor) and acting respectful would have at least said that BP understands the gravity of its situation.

But that isn’t what we got. An assessment of Hayward’s performance in the Telegraph (hat tip reader Doc Holliday):

Accused of stonewalling, he stonewalled. He couldn’t, or wouldn’t, answer most of the questions. In fact, he looked like a tired undertaker who was rather bored with having to look mournful. Given that a woman held up proceedings earlier on by shouting protests him, it would have been advisable to show some regret rather than say he felt “a great deal” of responsibility for the oil spill and that it was “a tragedy” with all the emphasis and enthusiasm of an autistic sloth.

Yves here. Of course, this ghastly show could simply be Hayward’s failing, not BP’s but that seems awfully generous. Companies chose CEOs deliberately, precisely because they tend to print the values and habits on the organization. Thus Hayward’s arrogance and tone deafness is unlikely to be an unfortunate deficiency in an otherwise stellar executive; it’s likely BP’s board saw those qualities as attractive. The high handed remarks of BP’s chairman suggest that Hayward’s attitude is widely shared within the oil company.

Consider this exchange during the hearings. From Glenn Stehle in comments:

There were several house members who brought up BP’s safety record at the hearing. It is Hayward’s contention that BP has changed since 2005-6, since he’s been at the helm.

Perhaps it is Bruce Braley who did the best job of countering Hayward’s claim. You can see his questioning of Hayward beginning at minute 00:18:30 on Part 3 in the C-Span coverage.

Braley: Explain to us why between June of 2007 and February of 2010 the Occupational Health and Safety Administration checked 55 oil refineries operating in the US, two of those 55 are owned by BP, and BP’s refineries racked up 760 citations for egregiously, willful safety violations accounting for 97% of the worst and most serious violations that OSHA monitors in the workplace. That doesn’t sound like a culture of safety.

Hayward: We acknowledge we had very serious issues in 2005 and 2006.

Braley: Well I’m not talking about 2005 and 2006. I’m citing from an OSHA study between June of 2007, on your watch, and February of 2010 where OSHA said “BP has a systemic safety problem,” and of those 760 that were classified as “egregious and willful,” it’s important to note that that is the worst violation that OSHA can identify, and their definition is “a violation committed with plain indifference or to intentional disregard for employee safety and health.” Ninety-seven percent of those egregious violations at US refineries, on your watch, were against your company. That doesn’t sound like a company, that to use your words, “is committed to safe reliable operations as your number one priority.” There’s a complete disconnect between your testimony and the reality of these OSHA findings. Do you understand that?

Yves here. Given how far the state of the art in lying in public spin doctoring has evolved, Hayward’s appearance looks as if he couldn’t even be bothered to offer defenses that were remotely plausible (the OSHA violations have been widely reported in the US media, they were certain to be discussed in the hearings). And the degree of preparation indicated by the extensively footnoted letter sent prior to the hearings signaled that he was appearing before a well briefed panel that was unlikely to cut him any slack.

Of course, this half-hearted performance may reflect the fact that BP regards Obama as a paper tiger, and that may prove to be 100% accurate. Or it could demonstrate that BP’s culture of corners-cutting is so deeply embedded as to be pathological.

Despite this sorry show, there have been some hysterical, strikingly divorced from reality defenses of BP, a particularly notable one in this week’s Economist. Ryan Chittum took it apart at the Columbia Journalism Review:

The Economist has a pathetic leader this week criticizing Obama for hammering BP and raising the ridiculous idea that his corporate-friendly administration is anti-business.

It actually (really!) calls the president “Vladimir Obama” and writes:

The collapse in BP’s share price suggests that he has convinced the markets that he is an American version of Vladimir Putin, willing to harry firms into doing his bidding.

The normally sober Economist has gone off the wagon here.

First, it knows better than to “suggest” what “the markets” think. Second, that blew up in its face rather quickly. Instaputz points out that BP shares soared 10 percent on news of the $20 billion fund… the Economist’s spin here is obnoxious. If anything ends up ruining BP, it will have been its own actions. Go read this The Wall Street Journal piece for a look at the company’s negligence.

And BP should have to pay for all the associated costs of its actions, not just the actual bill for cleaning up the oil….they will be very, very costly.

Moreover, a company’s market capitalization is based on expectations for future earnings. This disaster will surely make it harder for BP to get drilling rights that investors expected it to have just two months ago. The political climate for offshore drilling has just undergone a seismic change.

Another big factor in BP’s share decline is pure uncertainty. Investors don’t like it. Right now, the only thing certain is that BP’s hole is going to be spewing toxic oil into the Gulf of Mexico for at least another two months…

And this paragraph is a doozy:

The vitriol has a xenophobic edge: witness the venomous references to “British Petroleum”, a name BP dropped in 1998 (just as well that it dispensed with the name Anglo-Iranian Oil Company even longer ago). Vilifying BP also gets in the way of identifying other culprits, one of which is the government. BP operates in one of the most regulated industries on earth with some of the most perverse rules, subsidies and incentives. Shoddy oversight clearly contributed to the spill, and an energy policy which reduced the demand for oil would do more to avert future environmental horrors than fierce retribution.

BP was still being called “British Petroleum” here before the oil spill. The “newspaper” says that the administration is “vilifying BP,” as if it’s not a villain here. Hey, be nice to those guys that just spilled a hundred-million gallons of oil (and counting) on your shores and in your waters because they cut corners on their oil well! It’s unsporting to “vilify” them.

The Economist is part of the problem I talked about yesterday: Corporations get personhood under the law, but we’re warned you can’t retaliate against them for their bad actions. It would be bad for business!

But the biggest laugher is this, which it writes in arguing that the government should get its share of the blame (which it most definitely is, including from Obama himself in case The Economist hasn’t noticed):

BP operates in one of the most regulated industries on earth with some of the most perverse rules, subsidies and incentives.

So, it’s in one of the most regulated industries, but at the same time, regulators are responsible for its actions because they didn’t regulate? Huh?

Yes, regulators get plenty of blame for not forcing BP to act right, but BP is ultimately at fault here—especially since it helped get the regulators called off in the first place. That laissez-faire stuff didn’t happen in a vacuum.

Yves here. As Rex reader described the “blame the regulators” canard:

You have a few drinks and are driving home at about 100 mph, when it starts to rain. You lose control, crash, taking out a bunch of other drivers and starting a fire which burns down a lot of the surrounding neighborhood. Your defense — there were laws in place that should have prevented the accident. The fault lies with the cops who failed to stop you before the unfortunate accident which was triggered by an act of God (the rain).

Yves here. One of the reasons for negative reactions from the UK and some readers here no doubt isn’t that they have a vested interest (as in own BP stock) or simply haven’t been following closely the details of BP’s conduct (not just the decisions that led to the blow-out, but its actions in the containment/cleanup process). Remarkably, BP got very good marks from a corporate social responsibility standpoint, which suggests there are deep seated flaws in that methodology. The fact that they don’t consider safety records or regulatory violations for companies in production or environmentally sensitive businesses is stunning. A colleague, who runs a website that aggregates the ratings by corporate social responsibility experts wrote this defense of BP last month:

Our rating system is broad and balanced. It is backward-looking—but incorporates enough data points to be a good estimate of recent reality. Much of our evaluation is comparative—a company is judged against the performance of others in its industry. We measure twelve subcategories of performance—plus more than a dozen special issues. So, a company that performs poorly in one area can redeem itself in the others.

If you look at BP, it has remarkably good scores for a major oil company. I’ve attached a screen shot of the data you’d see if you were a subscriber. You’ll see several subcategory ratings above 70. It is pretty hard to get this good a score. We are tough enough that we don’t hand out any “As” and very few “Bs!” The average score is in the mid 40s.

For instance, BP has excellent governance scores. Take a look at the attached report from Governance Metrics (the best source IMHO of governance info). BP has excellent scores for its handling of board and transparency issues—especially when you compare it to other oil industry companies. Regardless of how BP did with the oil spill disaster, it probably is a pretty well governed company, with a balanced and responsible board.

Similarly, if you look at our custom report from Asset4, you’ll see that BP garnered 20 awards for its community service (one of the top numbers in our system). The organizations that granted their favor to BP were not all stupid, fooled, or swayed only by PR. They did real work to investigate and check on BP’s performance. Of course, many may regret the honors they bestowed on BP and renounce them after the fact. We are certain to see a drop in BP’s community scores, as we move forward.

Look at the other sources on our list. The Accountability list contains only 100 companies. It is hard to get on it. Universum says BP is great to black people. This is not what you’d expect from a bunch of red neck oil people! The Human Rights Council only has 100 companies on their list—and they check each carefully. BP joined BSR, UN Global Compact, and Carbon Disclosure Project. Joining these groups does not prove BP is good. But, it does say they care about transparency and communication—one valid component of social responsibility.

Someone using our system could knock BP for their involvement in military contracting or for their pollution problems. Some people will want to be anti any company that pumps oil or that does any kind of resource extraction. That is OK, because we are not saying there is a “right” overall number for BP or that they should always be a top company. However, looking at them broadly and fairly, they are not that bad—and they are certainly as good or better than most of the rest of the oil industry.

And based on that, he concluded: I don’t think the mistakes they’ve made changed their intentions or erased the reality of the hundreds of positive programs and initiatives they put in place over the last twenty years.

Yves here. This, of course, is halo effect, the tendency to see people, or in this case businesses, as all good or all bad. BP does well on CSR metrics, ergo it can’t be all bad. But this misses the point. The multi-billions of damage, and real possibility of lasting environmental damage, particularly if it is the result of gross negligence, does indeed more than cancel out whatever positive BP may have done in the past. That is something its defenders appear unable to recognize.

The New Republic Lays on Hot and Heavy JP Morgan PR

I recoiled on the first reading of Noam Schrieber’s “The Breakup,” an account of the recently-cooled relationship between JP Morgan and the White House at The New Republic this week. And I don’t like it much better upon a second perusal. So much of the piece is devoted to uncritical recitation of pure JP Morgan flattering bunk that it outweighs, by a considerable margin, the tidbits in the story. This is particularly unfortunate in the case of The New Republic, which is read primarily by political junkies and will thus serves to reinforce JP Morgan’s widely accepted hype.

Sadly, this style of article is becoming increasingly common among writers who don’t even seem to recognize that they’ve been captured via access journalism. Many have fallen so completely in the orbit of those in power that they’ve come to think that poking them with a toothpick is tantamount to Serious Reporting.

The arc of this discursive piece (it runs seven pages) is:

1. Jamie Dimon and the Administration were best buddies once upon a time

2. JP Morgan was particularly aggressive in undermining reform efforts

3. Jamie Dimon and the Administration are not such good friends right now

When you strip the article down to what it is all about, you can see there isn’t much to it. Yes, because this is an inside the beltway story with Big Names, the detail might seem titillating (particularly to those who see politics as an elite sport). And it does discuss two that appear to be new: first, that it was JP Morgan that was the moving force behind the clearly orchestrated push to have corporations say that they liked the derivatives market just the way it was. An amusing bit is how low the yield was on the efforts to get companies to shill for Wall Street:

“What they wanted was, ‘Hey, let’s get the dopey end users to go out and be the face of reform,’” recalls another person who participated in the strategizing.“‘We don’t have the credibility.’”…

The hope, according to a source privy to the calls and to internal planning documents, was that pressure from end users would help preserve the status quo on the derivatives the dealers sold to firms like hedge funds—which is to say, many of their most lucrative bets. “What you really had was fear,” says this person, fear that the profits from derivatives would evaporate…..

A handful of end users were on the initial calls and grumbled about their role in the plan. But, as a group, the end users did eventually become the public face of a well-financed campaign

Yves here. This is every rapist’s fantasy: to get the victim to say in public she really did want it.

Needless to say, this salvo, and JP Morgan’s generally aggressive anti-regulatory posture (”Congressional aides I spoke with proclaimed JP Morgan’s Capitol Hill contingent the most relentless in fighting reform”) didn’t put them in very good standing with Team Obama.

The article also reports a very peculiar volte face: the Administration announcing the Volcker Rule in the wake of Scott Brown’s election in Massachusetts (widely regarded as a “populist” move to garner public support and loathed on Wall Street) with a sudden need to pull out all stops on the Bernanke reappointment:

The next day, though, it was as if all had been forgotten. The nomination of Ben Bernanke for a second term as Federal Reserve chairman was suddenly losing altitude in the Senate. For a brief moment, it looked like it might crash, something the administration feared could damage the financial markets. Treasury officials asked Scher if senior JP Morgan executives could call a few senators to help put the nomination back on track, which they agreed to do without hesitation. By the time the White House called the following Monday to invite Dimon to lunch, Bernanke’s nomination looked assured.

Yves here. Notice two things: the desperation to secure the Bernanke reappointment, not because he’s the best choice, or because failure would represent a blow to the Administration’s credibility, but because Mr. Market might get in a snit. And JP Morgan rolled into action, knowing the importance of collecting favors when the Administration was ratcheting up the anti-bankster rhetoric (horrors, they might start to believe their own PR!).

The problem with the story is that the good bits are larded down with fever chart reporting of how in or out of grace Dimon was at various points in time, and even worse, overlong doses of complete rubbish about JP Morgan’s condition. For instance:

If Dimon took these shots personally, it wasn’t hard to see why. On one level, the crisis brought him vindication. For years, he’d preached the virtues of conservative risk-management and a “fortress balance sheet” that would arm JP Morgan to withstand any turmoil it faced. He’d largely abstained as other banks gorged on subprime securities. When Weill’s chosen successor, Chuck Prince, resigned in disgrace from Citigroup in late 2007, Dimon was increasingly regarded as the industry’s best manager. “[His view is] the other guys screwed up—Citi and those idiots. We did well. Had I been there, they would have been fine,” says an administration official.

And yet, for all the adulation Dimon received on Wall Street, these distinctions largely eluded the public consciousness, to Dimon’s everlasting frustration. Indeed, if there was a common strand to Dimon’s comments after the crisis, it was his resentment over being viewed as a bailed-out CEO, when in fact he took the government money as an act of good faith—so that rivals who really needed it wouldn’t be stigmatized. (Of course, even JP Morgan’s unassailable balance sheet would have been assailed had the crisis spread further.) But, instead of being heralded for this public-mindedness, Dimon found himself the target of populist attacks and an escalating reform offensive. “The incessant broad-based vilification of the banking industry isn’t fair and it is damaging,” Dimon told The Wall Street Journal.

Yves here, It appears that Dimon is possessed of a reality-distortion sphere as powerful as Steve Jobs’. And like Jobs, he has come to believe what he is selling. The difference between Jobs and Dimon, however, is that Jobs’ distortion are far less significant and consequential than Dimon’s.

Start with the myth that because JP Morgan was less involved in subprime, it was sound and didn’t need a bailout. Utter tripe. In case you missed it, the efforts to save the CDS market were to prevent JP Morgan from going under. Financial services analysts Josh Rosner has repeatedly said that JP Morgan would have collapsed had the authorities not intervened to salvage the CDS market. As Chris Whalen noted, JP Morgan is a $1.3 trillion bank attached to a $76 trillion derivatives clearing operation. The risks in the clearing operation vastly exceed what goes on at the bank. During the crisis, JP Morgan scored poorly on Whalen’s credit risk metrics in comparison to other large banks.

And even in banking terms, JP Morgan is a “fortress” with a lot of holes in the battlements.

JP Morgan is also the beneficiary of dubious accounting. Year end 2009 total equity was $165 billion. Per Mike Konczal’s conservative analysis, JPM’s losses on second mortgages are between $58 and $87 billion, if not higher.

But with front page magazine stories that talk your book for you, who needs to worry about messy realities?