Wednesday, March 30, 2011

Wisconsin Mobs: Thugs in Union Cause

"Rampaging crowds invading the Capitol, overwhelming police, kicking in doors and climbing through windows. Bomb threats and rounds of ammunition discovered at the State Capitol. Is this Nazi brownshirts at work, busting up a meeting of political opponents in 1933 Germany?  No, it's what has passed for democratic opposition in Wisconsin over the last six weeks,” wrote columnist Katherine Kersten. Protestors shouted, “This is what democracy looks like!” Though the union supporters claimed to be defending the noble cause of democracy, they were in fact subverting it. And the Democratic members of the Wisconsin Assembly ran away from democracy to hide in Illinois, choosing to obstruct democracy rather than participate in it.

Law enforcement agencies reported “numerous threats against elected officials," such as: “We will hunt you down. We will slit your throats. We will drink your blood. I will have your decapitated head on a pike in the Madison town square. This is your last warning.”

I as well as many others know where you and your family live, it's a matter of public records. We have all planned to assult [sic] you by arriving at your house and putting a nice little bullet in your head.”

A note pushed under the office door of Sen. Glenn Grothman read: “The ONLY GOOD Republican is a DEAD Republican.”

Within an hour and a half of the vote [approving Gov. Scott Walker's budget], the protestors had seized the building's lower floor,” reported WTMJ-TV in Milwaukee. “Police gave up guarding the building's entrances and retreated to the third floor.”

To read Katherine Kersten's full column, click here.

Why didn't the major news media report the threats and intimidation instead of portraying the Madison protests as peaceful demonstrations? And why didn't the Democratic cowards hiding out in Illinois denounce the thuggish tactics and tell their supporters to discontinue them?

What will happen the next time? And there will be next times. States such as New Jersey, Illinois, California and others are in worse shape than Wisconsin, and the federal government's far greater profligacy will ultimately require even greater hardships and austerity. Has Wisconsin set the pattern for the future?—one in which civil discourse is replaced by mob rule and intimidation?

When Greece was forced to take austerity measures to save the country from bankruptcy, violence erupted which the police were unable to prevent or control. In January 2011 “several hundred youths hurled projectiles, firecrackers and Molotov cocktails at police, who responded with volleys of tear gas....Protestors set up roadblocks, attacked shops and set small fires.”

On May 6, 2010, the Wall Street Journal reported, “Tens of thousands of protestors marched through Athens in the largest and most violent protests.... Angry youths rampaged through the center of Athens, torching several businesses and vehicles and smashing shop windows. Protestors and police clashed in front of parliament and fought running street battles around the city....[P]rotestors smashed the front window of Marfin Bank in central Athens and hurled Molotov cocktails inside. The three victims died from asphyxiation and smoke inhalation. Four others were seriously injured.” Fires were set in eight office buildings and banks.

As I write this I have in front of me a newspaper picture of Costis Hatzidakis, the former development minister of Greece, blood streaming down the side of his face from a cut above and to the side of his eye, and he is bleeding from his nose, too. He is being led away by a bodyguard who was unable to protect him from the mob of protestors. How near are we to such violence when menacing mobs surround Wisconsin Republican legislators homes and cars, or the legislators as they walk to work, and are swearing, screaming, jeering and spitting on them ? Or when police had to smuggle elected GOP officials through a tunnel from the Wisconsin Capitol to avoid confrontation with the mob and load them onto a bus under police guard? The howling mob then swarmed the bus, pounded on it and pursued it.

Mob violence broke out in France when the government proposed raising the retirement age for social security benefits, a measure also proposed for the U.S. by Obama's debt commission. Violence broke out in Britain when the government decided students would have to pay for their college education. But these were modest compared to the violence and magnitude of the fiscal problems of Greece, which may yet default on its payments under the bailout it received from the European Central Bank.

The U.S. faces far larger problems of fiscal austerity than any of those countries. What will be the reaction when the U.S. comes to grips with the looming problems of Medicare, Medicaid and Social Security—or the consequences of doing nothing about them? Obama's proposed budget deficit of $1.6 trillion essentially ignores the recommendations of his own debt commission (Bipartisan Commission on Fiscal Responsibility and Reform) co-chaired by Erskine Bowles and Allan Simpson. That commission called for $828 billion in cuts over 5 years.  Instead, Obama advocates even greater spending.

The U.S. House is unwilling to come up with even $100 billion in cuts demanded by Republicans members. There remains a gap of $51 billion from what the Democratic House members are agreeing to. But the numbers they are quibbling about are minuscule compared to what is required to avert bankruptcy. Senator Rand Paul has advocated a $500 billion cut in the budget, noting that even that amount wouldn't cover even one-third of the Obama budget deficit for the year.

On March 7, 2011 Bowles and Simpson appeared before the Senate Budget Committee to call for a serious response to what they called “the most predictable economic crisis in history.” Bowles told the committee, "If we just take the ostrich theory in this room, then we'll be spending $1 trillion a year in interest cost alone by the year 2020.... It's crazy."

We won't be spending $1 trillion in interest costs in the year 2020 because we don't have that much time. There will be a fiscal and monetary train wreck long before then. As I have pointed out in previous postings on this blog, the dollar will be lose its position as the world's reserve currency. The U.S. will no longer be able to fund its profligate spending by simply printing more money, and an impoverished populace will face a lower standard of living. What then will be the reaction of the mobs?

Wednesday, March 23, 2011

The Future of Fannie Mae and Freddie Mac

Last summer President Obama signed a sweeping financial reform law, which he said it would provide “the strongest financial protection for consumers in the nation's history.” But the 2,300-page law did not apply to Fannie or Freddie, which were at the heart of the housing/mortgage crisis and last year accounted for 90 percent of new mortgages. Now the administration has released its proposals—nearly two years in the making— in a “white paper” on the future of Fannie and Freddie. It is 31 pages.

When he signed the 2,300-page bill, Obama said consumers would “never again have to foot the bill for Wall Street's mistakes[!]” It was all due to Wall Street. The big banks. Those were the greedy villains responsible for selling mortgages to poor people who couldn't afford them. Or so we were told. Nothing was said about the fact Congress had established Fannie and Freddie and authorized them to securitize mortgages long before the Wall Street banks ever got into the act. Nothing was said about Fannie and Freddie being twice as leveraged as Bear Stearns, a global investment bank that was an early casualty of the financial crisis. Nor was anything said about the government's role in using the Community Reinvestment Act to force banks to lower their underwriting standards in order to qualify low-come people, principally minorities, for mortgages. Nor was anything said about the role of special interest groups such as ACORN—in which Obama had been active for years—in using the CRA to force banks to accept mortgage applications with low down payments, no verification of income, and weak credit history.

The Community Reinvestment Act of 1977 was passed when St. Jimmy the Simple was president. It purported to remedy “redlining”—racial discrimination by banks denying mortgages in black neighborhoods. The charge was false, as shown by a 1992 study from the Federal Reserve Bank of Boston, which showed 97 percent of mortgage applications by minorities were approved regardless of race. Most of the remaining 3 percent could be attributed to poor credit history. The charge of racial discrimination was made laughably false by the fact the loan denial rate for blacks and hispanics was also significantly higher than for whites and Asians at minority-owned banks! But the truth never caught up with the widely publicized charges of discrimination. Instead, the banks were now required to open new branches in low-income areas and to have a certain percentage of their small-business loans and home mortgages located there. They were also prevented from opening new branches in other—untroubled—areas if they failed to maintain this ratio.

According to Edward Pinto, former chief credit officer at Fannie Mae:

ACORN and other community groups were informally deputized by then House Banking Chairman Henry Gonzalez to draft statutory language setting the law's affordable-housing mandates....The goal of the community groups was to force Fannie and Freddie to loosen their underwriting standards, in order to facilitate the purchase of loans made under CRA....Thus a provision was inserted into the law whereby Congress signaled to the GSEs [government sponsored enterprises, Fannie Mae and Freddie Mac] that they should accept down payments of 5% or less, ignore impaired credit if the blot was over one year old, and otherwise loosen their lending guidelines.

In his biography of Obama, Stanley Kurtz, senior fellow with the Ethics and Public Policy Center, writes, “ACORN [Association of Community Organizations for Reform Now] won this showdown....[It] succeeded in dragging Fannie Mae and Freddie Mac—kicking and screaming—into the subprime mortgage business.”

He also writes: “By the mid-nineties, the CRA applied to only about a quarter of the banking system. Yet Achtenberg [Assistant Secretary for Fair Housing] made key regulatory changes that had the effect of pressuring the other three-quarters of America's mortgage industry into greater subprime lending....Achtenberg's new definition of discrimination helped push even institutions not covered by CRA into the business of subprime lending. ACORN pressed Achtenberg hard on this and other issues, at times with help from [President Clinton's] Housing Secretary Cisneros....Without being asked, Cisneros also requested ideas on ways HUD could channel money to ACORN and other community organizations.”

Initially, the affordable-housing mandate was set at 30 percent of single-family mortgages purchased by Fannie and Freddie. In 1995, Henry Cisneros directed Fannie and Freddie to buy the mortgages of low- and moderate-income borrowers amounting to 42 percent of their annual business volume. His successor Andrew Cuomo upped that to 50 percent and directed the GSEs to buy mortgages from borrowers with “very low income.” Banks ended up having to make more and more “subprime” loans and agreeing to dangerously lax underwriting standards—no down payment, no verification of income, interest-only payment plans, and weak credit history. By 2007, HUD's affordable housing regulations required 55 percent of all the GSE loans to be made to borrowers at or below the median income, with almost half of these required to be low-income borrowers. By the late 2000s, more than one-third of all new mortgages had down payments of 3 percent or less.

The credit bubble was now inflated to the bursting point. But when it burst, it was not government but the banks that took the blame. The virulently anti-business and anti-capitalist Obama was quick to decry the “fat-cat bankers on Wall Street,” the “greedy” and “irresponsible” lenders who pushed subprime mortgages on the poor and vulnerable who couldn't afford them and now were losing their homes. The Obama-adoring news media, still in love with him since the early days of the presidential campaign, flooded the public with stories about how the economic misery was due to businesses run amuck in the reckless pursuit of profit and the lack of regulation. What was needed, according to the politicians, commentators and opinion makers who dominated the media coverage was greater regulation “to prevent this from ever happening again.” The question of whether the problems had been caused by regulation in the first place never seemed to come up.

Obama's Treasury Department's “white paper” for housing finance reform is short on details but proposes reducing government investment in housing—while increasing government oversight of the mortgage market. This would include, among others, making underwriting standards stronger. Of course, it was government “oversight” that weakened them in the first place. The three proposals in the “white paper” offer varying degrees of government involvement and may include phasing out Fannie and Freddie. But the administration has said it is committed to ensuring that those two “have sufficient capital to perform under any guarantees now or in the future.” It also said it will still provide “targeted assistance” to low- and moderate-income home buyers and renters. Just like before.

If the government wanted real reform, it should repeal the CRA. Leaving that statute stand merely leaves the door open for future administrations to repeat abuses and again allocate credit for political purposes. Three statutes closely related to the CRA should also be repealed. These are the Equal Credit Opportunity Act (ECOA), the Home Mortgage Disclosure Act (HMDA), and the Fair Housing Act (FHA), all aimed towards eliminating “discrimination” in the lending process. The close relationship arises from the near-automatic determination that if ECOA or FHA are violated, the institution is not serving its community. The Department of Housing and Urban Development (HUD) and the Justice Department complement the efforts of the bank and thrift agencies in enforcing the FHA and ECOA. The CRA was enacted as a follow-up to the HMDA.

In the 1990s, Attorney General Janet Reno, along with her assistant Eric Holder, bludgeoned the banks with faulty statistical methods, quotas, market share, “disparate impact analysis” and other factors to extort millions of dollars from them with charges of racial discrimination. Many banks were intimidated and willing to acquiesce to cash settlements to avoid trials and bad publicity.

Vern McKinley, who worked for the FDIC and the Federal Reserve Board, wrote, “Lending commitments have also been extracted by community groups in connection with merger applications, when banks are most vulnerable to CRA protests, a phenomenon described as 'megamerger CRA megapledges.' These commitments range from a few hundred thousand dollars up to the largest CRA megapledge of $12 billion by Bank of America.... There is even a rule of thumb for calculating such CRA commitments of around one half of 1 percent of assets per year.” In the New York Post September 29, 2008, Kurtz wrote: “Intimidation tactics, public charges of racism and threats to use CRA to block business expansion have enabled ACORN to extract hundreds of millions of dollars in loans and contributions from America's financial institutions.”

Such commitments are often “set forth as proof of the positive economic impact resulting from active CRA enforcement,” says McKinley. “A more accurate characterization would be codified extortion. In fact, comments by those who utilize such agreements to extract negotiated settlements often resemble utterances of organized crime figures. Typical is a statement by Bruce Marks, executive director of Union Neighborhood Assistance Corporation and self-styled 'urban terrorist,' who threatened that, if banks aren’t willing to meet the new standards of community investment, then, 'we’ll have to start making it in their interest [to do so].'”

The idea that home ownership was a socially desirable goal that should be promoted by the government led to a vast, incredibly expensive, decades-long effort, but how effective was it? Home ownership in the U.S. peaked at 69 % at the top of the housing bubble and is now 67%. But there are at least 14 countries that have higher ownership rates than the U.S., including Hungary, Iceland, and Poland. In the European Union, where most countries don't offer tax breaks and subsidies like the U.S., home ownership was just shy of 75% in 2006, according to Eurostat. Home ownership in the U.S. increased by only 3.4 percentage points over the last 20 years, the period of the the U.S. government's greatest efforts to promote it. In the Netherlands and Italy, it increased by 12 percentage points between 1991 and 2008.

Canadian banks weathered the international financial crisis much better than U.S. banks. Canada has nothing comparable to Fannie or Freddie or our Community Reinvestment Act. It does not have 30-year fixed-rate mortgages, and interest on mortgages is not tax deductible. Down payments of less than 20 percent require the mortgage holder to buy mortgage insurance. Canada's regulatory agency concerns itself with risk management and abstains from social and political objectives, such as affordable housing and diversity. Yet it has a home ownership rate of 68%, and the percentage of mortgage loans delinquent for more than 90 days is approximately one-tenth of the U.S. level. A comparison to the U.S. shows two very different housing finance systems, one much more political and riskier than the other, with no advantage to the U.S. system. By the end of 2010, the financial meltdown and rising foreclosures wiped out more U.S. homeowners than were created in the 2000-2007 housing boom.

Employing government to achieve a socially desirable goal, home ownership, has led to the greatest economic contraction since the Great Depression. There is a glut on the housing market that is not going to go away any time soon. Nor will Fannie and Freddie disappear soon. If they do, their functions will likely be replaced in large measure by a similar agency with a new name. Already we hear claims that government still has to provide 30-year mortgages or people aren't going to be able to achieve the American Dream of owning their own home. But how have people in those other countries which do not have 30-year mortgages managed to achieve higher home ownership rates than the U.S​.? Other reasons, too, will no doubt be offered for stretching out the existence of Fannie and Freddie. But if that occurs, particularly if the CRA and related laws are retained, it will stretch into the future the potential for politicians to again employ them for social goals and vote-buying schemes. And there is no reason to believe the results next time will be any better than what we have just witnessed.

Saturday, March 19, 2011

Ron Paul's Subcommittee Hears Gold Testimony

Three gold experts, highly critical of the Federal Reserve, testified at a hearing of the House Subcommittee on Domestic Monetary Policy, chaired by Congressman Ron Paul, on March 17, 2011. Paul is a long-time critic of the Fed and author of the 2009 best-selling book End the Fed.

The three were: Lewis Lehrman, an investment banker, who served on Ronald Reagan's Presidential Gold Commission in 1981, and is head of the Lehrman Institute, a public policy foundation; James Grant, long-time editor of Grant's Interest Rate Observer and the author of five books on finance and financial history; and Joseph Salerno, an economics professor at Pace University in New York.

Here are excerpts from Mr. Lehrman's testimony:  "The Fed credit expansion, from late 2008 through March 2011--creating almost two trillion new dollars on the Fed balance sheet--triggered the commodity and stock boom, because the new credits could not at first be fully absorbed by the U.S. economy in recession.  Indeed, Chairman Bernanke recently wrote that Quantitative Easing aimed to inflate [italics added] U.S. equities and bonds directly, thus commodities indirectly.  But some of the excess dollars sought foreign markets, causing a fall in the dollar on foreign exchanges.  With Quantitative Easing the Fed seems to aim at depreciating the dollar.  In foreign countries, such as China, financial authorities frantically purchase the depreciating dollars, adding to their official reserves, issuing in exchange their undervalued currencies.  The new money is promptly put to work creating speculative bull markets and booming economies....

"The Consumer Price Index (CPI) will be suppressed because unemployment keeps wage rates from rising rapidly; the underutilization of industrial capacity keeps finished prices from rising rapidly.  Inflation has shown up first in commodity and stock prices....Bankers and speculators have been, and still are, the first in line, along with the Treasury, to get the zero interest credit of the Fed.  They were also the first to get bailed out.  Then, with new money, the banks financed stocks, bonds, and commodities, anticipating, as in the past, a Fed-created boom....But middle income professionals and workers, on salaries and wages, and those on fixed income and pensions, are impoverished by the very same inflation that subsidizes speculators and bankers.  Those on fixed incomes earn little, or negative returns on their savings.  Thus, they save less.  New investment then depends increasingly on bank debt, leverage, and speculation.  Unequal access to Fed credit was everywhere apparent during the government bailout of favored brokers and bankers in 2008 and 2009, while millions of not so nimble citizens were forced to the wall, and then into bankruptcy.  This ugly chapter is only the most recent chapter in the book of sixty years of financial disorder."

Mr. Lehrman pointed out that various changes in the way the CPI is calculated make it an unreliable inflation indicator.  He noted that if the CPI were calculated the way it was in 1980, it would show inflation now at 8 percent.

James Grant began by noting that the 1913 Federal Reserve Act says nothing about zero percent interest, quantitative easing, inflation targeting, stock price manipulation or even paper money. Grant showed the banking system is worse off because of the Fed's expansion of its role over the decades: he said Ben Bernanke testified that 12 of the 13 largest financial institutions were at risk of failure in 2008 although the GDP during the current recession has fallen no more than 4 percent, yet in the Great Depression the GDP fell 46% and most banks did not fail.

Grant said that Bernanke's zero-interest rate policy inflated price and investment values. And because “prices and investment values are the traffic signals of a market economy,” the Fed created “the unintended consequences of crashes and pile-ups on our financial streets and highways.” He also said Bernanke was the “self-appointed booster of stock prices.”

Grant explained the process by which purchasing goods from China is paid for by printing more dollars, which the Chinese central bank loans back to the U.S. by purchasing U.S. Treasury securities. It is as though the dollars never left the U.S. This maneuver is possible because of the U.S. dollar's status as the world's reserve currency. That status is a holdover from the days when the dollar was convertible into gold, but in today's parlance the dollar is now a “derivative.” The world's monetary system is now based on a derivative that has no asset value. Grant noted that if the dollar loses its status as the world's reserve currency, the result will be a lowering of the standard of living in the U.S. He also noted that the Fed should use terms that the public will understand. For example, instead of “quantitative easing,” it should say “printing money.”

Here are excerpts from Prof. Salerno's testimony: “Since it began operations in 1914 the Federal Reserve System ('the Fed') has presided over a relentless decline in the value of the U.S. dollar. Prices increased in 83 of the 97 years of the Fed’s existence....As a result the cumulative loss of the dollar’s buying power during the Fed’s existence has been staggering. For example, today a consumer pays $22.13 to purchase a basket of goods comparable to a basket that a consumer in 1913 would have paid $1.00 for. This means that since 1913 the dollar has lost 95 percent of its purchasing power and that today’s dollar is worth roughly a nickel in terms of the pre-Fed dollar of 1913...[EC: the 95 percent loss of purchasing power is based on the government's CPI since 1920, with adjustment for commodity prices before 1920; but there are other measurements that show greater inflation. See my series Monetary Mess, the Dollar, Gold—and You, Part II link]

"[I]n orchestrating this inflationary process, the Fed has repeatedly driven the interest rate below its natural market level, misleading investors and entrepreneurs and causing disastrous asset market bubbles, unsustainable business investments, and the creation of jobs that are not consistent with consumer preferences.  It is the arbitrary manipulation of the interest rate by the Fed that has caused the financial meltdowns and recessions that the U.S. economy has suffered over the last four decades.

"As technology advances and saving increases in a progressing economy, entrepreneurs and business firms are given the means and the incentive to invest in new methods of production, which in turn enable them to lower their cost and expand their profit margins.  In a given market, the natural result is an increase in the supply of the good and more intense competition among its suppliers.  Assuming no change in the money supply and continuing technological innovation, this competitive process will drive the production costs and the price of the good ever downward.  Consumers will benefit from the falling price because their real wages will continually increase as each dollar of income commands an increasing quantity of the good in exchange....

"Under a gold standard, prices naturally tend to decline as ongoing technological advances and investment in additional capital rapidly improve labor productivity and increase the supplies of consumer goods while the money supply grows very gradually.  For instance, throughout the nineteenth century and up until World War I, the heyday of the classical gold standard, a mild deflationary trend prevailed in the U.S.  As a result, an American consumer in the year 1913 needed only $0.79 to purchase the same basket of goods that required $1.00 to purchase in 1800.  In other words, due to the gentle fall in prices during the nineteenth century, a dollar could purchase 27 percent more in terms of goods in 1914 than it could in 1800....

"Ironically, while Chairman Bernanke just affirmed again a few days ago that the Fed will persist in its inflationary policy of quantitative easing to ward off the imaginary threat of falling prices, signs of inflation abound....The U.N. index of grain export prices has risen by 70 percent in the past year and stands at its highest level in 21 years.  Gasoline prices have surged 49 percent in the last six months.  According to IMF statistics, commodity prices are up by 33 percent in the past year; metal prices by 40 percent; energy prices by 30 percent; crude oil prices by 31 percent; and commodity industrial inputs by 40 percent....Mr. Bernanke has declared Fed policy quantitative easing a success on the basis of yet another financial asset bubble that threatens again to devastate the global economy.  This would be farcical were it not so tragic.  But what else can be expected from the leader of an institution whose very rationale is to manipulate interest rates and print money."