FedUpUSA

Archive for January 13th, 2010

Don’t Like the Numbers? Change ‘Em

If a CEO issued the kind of distorted figures put out by politicians and scientists, he’d wind up in prison.

By MICHAEL J. BOSKIN

Politicians and scientists who don’t like what their data show lately have simply taken to changing the numbers. They believe that their end—socialism, global climate regulation, health-care legislation, repudiating debt commitments, la gloire française—justifies throwing out even minimum standards of accuracy. It appears that no numbers are immune: not GDP, not inflation, not budget, not job or cost estimates, and certainly not temperature. A CEO or CFO issuing such massaged numbers would land in jail.

The late economist Paul Samuelson called the national income accounts that measure real GDP and inflation “one of the greatest achievements of the twentieth century.” Yet politicians from Europe to South America are now clamoring for alternatives that make them look better.

A commission appointed by French President Nicolas Sarkozy suggests heavily weighting “stability” indicators such as “security” and “equality” when calculating GDP. And voilà!—France outperforms the U.S., despite the fact that its per capita income is 30% lower. Nobel laureate Ed Prescott called this disparity the difference between “prosperity and depression” in a 2002 paper—and attributed it entirely to France’s higher taxes.

With Venezuela in recession by conventional GDP measures, President Hugo Chávez declared the GDP to be a capitalist plot. He wants a new, socialist-friendly way to measure the economy. Maybe East Germans were better off than their cousins in the West when the Berlin Wall fell; starving North Koreans are really better off than their relatives in South Korea; the 300 million Chinese lifted out of abject poverty in the last three decades were better off under Mao; and all those Cubans risking their lives fleeing to Florida on dinky boats are loco.

In Argentina, President Néstor Kirchner didn’t like the political and budget hits from high inflation. After a politicized personnel purge in 2002, he changed the inflation measures. Conveniently, the new numbers showed lower inflation and therefore lower interest payments on the government’s inflation-linked bonds. Investor and public confidence in the objectivity of the inflation statistics evaporated. His wife and successor Cristina Kirchner is now trying to grab the central bank’s reserves to pay for the country’s debt.

America has not been immune from this dangerous numbers game. Every president is guilty of spinning unpleasant statistics. President Richard Nixon even thought there was a conspiracy against him at the Bureau of Labor Statistics. But President Barack Obama has taken it to a new level. His laudable attempt at transparency in counting the number of jobs “created or saved” by the stimulus bill has degenerated into farce and was just junked this week.

The administration has introduced the new notion of “jobs saved” to take credit where none was ever taken before. It seems continually to confuse gross and net numbers. For example, it misses the jobs lost or diverted by the fiscal stimulus. And along with the congressional leadership it hypes the number of “green jobs” likely to be created from the explosion of spending, subsidies, loans and mandates, while ignoring the job losses caused by its taxes, debt, regulations and diktats.

The president and his advisers—their credibility already reeling from exaggeration (the stimulus bill will limit unemployment to 8%) and reneged campaign promises (we’ll go through the budget “line-by-line”)—consistently imply that their new proposed regulation is a free lunch. When the radical attempt to regulate energy and the environment with the deeply flawed cap-and-trade bill is confronted with economic reality, instead of honestly debating the trade-offs they confidently pronounce that it boosts the economy. They refuse to admit that it simply boosts favored sectors and firms at the expense of everyone else.

Rabid environmentalists have descended into a separate reality where only green counts. It’s gotten so bad that the head of the California Air Resources Board, Mary Nichols, announced this past fall that costly new carbon regulations would boost the economy shortly after she was told by eight of the state’s most respected economists that they were certain these new rules would damage the economy. The next day, her own economic consultant, Harvard’s Robert Stavis, denounced her statement as a blatant distortion.

Scientists are expected to make sure their findings are replicable, to make the data available, and to encourage the search for new theories and data that may overturn the current consensus. This is what Galileo, Darwin and Einstein—among the most celebrated scientists of all time—did. But some climate researchers, most notably at the University of East Anglia, attempted to hide or delete temperature data when that data didn’t show recent rapid warming. They quietly suppressed and replaced the numbers, and then attempted to squelch publication of studies coming to different conclusions.

The Obama administration claims a dubious “Keynesian” multiplier of 1.5 to feed the Democrats’ thirst for big spending. The administration’s idea is that virtually all their spending creates jobs for unemployed people and that additional rounds of spending create still more—raising income by $1.50 for each dollar of government spending. Economists differ on such multipliers, with many leading figures pegging them at well under 1.0 as the government spending in part replaces private spending and jobs. But all agree that every dollar of spending requires a present value of a dollar of future taxes, which distorts decisions to work, save, and invest and raises the cost of the dollar of spending to well over a dollar. Thus, only spending with large societal benefits is justified, a criterion unlikely to be met by much current spending (perusing the projects on recovery.gov doesn’t inspire confidence).

Even more blatant is the numbers game being used to justify health-insurance reform legislation, which claims to greatly expand coverage, decrease health-insurance costs, and reduce the deficit. That magic flows easily from counting 10 years of dubious Medicare “savings” and tax hikes, but only six years of spending; assuming large cuts in doctor reimbursements that later will be cancelled; and making the states (other than Sen. Ben Nelson’s Nebraska) pay a big share of the cost by expanding Medicaid eligibility. The Medicare “savings” and payroll tax hikes are counted twice—first to help pay for expanded coverage, and then to claim to extend the life of Medicare.

One piece of good news: The public isn’t believing much of this out-of-control spin. Large majorities believe the health-care legislation will raise their insurance costs and increase the budget deficit. Most Americans are highly skeptical of the claims of climate extremists. And they have a more realistic reaction to the extraordinary deterioration in our public finances than do the president and Congress.

As a society and as individuals, we need to make difficult, even wrenching choices, often with grave consequences. To base those decisions on highly misleading, biased, and even manufactured numbers is not just wrong, but dangerous.

Squandering their credibility with these numbers games will only make it more difficult for our elected leaders to enlist support for difficult decisions from a public increasingly inclined to disbelieve them.

Mr. Boskin is a professor of economics at Stanford University and a senior fellow at the Hoover Institution. He chaired the Council of Economic Advisers under President George H.W. Bush.

A Paper You MUST Read

Posted by Karl Denninger

Buried in the smoke and furor yesterday was the second panel in the FCIC testimony – the one CNBC did not provide any meaningful coverage of.

And right up front is the one person’s testimony you need to read.

That would be Michael Mayo.

Mr. Mayo hits on the themes that I have been hammering for the last two and a half years, absent some of the pointed allegations of knowing deception (that’s otherwise called “fraud”.)

Mr. Mayo used to work at The Federal Reserve, and was there during the previous banking crisis.  He points out, as has Bill Black, that we learned nothing from the S&L crisis when it came to lessons on control fraud and overextension of risk, and in fact we’re doing it again.

He calls out ten failures, and then puts forward three prescriptions.  I will not reproduce them here, since I maintain that everyone who reads The Ticker owes it to themselves not to read my summary, but rather to read Mr. Mayo’s original work – every word of it.

I will capture a few points however:

• It is pointed out that it is difficult to recreate the reality of a balance sheet through analysis if the numbers are not reported on a similar basis. Exactly.  I cannot, today, analyze a given bank’s balance sheet and tell you whether I believe they are in good health or bad, whether their cash flow is sufficient to service their debt, or the likelihood that their assets will perform.  This obfuscation is intentional and in no small part a direct consequence of lobbying by the banks themselves for the ability to provide other than market prices for alleged assets!
• Mr. Mayo asserts that there is such a thing as “too big to fail.”  I argue that if JP Morgan is too big to fail then anti-trust law says they’re too big to legally exist, as they continue in business with a de-facto unlawful “put” from the federal government, acquired through what amounts to extortion, that smaller institutions do not enjoy.  This is the essence of anti-trust law – that some firms, when they control too much of a market, abuse that position to gain advantage and shut out competition through collusive action.  This is what the “government PUT” for “too big to fail” entities comprises and the solution is simple: If you have to be bailed out in any way by the government you are broken up and your entire management team is permanently barred from ever serving as an officer of a public company again.  No ifs, ands or buts.
• Mr. Mayo also talks about capital and the need to be certain that there is never a question as to whether there is enough.  The simplest way to do this is to impose hard leverage limits and require that liquid and/or immediately-convertible capital be present at all times to cover any potential deficiency on carried assets.  At the same time all off-balance sheet exposures and naked derivative positions must be absolutely barred.  The simplest means to accomplish this is to restore Glass-Steagall, thereby removing the ability of commercial banks to play with levered instruments in the first place, limiting their leverage to their reserve ratio, and reinstate mark-to-market accounting performed nightly.  Bingo: We know you have enough capital in each and every case, and if you get close to the line you’re forced to divest assets or convert some of your prearranged debt to equity.

Folks, these solutions are not technically difficult.  They are politically difficult but the question we need ask ourselves in this country is this:

Are we willing to undergo another crash similar to 2008/2009?  WE WILL if we don’t stop the insanity, and it will likely come sooner rather than later.

The bad debt on the balance sheets of the banks and others has not been removed, either by payment or default.  It is being carried at values that suggest performance will occur even in instances where we know that is very unlikely, such as with second mortgage lines (HELOCs, etc) that are underwater.  When, not if, the foreclosures occur on the senior (first) mortgages these lines will be exposed as worthless, triggering another problem.

Nor is the issue confined to second lines.  Commercial Real Estate, OptionARMs and allegedly-”prime” loans that in fact were not all are deteriorating in record numbers.  These losses have already occurred and are being hidden, but that charade can continue only so long as the cash flow permits.

This is why there are no meaningful numbers of permanent modifications on mortgages nor will there be – the program cannot succeed as for it to do so the losses embedded in these institutions must be admitted to and recognized, and our government refuses to force that to happen.

The current attempt is to re-inflate house prices and thus pretend the crisis has past.  But we have destroyed our wage base over the last 18 months, which has simply compounded more losses into what were doomed loans, rather than forcing the defaults out into the open and selling them off at whatever price they would fetch.  By doing so we have literally added hundreds of billions of additional dollars in loss to what was already a horrible situation, and that loss has now been accrued and will not be able to be avoided either.

Within a few years time (before 2010) we will face a new problem – boomer retirements will go “over-center” and they will be net sellers of all asset classes to fund their retirements, while entitlement spending will ramp toward the moon.  That problem is extremely serious but on the path we are on now we will not get there before what we believe avoided smacks us.

Our choice is to take our medicine now and be able to recover before this tectonic shift occurs with boomer retirements and entitlement spending, or walk straight into that mess in the midst of a decade-long depression.

Oh SEC! What Sort Of BS Game Was This?

Posted by Karl Denninger

Gee, honest mistake?

—–Original Message—–
From: CME Globex Control Center
Sent: Wednesday, January 13, 2010 4:54 PM
Subject: ESH0 Event
Importance: High

Between 11:03 and 11:04 CT today, there were a series of transactions in ESH0 in which a market participant appears to have inadvertently traded approximately 200,000 contracts as both buyer and seller. CME maintains trade practice and risk management rules and procedures respecting such matters. In keeping with standard practices and CME’s self-regulatory responsibilities, CME is reviewing the circumstances of this event.

As both buyer and seller?  Uh…. wait a second.  On the same order?

This is the “action” being discussed:

That was roughly 94,000 contracts on a one-minute bar, as you can see, an absolutely massive amount of volume compared to that in the immediate vicinity. 

Needless to say that spooked people.  My initial thought when I saw it (and I did see the blocks go by on T&S – there were a lot of 1,000 and 2,000 contract orders that filled!) was that they were buy stops just above the overnight range set at about 7:00 AM Central.  The “barker” in the pit also characterized it this way – understandable, since that’s exactly what it looked like.  Of course the pit folks saw it, assumed it was a big buy stop and piled in.

But both the CME email and the volume bar implies that the same “market participant” was both the buyer AND THE SELLER.

Here’s the problem, in a nutshell:

There is no way you could come in with 200,000 contracts worth of bid without lifting the entire offer chain and spiking the market 20 handles or more north instantly.  Yet that didn’t happen, which strongly implies that whoever entered the “buy” also, at the same time, entered a “sell” at the same strike and time, which the email from CME seems to confirm. The fact that the executions came literal milliseconds apart and were in even-lot blocks of 1,000 and 2,000 contracts further implies that this was some sort of manipulative game.

“Mistake” eh? 

This entire little episode smells like dead fish.  Someone was either “lying in wait” with enough liquidity to soak that up and not generate a price spike, whoever did it was on both sides (and thus GUARANTEED there would be no material price spike) or one of the oddest coincidences I’ve ever seen in the futures markets – 100,000 contracts magically appearing on both bid and offer from two different people at the same precise instant – magically occurred.

If the intent was to scare the bejeezus out of anyone who would “dare” to short a potentially-failed breakout, they succeeded.  Who’s going to try to short into someone who has 100,000 contracts that will magically appear opposite your offer at the most-opportune time (for them) and bury you 6 feet under? 

Of course this begs the obvious question: Who has the margin capacity to execute a trade like that ($5,625 per contract required for initial margin), or $562,500,000 – yes, $562.5 million) – on each side of the trade? (this assumes the volume I have here is right – if its really 200,000+ contracts, double that.)

Hmmmm….

I’ll bet my last nickel neither the CME or SEC will do a damn thing about this, despite the outrageously blatant character and the clear implication of the event.  Nor will we see ANY update from the CME or SEC on what did actually happen or who was responsible. 

You can take that to the bank.

Charles Biderman of Trimtabs (a very well-respected research outfit) has argued for a while now that the rally for the last several months cannot be explained by buying coming from any of the trackable sources.  That is, it’s not coming from institutions, it’s not coming from households (individual investors), it’s not coming from pension funds or hedge funds.  He therefore argues, as a matter of exhaustion (who’s left?) that it likely is coming directly from The Federal Reserve and/or Treasury via intervention in the equity markets.

Are we all trading in a rigged casino?  I have not been a subscriber to these sorts of theories over the years, but when you see activity like I saw today in the futures market without a clear, cogent explanation of what actually happened that also fits the facts you have to wonder.

OECD:Global Government Support For Financial System $11.4 Tln

LONDON (Dow Jones)–Governments and central banks around the world have provided $11.4 trillion in support to banks and other financial firms in an effort to stem the financial crisis, economists at the Organization for Economic Cooperation and Development have calculated.

The final cost of bailing out the financial system won’t be known for several years, since not all of those guarantees will be called on, and the ultimate value of the assets and equity stakes purchased by governments will change over time. On the other hand, it is still possible that even more help will be needed.

But if everything that could go wrong did go wrong, the OECD’s calculations give some estimate of how much taxpayers would have to come up with under current schemes.

In a paper released on its website last week, the OECD economists calculated that as of October last year, governments had provided $1.5 trillion in capital injections and capital facilities.

They provided a further $5.2 trillion through the purchases of assets and facilities to insure banks against losses on assets, and $4.6 trillion in debt guarantees.

Within the global total, European governments provided $4.27 trillion in support, while the U.S. government provided $6.428 trillion.

The sums involved in supporting the financial system are enormous. In 2006, the year before the start of the financial crisis, the total government debt of all of the European Union’s 27 members stood at EUR7.2 trillion.

Given that the world’s population was 6.7 billion in 2008 and has likely risen since, it amounts to a contribution of over $1,600 for every person on the planet.

 -By Paul Hannon, Dow Jones Newswires; +44 20 7842 9491; paul.hannon@dowjones.com

Stop Complaining and Start Acting; We Need to Solve the Problem With Wall St. Bonuses, Black Says

 by Peter Gorenstein

There’s no absence of backlash and outrage over the billions Wall Street bankers will take home this year in bonuses. What’s missing is a solution.

The FDIC in a proposal made Tuesday, said it wants employee compensation to be another factor in how it determines bank payments to the insurance fund.

In other words, the riskier the bank’s compensation structure the more they should pay into the total insurance pot. William Black, economics and law professor at the University of Missouri – Kansas City, tells Henry the proposal doesn’t go far enough to align the interest of the bank employees with the long-term interest of shareholders.

To solve that he’s proposing:

• Clawback provisions.  
• Paying bonuses in stock.  Black says employees should be restricted from selling stock for years.

The former regulator during the Savings & Loan Crisis also recommends reinstating mark-to-market accounting. Until that’s done, he says, there’s no way to tell whether 2009 paper gains won’t be wiped out in the near future if the market sours again. Black argues “people are being paid bonuses when the company, the bank has actually lost tens of billions of dollars. That’s an obscenity.”  

CLICK HERE FOR VIDEO

Geithner’s E-Mails, Phone Logs Subpoenaed by House

Jan. 13 (Bloomberg) — The Federal Reserve Bank of New York was ordered by a House committee to provide Timothy Geithner’s e-mails, phone logs and meeting notes tied to the bailout of American International Group Inc.

The subpoena from House Oversight and Government Reform Committee Chairman Edolphus Towns demands by Jan. 19 all documents related to the New York Fed decision to fully reimburse banks that bought protection from AIG and efforts to persuade AIG to keep information about the payments from the public, Towns said in a statement today.

“We need to understand why and how taxpayer dollars were used to bail out the same people who helped cause the financial crisis in the first place,” Towns said in a statement. Geithner, who was president of the New York Fed when AIG was rescued, is now President Barack Obama’s Treasury secretary.

The New York Fed had resisted since November calls to provide documents without a subpoena, Darrell Issa, the ranking Republican on the oversight committee, said yesterday in a letter. The New York Fed asked AIG in 2008 and 2009 to remove information about the bank payments from regulatory filings, according to e-mails released by Issa last week.

The subpoena also called for documents from New York Fed General Counsel Thomas Baxter, Stephen Friedman, a former New York Fed director and current Goldman Sachs Group Inc. director, and Sarah Dahlgren, a New York Fed senior vice president who manages its AIG oversight team. Towns also demanded term sheets related to payments to AIG’s credit-default swap counterparties.

Full Payment

Deborah Kilroe, a spokeswoman for the New York Fed, declined to comment. She said yesterday that the New York Fed will “work with the committee to provide relevant information as appropriate.”

Geithner made the decision to pay banks 100 cents on the dollar for their AIG swaps tied to subprime mortgages even though the underlying assets had declined in value, according to a November report by the government watchdog overseeing the bailout program. Banks including Goldman Sachs Group Inc. and Societe Generale SA were among beneficiaries of AIG’s rescue, called by lawmakers a “backdoor bailout” for financial firms.

The insurer’s rescue “provided AIG’s counterparties with tens of billions of dollars they likely would have not otherwise received,” wrote Neil Barofsky, the special inspector of the U.S. Troubled Asset Relief Program.

Reference Crossed Out

AIG planned to disclose in December 2008 that it fully reimbursed the banks to retire the swaps contracts. The New York Fed crossed out the reference to the full payments in a draft of a regulatory filing, according to the e-mails released by Issa, and AIG excluded the language when the filing was made public Dec. 24, 2008.

Geithner was also asked by the oversight committee last week to testify in public hearings about what he knew of the New York Fed’s efforts to limit the disclosure. Baxter said last week that Geithner wasn’t aware of the issue because the lawyer didn’t think it merited Geithner’s attention.

Andrew Williams, a spokesman for the Treasury, declined to comment on the demand for Geithner’s e-mail from his time at the New York Fed.

To contact the reporters on this story: Hugh Son in New York at hson1@bloomberg.net; Andrew Frye in New York at afrye@bloomberg.net.

Last Updated: January 13, 2010 18:11 EST