Bill Black: Why the World Economic Forum and Goldman Sachs are Capitalism’s Worst Enemies

It is fitting that Goldman Sachs is the recipient of this year’s “Public Eye” designation, but it is even more fitting that it is being announced during the World Economic Forum (WEF) at Davos. Goldman Sachs exemplifies the travesty that WEF has created. It is not the worst of the worst. It is representative of the financial world of systemically dangerous institutions (SDIs) that are spreading crony capitalism through the West. The SDIs are the so-called “too big to fail (or prosecute)” banks.

The ability of the SDIs to commit fraud with impunity from the criminal laws is a defining element of crony capitalism. The impunity and implicit national subsidies to SDIs combine to make “free markets” an oxymoron. The SDIs’ economic power translates easily into dominant political power. Crony capitalism cripples markets and democracy.

The ability of the SDIs’ senior officers to commit massive frauds with impunity from the criminal laws makes “control fraud” a “sure thing.” Control fraud will make the largest banks’ senior officers exceptionally wealthy very quickly – but it will also cause severe harm to the public (and often the bank). Control fraud occurs when the persons who control a seemingly legitimate entity use it as a “weapon” to defraud. In finance, accounting is the “weapon of choice.” It is important to remember, however, that other forms of control fraud maim and kill hundreds of thousands and cause grave environmental damage. We must always remember the infant formula scandal in China where 300,000 infants were hospitalized with kidney stones due to consumer frauds that drove every honest manufacturer out of business.

Large, individual accounting control frauds cause greater financial losses than all other forms of property crime – combined. Accounting control frauds are weapons of mass financial destruction. Epidemics of accounting control fraud drove the national crises that produced the Great Recession. We have reliable information on this in the United States, the United Kingdom, Ireland, and Iceland. Spain has kept the facts about lending too opaque to determine reliably what caused their bubble to hyper-inflate, but the lending pattern is consistent with accounting control fraud. These accounting control fraud epidemics drove crises that caused a loss of over $20 trillion in wealth and cost roughly 20 million workers their jobs.
These epidemics of accounting control fraud were not random “black swan” events. Criminogenic environments produce such intense and perverse incentives that they generate epidemics of control fraud. Our financial policies have been so criminogenic for decades that we are suffering recurrent, intensifying financial crises. WEF is one of the important architects and engineers that have made our financial system so criminogenic. WEF’s dogmas and policies are so perverse that they drive financial crises, create crony capitalism, and make WEF’s leading products (the Global Competitiveness Index (GCI) and Global Risk Reports (GRR) epic embarrassments. The WEF is degrading the state of the world.

Criminogenic environments for Accounting Control Fraud

1. The dogma that control fraud cannot be material
2. The three “de’s” – deregulation, desupervision, and de facto decriminalization
3. Modern executive and professional compensation
4. The ability to grow quickly
5. Extreme leverage
6. Ease of entry
7. Assets that lack readily verifiable market values
8. Weak accounting requirements, particularly on allowances for loan and lease losses (ALLL)
9. Distressed banks

Each of these factors need not be present. I discuss here only the first three environmental characteristics, which are the most important.

Fraud Deniers

In 2012, in response to endemic, elite financial frauds, the WEF declared the following without citation or reasoning in its 2012 report on “Rethinking Financial Innovation.”

6.1.1 Consumer Disservice
Malfeasance and outright fraud [in finance] are extraordinarily damaging but also, fortunately, extremely rare.

This is a convenient dogma for a group of CEOs to hold. It is an empirical claim that is falsified by reality, but it is a vital belief if one is a philosophical opponent of regulation. Alan Greenspan was the high priest of this dogma, claiming that there was no such thing as an unregulated market because private creditors always regulated markets to prevent misconduct. Greenspan’s most infamous statement of this dogma was to Brooksley Born, then Chair of the Commodities Futures Trading Commission in connection with her proposal to investigate whether to regulate credit default swaps (CDS). Here is her account of the discussion.

“Well, Brooksley, I guess you and I will never agree about fraud” [Greenspan]
“What is there not to agree on?” [Born]
“Well, you probably will always believe there should be laws against fraud, and I don’t think there is any need for a law against fraud,” she recalls. Greenspan, Born says, believed the market would take care of itself.

Greenspan later admitted that this dogma had failed. The WEF has, recurrently (and implicitly) assumed away control fraud because it shares Greenspan’s dogma. (The implicit nature of the assumption is particularly dangerous – and symptomatic of dogma. It is the things we assume out of existence implicitly that are most dangerous because we do not consciously know we have made the assumption and therefore never test its accuracy.)

The leading “law and economics” text on corporate law has taught a generation of American lawyers that “a rule against fraud is not an essential or … an important ingredient of securities markets” (Easterbrook & Fischel 1991).

WEF’s founding ideology is “stakeholder” theory – the philosophical belief that a corporation should serve the interests of its stakeholders. The stakeholders include stockholders, creditors, and workers. Variants of control fraud target each of these stakeholders. Control frauds, therefore, are the kryptonite to stakeholder theory. Control frauds drive stakes through their stakeholders. WEF’s solution is to assume away reality. WEF ignores the findings about control fraud made by modern criminology, effective regulators and prosecutors, and top economists and to embrace Greenspan’s dogma even after Greenspan has abandoned it.
I cite information below on the dominant role of fraud during the savings and loan debacle. The role of accounting control fraud in the Enron-era is not in dispute. My FCIC testimony details the extraordinary levels of accounting control fraud driving the U.S. crisis. (I have other papers discussing the decisive role of accounting control fraud in Ireland and Iceland.) The briefest version is that by 2006, roughly 40% of mortgage loans made that year were “liar’s” loans. The incidence of fraud in liar’s loans is 90%. Lenders put the lies in liar’s loans.

The figure for liar’s loans was even higher in the UK. On January 25, 2012, Martin Wheatley delivered a speech to the British Bankers’ Association entitled “My Vision for the FCA.”

And so it must be different from some of the behaviour we saw during the boom years for the housing market.

Here we saw many examples of both poor lending and poor borrowing. It became more common for people to borrow without having their income verified – 45% of people did this at the market’s peak – and, as many have observed, both lenders and consumers were caught up in a misplaced faith in never-ending house price rises.

It is now obvious that the market in the years leading up to the crisis was unsustainable. The crisis and its aftermath changed things temporarily, but we want to change things for the better, for good.

And so here we have to look at the FSA’s mortgage market review proposals, these are currently out for consultation; we hope to be able to finalise rules in the summer.
And what our first-time buyer won’t see in a FCA-regulated world is a queue of lenders waiting to offer them a loan on the basis of what they claim their income is, with no proof required.

And they won’t find brokers thinking they can get away with persuading them to lie about their income.

This is why, based on our discussions with you, with brokers, and with consumer organisations, we are embedding common sense standards to lending across the board, so that we don’t see a return to the risky mortgage lending and borrowing seen in the boom times.

Forty-five percent of the home mortgage loans in the UK were liar’s loans – and the new “supervisor” believes that the bank officers made these loans because they all went simultaneously delusional and believed that there was an infinite bubble.

The Three “De’s” and the First Virgin Crisis

George Akerlof was made the Nobel Laureate in Economics in 2001. He co-authored a famous article in 1993 about accounting control fraud (“Looting: the Economic Underworld of Bankruptcy for Profit”). They concluded the article with this paragraph in order to give it special emphasis.

Neither the public nor economists foresaw that [S&L deregulation was] bound to produce looting. Nor, unaware of the concept, could they have known how serious it would be. Thus the regulators in the field who understood what was happening from the beginning found lukewarm support, at best, for their cause. Now we know better. If we learn from experience, history need not repeat itself (George Akerlof & Paul Romer.1993: 60).

Akerlof & Romer explained why deregulation encouraged control fraud.

[M]any economists still seem not to understand that a combination of circumstances in the 1980s made it very easy to loot a financial institution with little risk of prosecution. Once this is clear, it becomes obvious that high-risk strategies that would pay off only in some states of the world were only for the timid. Why abuse the system to pursue a gamble that might pay off when you can exploit a sure thing with little risk of prosecution? (Akerlof & Romer 1993: 4-5).

N. Gregory Mankiw was a discussant on the Akerlof & Romer paper. His infamous response to their warning about control fraud was that: “it would be irrational for savings and loans [CEOs] not to loot.” Mankiw is arguably the most influential economist because of his textbook and his role as a leading Republican economic adviser. “Mankiw morality” explains why theoclassical economics fails substantively and ethically.

The National Commission on Financial Institution Reform, Recovery and Enforcement (NCFIRRE) investigated the causes of the savings and loan debacle that Akerlof and Romer referenced.

The typical large failure [grew] at an extremely rapid rate, achieving high concentrations of assets in risky ventures…. [E]very accounting trick available was used…. Evidence of fraud was invariably present as was the ability of the operators to “milk” the organization (NCFIRRE 1993).

Investigations, and successful actions and prosecutions, by regulators, the FBI, prosecutors, and white-collar criminologists confirmed the key role that accounting control fraud played in causing the second phase of the S&L debacle.

The Financial Crisis Inquiry Commission (FCIC) investigated the causes of the current U.S. crisis. It reported:

We conclude widespread failures in financial regulation and supervision proved devastating to the stability of the nation’s financial markets. The sentries were not at their posts …due to the widely accepted faith in the self-correcting nature of the markets and the ability of financial institutions to effectively police themselves.

More than 30 years of deregulation and reliance on self-regulation

… championed by …Greenspan and others, supported by successive administrations and Congresses, and actively pushed by the powerful financial industry … stripped away key safeguards, which could have helped avoid catastrophe.

This approach had opened up gaps in oversight of critical are as with trillions of dollars at risk….

In addition, the government permitted financial firms to pick their preferred regulators in what became a race to the weakest supervisor.” [FCIC Report:xviii]

The Office of Thrift Supervision (OTS) “won” the U.S. race to the bottom. The photograph of OTS head “Chainsaw” Gilleran (see Exhibit A at the end of this text) is the iconic image of this crisis. It was intended to symbolize that the regulator (sic) and the industry would work together to destroy any regulations or supervision the industry felt was onerous. The OTS and the FDIC were so proud of the image that they placed it in the annual report of the FDIC.

The “race to the weakest supervisor” did not occur only within the U.S. Brooksley Born and a former senior SEC official have confirmed to me that UK regulators directly pitched U.S. financial firms to relocate operations to the City of London in order to obtain weaker supervision. “Fed lite” supervision was a competitive response to the FSA’s “reg lite” system of deliberately weak supervision. The City of London became the most criminogenic environment in the world for financial fraud, which is why so many UK banks and units of foreign banks located in the City have caused the major scandals in the UK and globally.
The investigations into the Irish crisis described their deliberately weak supervision as an EU policy.

…there was a socio-political context in which it would have taken some courage to seem to prick the Irish property bubble….

generic weaknesses in [EU] regulation and supervision…

Four main failings of supervision: (i) Supervisory culture was insufficiently intrusive, and staff resources were seriously inadequate ….

On-site inspections were infrequent. Supervisors … imposed no penalties on banks at all….
Ireland’s mounting financial vulnerabilities meant that strong action was called for to over-ride the prevalent light-touch and market-driven fashions of supervision: to call a spade a spade….
failure to identify, recognise the gravity of, and take tough remedial action to correct such serious governance breaches was a cardinal error of supervision…. [Report on the Irish Crisis (2010)].

The FCIC dissent claimed that deregulation and desupervision could not be a major cause of the U.S. crisis because the crisis also occurred in Europe. The dissent incorrectly (and implicitly) assumed that the three de’s did not occur in the EU.

Only Regulators and Prosecutors can Break a Gresham’s Dynamic and Save Markets

In its 2011-2012 Global Competiveness Report, the WEF conceded that effective financial regulation is essential to a safe and sound financial system.

In order to fulfill all those functions, the banking sector needs to be trustworthy and transparent, and—as has been made so clear recently—financial markets need appropriate regulation to protect investors and other actors in the economy at large [p. 7].

Its GCI, however, has no index category for effective financial regulation – only securities law regulation. The WEF has several more general indices that refer to regulation. Each of them assumes that regulation is inherently harmful – rather than essential. The WEF encourages Nations to use its indices to engage in a competition in regulatory laxity. It makes the financial environment deeply criminogenic.

The key potential of regulators and prosecutors is that we are not employees or agents of the banks we regulate. Control frauds use their powers to hire, fire, promote, and compensate to suborn the supposed internal and external “controls” (such as auditors). As Akerlof and Romer noted, accounting control fraud is a “sure thing” that will promptly produce record (albeit fictional) profits. Creditors love to lend to highly profitable borrowers. Private markets do not “discipline” accounting control frauds – they fund their rapid expansion.

Control frauds have shown strong abilities to suborn even elite financial players, such as audit partners at top tier firms. George Akerlof was the first economist to apply the concept of Gresham’s law as a metaphor to explain how control fraud can create a competitive advantage that drives honest firms out of the markets. In his famous article on markets for “lemons” he explained.

[D]ishonest dealings tend to drive honest dealings out of the market. The cost of dishonesty, therefore, lies not only in the amount by which the purchaser is cheated; the cost also must include the loss incurred from driving legitimate business out of existence. George Akerlof (1970).

While economists have had no excuse for not understanding this dynamic for over 40 years, economists were not the first to explain a Gresham’s dynamic. An acute observer of human nature wrote centuries earlier than Akerlof:

The Lilliputians look upon fraud as a greater crime than theft. For, they allege, care and vigilance, with a very common understanding, can protect a man’s goods from thieves, but honesty hath no fence against superior cunning. . . where fraud is permitted or connived at, or hath no law to punish it, the honest dealer is always undone, and the knave gets the advantage. [Swift, J. Gulliver’s Travels].

The WEF, through its many indices that purport to measure internal and external controls and quality of governance spreads the false belief that these actions prevent accounting control fraud. A recent OECD report confirms that the EU suffered from the complete failure of audit and governance to prevent the crisis.
Effective financial regulation is not the enemy of markets or competition – it is essential to the preservation of well-functioning markets and the ability of honest business people to compete. Control fraud begets fraud in the industry and other professions that are supposed to serve as controls. NCFIRRE found that:

abusive operators of S&L[s] sought out compliant and cooperative accountants. The result was a sort of “Gresham’s Law” in which the bad professionals forced out the good (NCFIRRE 1993).

FCIC found a similar Gresham’s dynamic among appraisers.

From 2000 to 2007, a coalition of appraisal organizations … delivered to Washington officials a public petition; signed by 11,000 appraisers…. [I]t charged that lenders were pressuring appraisers to place artificially high prices on properties [and] “blacklisting honest appraisers” and instead assigning business only to appraisers who would hit the desired price targets.( FCIC: 18)

Note that loan origination fraud originated with the loan originators rather than the borrowers.
Modern Executive Compensation is Criminogenic
In a delicious irony, Business Week asked Franklin Raines, Fannie Mae’s CEO why there was such widespread securities fraud during the Enron-era. Raines replied:

Don’t just say: “If you hit this revenue number, your bonus is going to be this.” It sets up an incentive that’s overwhelming. You wave enough money in front of people, and good people will do bad things.

Raines knew that bonuses had corrupted the unit at Fannie that should have been most resistant – internal audit. We know that Raines read Rajappa’s speech because he made handwritten comments on it suggesting how to strengthen the message, which he returned to Rajappa.

“By now every one of you must have 6.46 [EPS] branded in your brains. You must be able to say it in your sleep, you must be able to recite it forwards and backwards, you must have a raging fire in your belly that burns away all doubts, you must live, breath and dream 6.46, you must be obsessed on 6.46…. After all, thanks to Frank, we all have a lot of money riding on it…. We must do this with a fiery determination, not on some days, not on most days but day in and day out, give it your best, not 50%, not 75%, not 100%, but 150%.
Remember, Frank has given us an opportunity to earn not just our salaries, benefits, raises, ESPP, but substantially over and above if we make 6.46. So it is our moral obligation to give well above our 100% and if we do this, we would have made tangible contributions to Frank’s goals.” (Mr. Rajappa, head of Fannie’s internal audit, emphasis in original.)

The investigation into the Irish crisis by Mr. Nyberg displays poor analytics, but the facts he found demonstrate the perverse effects of compensation in encouraging accounting control fraud and enlisting the support of subordinates.

Targets that were intended to be demanding through the pursuit of sound policies and prudent spread of risk were easily achieved through volume lending to the property sector. (Nyberg 2011: 30)
Bank management and boards in some of the other covered banks feared that, if they did not yield to the pressure to be as profitable as Anglo, in particular, they would face loss of long-standing customers, declining bank value, potential takeover and a loss of professional respect. (Nyberg 2011: v)
The [compensation] models, as operated by the covered banks in Ireland, lacked effective modifiers for risk. Therefore rapid loan asset growth was extensively and significantly rewarded at executive and other senior levels in most banks, and to a lesser extent among staff where profit sharing and/or share ownership schemes existed.” (Nyberg 2011: 30)
“The associated risks appeared relevant to management and boards only to the extent that growth targets were not seriously compromised. (Nyberg 2011: 49)
Occasionally, management and boards clearly mandated changes to credit criteria. However, in most banks, changes just steadily evolved to enable earnings growth targets to be met by increased lending. (Nyberg 2011: 34)
all of the covered banks regularly and materially deviated from their formal policies in order to facilitate rapid and significant property lending growth. In some banks, credit policies were revised to accommodate exceptions, to be followed by further exceptions to this new policy, thereby continuing the cycle. (Nyberg 2011).
The demand for Development Finance was so strong over the Period that bank and individual growth targets were easily met from this sector. Both of the bigger banks continued to lend into the more speculative parts of the property market well into 2008, even though demand for residential property (a major end-user) had begun to decline by the end of 2006. (Nyberg 2011: 35-36)
The few that admitted to feeling any degree of concern at the change of strategy often added that consistent opposition would probably have meant formal or informal sanctioning (Nyberg 2011: v).

The last sentence makes explicit the root ethical issue. FCIC examined the same question.

We conclude there was a systemic breakdown in accountability and ethics. The integrity of our financial markets and the public’s trust in those markets are essential to the economic well-being of our nation.

Modern executive compensation further misaligns executives’ financial interests with the shareholders’. It is, instead, superb for fraud because it is very large, largely based on short-term reported earnings or share prices (which the CEO can easily manipulate), and lacks a “claw back” provision. It helps fraudulent CEOs convert firm assets to his personal benefit through seemingly normal corporate mechanisms, which makes it harder to prosecute.

The WEF is, again, a force for harm. It has an index for performance pay. CEOs who participate in the WEF survey are instructed that tying pay to performance is a desirable step, but there is no attempt by the WEF to verify that the dominant executive compensation system in their Nation is tied to long-term performance and has claw-back rights. The index, therefore, tells Nations that they should make their financial environments even more criminogenic.

The WEF Gets it so Wrong Because it Ignores Accounting Control Frauds

WEF’s competitiveness index has a series of indices that relate to the financial system and the quality of public and private institutions. The WEF loved Ireland, Iceland, and the UK’s financial systems while they were massively insolvent – an insolvency hid by accounting fraud and the grotesque failure of EU Nations and audit bodies to interpret international accounting standards as requiring lenders to recognize losses arising from their fraudulent lending.

In its 2006-2007 and 2007-2008 GCI’s, WEF’s executive survey claimed that Irish banks’ “soundness” was, respectively, the 3rd and 5th best in the world. Today, the same index rates them 144 – the worst in the world. The truth is that the worst Irish banks were in economic reality insolvent long before 2006 because of their fraudulent lending practices.

The respective ranks WEF gave Iceland’s banks in those years were 26 and 29. The WEF now ranks them 136. Spain’s banks are down to 109th from 16 and 19. The UK’s banks fell from the fiction that they were the best in the world (2006-07) (4th best in 2007-2008) to 97.

The WEF’s Global Risk Reports’ financial warnings are every bit as embarrassing. They are overwhelmingly odes to the austerity that threw the Eurozone back into a gratuitous recession.

The WEF survey is a mass of business prejudices collated and called science. If the CEOs, despite their close ties with the banks (indeed, many of them are bankers) cannot even spot the problems of banks in Ireland, Iceland, the UK, and Spain over a year after the bubbles have ceased expanding they are even more useless than scholars feared. It is time for WEF to get out of the business of being an apologist for and enabler of control fraud and to tell the likes of Goldman Sachs that a banker who sells its clients toxic mortgages the bank describe internally as “shitty” is a bank that is degrading the state of the world and it is unwelcome in Davos.

Exhibit A

The Faces of Desupervision in the U.S.: “Chainsaw” Gilleran and friends – America’s leading bank lobbyists act together with their faux regulators to destroy effective regulation and supervision.

Source

Fed's Balance Sheet Tops $3 Trillion, But...

... that's not true. The Fed's balance sheet, from a transaction basis, topped $3 trillion some 5-6 weeks ago. The only reason the Fed reported a $3 trillion number in today's H.4.1, or $3.013,333 trillion to be precise, is because all those MBS purchased in September and October following the September 13 reactivation of QE4EVA finally settled. In reality, the Fed's balance sheet is now some $3.12 trillion as there is about a $80-$120 billion lag between what the Fed has actually purchased, and what has settled. Luckily, at least Treasury purchases take far less to settle.

None of the above should come as a surprise to anyone: the Fed's balance sheet has been, even purely nominally, at $2.8/2.9 trillion for months. Wake us up when the Fed's balance sheet is $4 trillion, in precisely 11 months.

Does China Plan To Establish “China Cities” And “Special Economic Zones” All Over America?

What in the world is China up to? Over the past several years, the Chinese government and large Chinese corporations (which are often at least partially owned by the government) have been systematically buying up businesses, homes, farmland, real estate, infrastructure and natural resources all over America. In some cases, China appears to be attempting to purchase entire communities in one fell swoop. So why is this happening? Is this some form of "economic colonization" that is taking place? Some have speculated that China may be intending to establish "special economic zones" inside the United States modeled after the very successful Chinese city of Shenzhen. Back in the 1970s, Shenzhen was just a very small fishing village, but now it is a sprawling metropolis of over 14 million people. Initially, these "special economic zones" were only established within China, but now the Chinese government has been buying huge tracts of land in foreign countries such as Nigeria and establishing special economic zones in those nations. So could such a thing actually happen in America? Well, according to Dr. Jerome Corsi, a plan being pushed by the Chinese Central Bank would set up "development zones" in the United States that would allow China to "establish Chinese-owned businesses and bring in its citizens to the U.S. to work." Under the plan, some of the $1.17 trillion that the U.S. owes China would be converted from debt to "equity". As a result, "China would own U.S. businesses, U.S. infrastructure and U.S. high-value land, all with a U.S. government guarantee against loss." Does all of this sound far-fetched? Well, it isn't. In fact, the economic colonization of America is already far more advanced than most Americans would dare to imagine.

So how in the world did we get to this point? A few decades ago, the United States was the unchallenged economic powerhouse of the world and China was essentially a third world country.
So what happened?

Well, we entered into a whole bunch of extremely unfavorable "free trade" agreements, and countries such as China began to aggressively use "free trade" as an economic weapon against us.
Over the past decade, we have lost tens of thousands of businesses and millions of jobs to China.

When the final numbers for 2012 come out, our trade deficit with China for the year will be well over 300 billion dollars, and that will be the largest trade deficit that one country has had with another country in the history of the world.

Overall, the U.S. has run a trade deficit with China over the past decade that comes to more than 2.3 trillion dollars. That 2.3 trillion dollars could have gone to U.S. businesses and U.S. workers, and in turn taxes would have been paid on all of that money. But instead, all of that money went to China.
Rather than just sitting on all of that money, China has been lending much of it back to us - at interest. We now owe China more than a trillion dollars, and our politicians are constantly pleading with China to lend more money to us so that we can finance our exploding debt.

Today, the U.S. government pays China approximately 100 million dollars a day in interest on the debt that we owe them. Those that say that the U.S. debt "does not matter" are being incredibly foolish.

So thanks to our massive trade deficit and our exploding national debt, China is systematically getting wealthier and the United States is systematically getting poorer.

And now China is starting to use a lot of that wealth to aggressively expand their power and influence around the globe.

But isn't it more than a bit far-fetched to suggest that China may be planning to establish Chinese cities and special economic zones in America?
Not really.

Just look at what has already happened up in Canada. It is well-known that the Chinese population of Vancouver, Canada has absolutely exploded in recent years. In fact, the Vancouver suburb of Richmond is now approximately half Chinese. The following is an excerpt from a BBC article...

Richmond is North America's most Asian city - 50% of residents here identify themselves as Chinese. But it's not just here that the Chinese community in British Columbia (BC) - some 407,000 strong - has left its mark. All across Vancouver, Chinese-Canadians have helped shape the local landscape.

A similar thing is happening in many communities along the west coast of the United States. In fact, Chinese citizens purchased one out of every ten homes that were sold in the state of California in 2011.

But in other areas of the United States, the Chinese are approaching things much more systematically.
For example, as I have written about previously, a Chinese group identified as "Sino-Michigan Properties LLC" has purchased 200 acres of land near the town of Milan, Michigan. Their stated goal is to build a "China City" that has artificial lakes, a Chinese cultural center and hundreds of housing units for Chinese citizens.

In other instances, large chunks of real estate in major U.S. cities that are down on their luck are being snapped up by Chinese investors. Just check out what a Fortune article from a while back says has been happening over in Toledo, Ohio...

In March 2011, Chinese investors paid $2.15 million cash for a restaurant complex on the Maumee River in Toledo, Ohio. Soon they put down another $3.8 million on 69 acres of newly decontaminated land in the city's Marina District, promising to invest $200 million in a new residential-commercial development. That September, another Chinese firm spent $3 million for an aging hotel across a nearby bridge with a view of the minor league ballpark.

Toledo is being promoted to Chinese investors as a "5-star logistics region". From Toledo it is very easy to get to Chicago, Detroit, Cleveland, Pittsburgh, Columbus and Indianapolis...

With a population of 287,000, Toledo is only the fourth largest city in Ohio, but it lies at the junction of two important highways -- I-75 and I-80/90. "My vision is to make Toledo a true international city," Toledo's Mayor Mike Bell told the Toledo Blade.

But some of these deals appear to be about far more than just making "investments". According to the Idaho Statesman, a Chinese company known as Sinomach (which is actually controlled by the Chinese government) was actually interested in developing a 50 square mile self-sustaining "technology zone" south of the Boise airport...

A Chinese national company is interested in developing a 10,000- to 30,000-acre technology zone for industry, retail centers and homes south of the Boise Airport.

Officials of the China National Machinery Industry Corp. have broached the idea — based on a concept popular in China today — to city and state leaders.

The article suggested that this "technology zone" would be modeled after similar projects that already exist in China, and that Chinese officials were conducting similar negotiations with other U.S. states as well...

Sinomach is not looking only at Idaho.

The company sent delegations to Ohio, Michigan and Pennsylvania this year to talk about setting up research and development bases and industrial parks. It has an interest in electric transmission projects and alternative energy as well.

The technology zone proposal follows a model of science, technology and industrial parks in China — often fully contained cities with all services included.

Thankfully the deal in Idaho appears to be stalled for now, but could we soon see China establish special economic zones in other communities all around America?

The Chinese certainly do seem to be laying the groundwork for something. They have been voraciously gobbling up important infrastructure all over the country. The following comes from a recent American Free Press article...

In addition to already owning vital ports in Long Beach, Calif. and Boston, Mass., the China Ocean Shipping Company is eyeing major ports on the East Coast and Gulf of Mexico. China also owns access to ports at the entry and exit points of the Panama Canal.

And due to fiscal woes plaguing many American cities and states, U.S. legislators have been actively seeking out Chinese investors. In one of the worst cases, Baton Rouge, La., Mayor Kip Holden offered the Chinese government ownership and operating rights to a new toll way system if the Chinese would provide the funding to build it.

Does it make sense for the Chinese to own some of our most important ports?
Isn't there a national security risk?

Sadly, there isn't much of anything that our politicians won't sell these days as long as someone is willing to flash a lot of cash.

The Chinese have also been busy buying up important real estate on the east coast as a recent Forbes article explained….

According to a recent report in the New York Times, investors from China are “snapping up luxury apartments” and are planning to spend hundreds of millions of dollars on commercial and residential projects like Atlantic Yards in Brooklyn. Chinese companies also have signed major leases at the Empire State Building and at 1 World Trade Center, the report said.

But it is not only just land and infrastructure that the Chinese have been buying up.
They have also been purchasing rights to vital oil and natural gas deposits all over the United States.
There have been two Chinese companies that have been primarily involved in this effort.
The first is the China National Offshore Oil Corporation (CNOOC). According to Wikipedia, CNOOC is 100 percent owned by the Chinese government…

CNOOC Group is a state-owned oil company, fully owned by the Government of the People’s Republic of China, and the State-Owned Assets Supervision and Administration Commission of the State Council (SASAC) performs the rights and obligations of shareholder on behalf of the government.

The second is Sinopec Corporation. Sinopec Group is the largest shareholder (approx. 75% ownership) in Sinopec Corporation. And as the Sinopec website tells us, Sinopec Group is fully owned by the Chinese government…

Sinopec Group, the largest shareholder of Sinopec Corp., is a super-large petroleum and petrochemical group incorporated by the State in 1998 based on the former China Petrochemical Corporation. Funded by the State, it is a State authorized investment arm and State-owned controlling company.

So whenever you see CNOOC or Sinopec, you can replace those names with the Chinese government. The Chinese government essentially runs both of those companies.

And as you can see from the following list compiled by the Wall Street Journal, those two companies have been extremely aggressive in buying up rights to oil and natural gas all over the nation...

Colorado: Cnooc gained a one-third stake in 800,000 acres in northeast Colorado and southeast Wyoming in a $1.27 billion pact with Chesapeake Energy Corp.
Louisiana: Sinopec has a one-third interest in 265,000 acres in the Tuscaloosa Marine Shale after a broader $2.5-billion deal with Devon Energy.
Michigan: Sinopec gained a one-third interest in 350,000 acres in a larger $2.5 billion deal with Devon Energy.
Ohio: Sinopec acquired a one-third stake in Devon Energy’s 235,000 Utica Shale acres in a larger $2.5 billion deal.
Oklahoma: Sinopec has a one-third interest in 215,000 acres in a broader $2.5 billion deal with Devon Energy.
Texas: Cnooc acquired a one-third interest in Chesapeake Energy’s 600,000 acres in the Eagle Ford Shale in a $2.16-billion deal.
Wyoming: Cnooc has a one-third stake in 800,000 acres in northeast Colorado and southeast Wyoming after a $1.27 billion pact with Chesapeake Energy. Sinopec gained a one-third interest in Devon Energy’s 320,000 acres as part of a larger $2.5 billion deal.
Gulf of Mexico: Cnooc Ltd. separately acquired minority stakes in some of Statoil ASA’s leases as well as six of Nexen Inc.’s deep-water wells.

So why is the U.S. government allowing this?

That is a very good question.

For a nation that purports to be pursuing "energy independence", we sure do have a funny way of going about things.

Unfortunately, the sad truth is that China is absolutely mopping the floor with the United States on the global economic stage. China is rising and America is in an advanced state of decline. Global economic power has shifted dramatically and most Americans still don't understand what has happened.

The following are 44 more signs of how dominant the economy of China has become...

1. A Chinese firm recently made a $2.6 billion offer to buy movie theater chain AMC.
2. A different Chinese firm made a $1.8 billion offer to buy aircraft maker Hawker Beechcraft.
3. In December it was announced that a Chinese group would be purchasing AIG's plane leasing unit for $4.23 billion.
4. It was recently announced that the Federal Reserve will now allow Chinese banks to buy up American banks.
5. A $190 million bridge project up in Alaska was awarded to a Chinese firm.
6. A $400 million contract to renovate the Alexander Hamilton bridge in New York was awarded to a Chinese firm.
7. A $7.2 billion contract to construct a new bridge between San Francisco and Oakland was awarded to a Chinese firm.
8. The uniforms for the U.S. Olympic team were made in China.
9. 85 percent of all artificial Christmas trees are made in China.
10. The new World Trade Center tower is going to include glass that has been imported from China.
11. The new Martin Luther King memorial on the National Mall was made in China.
12. In 2001, American consumers spent 102 billion dollars on products made in China. In 2011, American consumers spent 399 billion dollars on products made in China.
13. The United States spends about 4 dollars on goods and services from China for every one dollar that China spends on goods and services from the United States.
14. According to the New York Times, a Jeep Grand Cherokee that costs $27,490 in the United States costs about $85,000 in China thanks to all the tariffs.
15. The Chinese economy has grown 7 times faster than the U.S. economy has over the past decade.
16. The United States has lost a staggering 32 percent of its manufacturing jobs since the year 2000.
17. The United States has lost an average of 50,000 manufacturing jobs per month since China joined the World Trade Organization in 2001.
18. Overall, the United States has lost a total of more than 56,000 manufacturing facilities since 2001.
19. According to the Economic Policy Institute, America is losing half a million jobs to China every single year.
20. Between December 2000 and December 2010, 38 percent of the manufacturing jobs in Ohio were lost, 42 percent of the manufacturing jobs in North Carolina were lost and 48 percent of the manufacturing jobs in Michigan were lost.
21. In 2010, China produced more than twice as many automobiles as the United States did.
22. Since the auto industry bailout, approximately 70 percent of all GM vehicles have been built outside the United States.
23. After being bailed out by U.S. taxpayers, General Motors is currently involved in 11 joint ventures with companies owned by the Chinese government. The price for entering into many of these “joint ventures” was a transfer of “state of the art technology” from General Motors to the communist Chinese.
24. Back in 1998, the United States had 25 percent of the world’s high-tech export market and China had just 10 percent. Ten years later, the United States had less than 15 percent and China’s share had soared to 20 percent.
25. The United States has lost more than a quarter of all of its high-tech manufacturing jobs over the past ten years.
26. China’s number one export to the U.S. is computer equipment.
27. The number one U.S. export to China is "scrap and trash".
28. The U.S. trade deficit with China is now more than 28 times larger than it was back in 1990.
29. Back in 1985, the U.S. trade deficit with China was just 6 million dollars for the entire year. For the month of November 2012 alone, the U.S. trade deficit with China was 28.9 billion dollars.
30. China now consumes more energy than the United States does.
31. China is now the leading manufacturer of goods in the entire world.
32. China uses more cement than the rest of the world combined.
33. China is now the number one producer of wind and solar power on the entire globe.
34. Today, China produces nearly twice as much beer as the United States does.
35. Right now, China is producing more than three times as much coal as the United States does.
36. China now produces 11 times as much steel as the United States does.
37. China produces more than 90 percent of the global supply of rare earth elements.
38. China is now the number one supplier of components that are critical to the operation of U.S. defense systems.
39. A recent investigation by the U.S. Senate Committee on Armed Services found more than one million counterfeit Chinese parts in the Department of Defense supply chain.
40. 15 years ago, China was 14th in the world in published scientific research articles. But now, China is expected to pass the United States and become number one very shortly.
41. China now awards more doctoral degrees in engineering each year than the United States does.
42. According to one study, the Chinese economy already has roughly the same amount of purchasing power as the U.S. economy does.
43. According to the IMF, China will pass the United States and will become the largest economy in the world in 2016.
44. Nobel economist Robert W. Fogel of the University of Chicago is projecting that the Chinese economy will be three times larger than the U.S. economy by the year 2040 if current trends continue.

Without the "globalization" of the world economy, none of this would have ever happened. But instead of admitting our mistakes and fixing them, our politicians continue to press for even more "free trade" and even more integration with communist nations such as China.

In fact, according to Dr. Jerome Corsi, the U.S. government has already set up 257 "foreign trade zones" all over America. These "foreign trade zones" are apparently given "special U.S. customs treatment" and are used to promote "free trade"…

Corsi noted that the U.S. government has created 257 foreign trade zones, or FTZs, throughout the United States, designed to extend special U.S. customs treatment to U.S. plants engaged in international-trade-related activities.

The FTZs tend to be located near airports, with easy access into the continental NAFTA and WTO multi-modal transportation systems being created to move free-trade goods cheaply, quickly and efficiently throughout the continent of North America.
“There is nothing in the U.S. government’s description of FTZs that would prevent a foreign government, like China, from operating a shell U.S. company that is in reality owned and financed by the Chinese government and operated through a Chinese government-owned corporation,” Corsi wrote.

Sadly, we are probably going to see a whole lot more of this in the years ahead.

According to Corsi, a professor of economics at Tsighua University in Beijing named Yu Qiao has suggested the following plan as a way to transform the debt that the United States owes China into something more "tangible"...

1. China would negotiate with the U.S. government to create a “crisis relief facility,” or CRF. The CRF “would be used alongside U.S. federal efforts to stabilize the banking system and to invest in capital-intensive infrastructure projects such as high-speed railroad from Boston to Washington, D.C.
2. China would pool a portion of its holdings of Treasury bonds under the CFR umbrella to convert sovereign debt into equity. Any CFR funds that were designated for investment in U.S. corporations would still be owned and managed by U.S. equity holders, with the Asians holding minority equity shares “that would, like preferred stock, be convertible.”
3. The U.S. government would act as a guarantor, “providing a sovereign guarantee scheme to assure the investment principal of the CRF against possible default of targeted companies or projects”.
4. The Federal Reserve would set up a special account to supply the liquidity the CRF would require to swap sovereign debt into industrial investment in the United States.

Apparently the Bank of China really likes this plan and would like to see something like this implemented.

In the years ahead, perhaps many of you will end up working in a "special economic zone" for a Chinese company on a project that is being financially guaranteed by the U.S. government.
If that sounds like a form of slavery to you, the truth is that you are probably not too far off the mark.
The borrower is the servant of the lender, and we should have never allowed ourselves to get into so much debt.

Now we will pay the price.

To get an idea of how much the world has changed in recent years, just check out this incredible photo which contrasts the decline of Detroit over the years with the amazing rise of Shanghai, China.
Things did not have to turn out this way. Unfortunately, we made decades of incredibly foolish decisions and we wrecked the greatest economic machine that the world has ever seen.
Now the future for America looks really bleak.

Or could it be that I am being too pessimistic? Please feel free to post a comment with your thoughts below...

German Gold Claw Back Causes Concern

Last week the Bundesbank (the German central bank) surprised markets around the world by announcing that it will repatriate a sizable portion of its gold bullion reserves held in France and the United States. To many, the news from the world's second largest holder of gold signaled a growing, if clandestine, mistrust among central banks, possibly fueled by diverging policy goals. The Germans have attempted to tamp down the alarm by highlighting the myriad of logistical, practical and historical reasons that qualified the announcement as unremarkable. But the size, scope, and timing of the move makes it hard not to draw more strategic conclusions.

Coming during a time of supposed central bank cooperation, the decision to withdraw billions of dollars of bullion was bound to raise eyebrows. At present, Germany has official gold holdings of some 3,396 tonnes. 1,500 tonnes resides in New York and 374 tonnes in Paris. Between now and 2020, Germany will repatriate 674 tonnes of gold – 300 from the Fed in New York (valued at $17.9 billion) and the entire 374 tonne allotment from Paris (valued at $22.3 billion). Although financial leaders like Fed Chairman Ben Bernanke have said that gold "is not money" and senior investors like Warren Buffet have described it as "a barbarous relic," the movement of gold nevertheless makes a strong emotional impact. Is such a response justified?

Coming during a time of supposed central bank cooperation, the decision to withdraw billions of dollars of bullion was bound to raise eyebrows. Although financial leaders like Fed Chairman Ben Bernanke have said that gold "is not money" and senior investors like Warren Buffet have described it as "a barbarous relic," the movement of gold nevertheless makes a strong emotional impact. Is such a response justified?

Following World War II, the threat of a sudden Soviet invasion convinced many Western European nations to diversify their gold holdings abroad, particularly overseas to the US and the UK. Today, Germany holds only 31 percent of its gold within the Bundesbank. Of the remainder, 45 percent is held at the Federal Reserve Bank in New York, 11 percent with the Banque de France in Paris, and 13 percent with the Bank of England in London. But now that the Russian military threat has dissipated, the Germans have rightly reevaluated its dispositions.

For decades, central banks have been secretive about their gold holdings. Despite this, few doubt the published aggregate gold holdings of central banks. But serious questions arise as to the precise ownership of the gold held in the vaults of central banks and some commercial banks. To the astonishment of many German citizens and international observers, the Bundesbank admitted some years ago that it had not held an audit of its gold holdings for decades, if ever. (See my prior commentary on this subject)

The developed nations of the world have adopted a form of Keynesian economics that has created a world awash with debased fiat currency supported by seemingly unsupportable mountains of official debt. In such a world, it is understandable that German citizens feel their nation's gold should be held at home. Such sentiment could spread. Holland's CDA Party already has asked that their nation's 612 tonnes, or metric tons, of gold be repatriated from the U.S., the UK and from Canada.

Some question whether such sentiments will spread and expose even a shortage of physical gold in hitherto trusted vaults. In addition, in a world where trust in central banks is waning fast, central banks themselves may become mistrusting of each other.

At the same time, central banks in the developing world, particularly in China and Southeast Asia, are accumulating gold, as are nations like Russia, Turkey and Ukraine. China is now the world's largest producer of gold worldwide, but she retains her production and even buys more on the open market. This has occurred even while no major central banks are selling significant amounts of gold. The Bank of England's disastrous selling campaign in the early years of the current century, in which it sold hundreds of tons below $300 per ounce, is no doubt a controlling factor.

The unwillingness of central banks to part with their hoarding of gold, highlighted by Germany's repatriation, contrasts starkly with the central bank policies of the 1970s and 1980s, when concerted efforts were made to de-monetize gold, which could only be done through active selling. Does this change reflect a growing and shared distrust of fiat currency by sophisticated private investors who hoard gold?

The repatriation of even a part of Germany's central bank gold holdings, especially if followed by other nations such as Holland, should be regarded with concern. Today, no central bank would dare to risk rocking the central banking boat. But as the Keynesian economies have slid towards financial disaster, any increase in central bank gold repatriation could indicate a real fear by the great insiders — central banks.

A particularly interesting aspect of the announcement that has been largely ignored is the extraordinarily lengthy seven year time period in which the Germans expect to receive back their gold. The 300 tons they're repatriating from the New York Fed reflects just five percent of the more than 6,700 tons held there. It strikes many as unusual that the Fed would need so much time to deliver what should be a manageable withdrawal.

Source

Japan's Chain Of Events: Stagnation -> Monetization -> Devaluation -> Stabilization -> Retaliation -> Hyperinflation

As the world's equity markets prepare to rally on the back of yet more central bank printing as Japan's Shinzo Abe takes the helm with a 2% inflation target, to be announced momentarily, and a central bank entirely in his pocket, The Telegraph's Ambrose Evans-Pritchard suggests a rather concerning analog for the last time a Japanese minister attempted to salvage his deflation/depression strewn nation: the 1930s 'brilliant rescue' by Korekiyo Takahashi, who removed Japan from the Gold Standard, ran huge 'Keynesian' budget deficits intentionally, and compelled the Bank of Japan to monetize his debt until the economy was back on its feet managed to devalue the JPY by 60% (40% on a trade-weighted basis).

Initially this led to exports rising dramatically and brief optical stability, but the repercussion is the unintended consequence (retaliation) that the world missed then and is missing now. Though the economy appeared to stabilize, the responses of other major exporting nations, implicitly losing in the game of world trade, caused Japan's policies to backfire, slowed growth and left a nation needing to chase its currency still lower - eventually leading to hyperinflation in Japan... and Takahashi's assassination.

And with no Martians to export to, why should we expect any difference this time? and how much easier (and quicker) are trade flows altered in the current world?

Via The Telegraph:

Premier Shinzo Abe has vowed an all-out assault on deflation, going for broke on multiple fronts with fiscal, monetary, and exchange stimulus.

What happened last time the a Japanese minister tried to desperately devalue his nation to growth?

This is a near copy of the remarkable experiment in the early 1930s under Korekiyo Takahasi, described by Ben Bernanke as the man who "brilliantly rescued" his country from the Great Depression. Takahasi was the first of his era to tear up rule book completely. He took Japan off gold in December 1931. He ran "Keynesian" budget deficits deliberately, launching a New Deal blitz before Franklin Roosevelt took office. He compelled the Bank of Japan to monetize debt until the economy was back on its feet. The bonds were later sold to banks to drain liquidity. He devalued the yen by 60pc against the dollar, and 40pc on a trade-weighted basis. Japan's textile, machinery, and chemical exports swept Asia, ultimately causing the British Empire and India to retaliate with Imperial Preference and all that was to follow -- and there lies the rub, you might say. Takahasi was assassinated by army officers in 1936 when he tried to tighten by cutting military costs. Policy degenerated. Japan later lurched into hyperinflation.

but the initial stability and growth could have unintended consequences as:

Needless to say, printing money has its perils too. The risk is that Japan could escape gentle but stable deflation -- the Devil it knows -- only to see a panic flight from bonds that overwhelms the Bank of Japan. As Governor Masaaki Shirakawa told the Diet through gritted teeth, "long-term yields could rise, and that would be a problem for public finances."

Japan's unilateral move may also be perceived badly by the rest of the G-20...

Mr Abe's frustration is understandable. Japan is cursed with a safen-haven currency that strengthens in times of trouble when least wanted, the cross that creditor states must bear. Japan did uphold the G20 deal in March 2009 to refrain from "competitive devaluations", when others did not. But should Japan now buy foreign bonds on a mass scale to suppress the yen, there will be trouble. Tokyo will be blamed as the aggressor in the outbreak of currency wars. Others will retaliate.

And just as we have warned (and Kyle Bass has painstakingly described):

"Banks hold JGBs worth 900pc of their Tier 1 capital. Their portfolios would be decimated if long rates punched above 2pc. Japan might then face a banking disaster as well. These are the hard choices that Mr Abe has to make. "

And as Evans-Pritchard concludes correctly:

Huge issues are at play here. The world's trade system is fragile. The wasting disease behind the Long Slump is a record high savings rate of 24pc of global GDP, and too little demand to go around. Everybody wants a weaker a currency. They can't all have it.

Japan's great experiment cuts both ways for the rest of us: the reflation blitz helps lift the global economy out of the doldrums: but yen manipulation snatches market share, incites protectionism, and takes us into the brave new world of "actively managed exchange rates", as Sir Mervyn King put it last month.

To summarize:

• Stagnation
• Monetization
• Devaluation
• Stabilization
• Retaliation
• Hyperinflation

Almost like a U2 song. And this is what already happened in Japan. Luckily, this time will be different.

Source

The Sovereign Debt Bubble Will Continue To Expand Until – BANG – The System Implodes

Why are so many politicians around the world declaring that the debt crisis is "over" when debt to GDP ratios all over the planet continue to skyrocket?  The global economy has never seen anything like the sovereign debt bubble that we are experiencing today.  The United States, Japan, and nearly every major nation in Europe are absolutely drowning in debt.  We have heard a lot about "austerity" over in Europe in recent years, but debt to GDP ratios continue to rise in Greece, Spain, Italy, Ireland and Portugal.  In general, most economists consider a debt to GDP ratio of 100% to be a "danger level", and most of the economies of the western world have either already surpassed that level or are rapidly approaching it.  Of course the biggest debt offender of all in many ways is the United States.  The U.S. debt to GDP ratio has risen from 66.6 percent to 103 percent since 2007, and the U.S. government accumulated more new debt during Barack Obama's first term than it did under the first 42 U.S. presidents combined.  This insane sovereign debt bubble will continue to expand until a day of reckoning arrives and the system implodes.  Nobody knows exactly when that moment will be reached, but without a doubt it is coming.

But if you listen to the mainstream media in the United States, you would be tempted to think that this giant bubble of debt is not much of a concern at all.  For example, in a recent article in the Washington Post entitled "The case for deficit optimism", Ezra Klein wrote the following...

"Here’s a secret: For all the sound and fury, Washington’s actually making real progress on debt."

How many times have we heard that before?

About a decade ago, government officials were projecting that we would be swimming in gigantic government surpluses by now.

Instead, we are running trillion dollar deficits.

But right now there is a lot of optimism about the economy.  The stock market recently hit a 5 year high and the business community is loving all of the false prosperity that all of this debt is buying us.
Even Warren Buffett does not really seem concerned about the exploding U.S. government debt.  He recently made the following statement...

"It is not a good thing to have it going up in relation to GDP.  That should be stabilized. But the debt itself is not a problem."

Oh really?

A debt of 16 trillion dollars "is not a problem"?

Perhaps we should all run our finances that way.

Why don't we all go out and open up 20 different credit cards, run them all up to the max, and then tell the credit card companies that we can't pay them back but that it "is not a problem".
Of course real life does not work that way.

The truth is that government debt is becoming a monstrous problem all over the globe.  Just check out how debt to GDP ratios all over the planet have grown over the past five years...

United States
Debt to GDP ratio in 2007: 66.6 percent
Debt to GDP ratio in 2012: 103 percent

United Kingdom
Debt to GDP ratio in 2007: 43.4 percent
Debt to GDP ratio in 2012: 85.0 percent

France
Debt to GDP ratio in 2007: 63.7 percent
Debt to GDP ratio in 2012: 86 percent

Germany
Debt to GDP ratio in 2007: 67.6 percent
Debt to GDP ratio in 2012: 80.5 percent

Spain
Debt to GDP ratio in 2007: 39.6 percent
Debt to GDP ratio in 2012: 69.3 percent

Ireland
Debt to GDP ratio in 2007: 24.8 percent
Debt to GDP ratio in 2012: 106.4 percent

Portugal
Debt to GDP ratio in 2007: 63.9 percent
Debt to GDP ratio in 2012: 108.1 percent

Italy
Debt to GDP ratio in 2007: 106.6 percent
Debt to GDP ratio in 2012: 120.7 percent

Greece
Debt to GDP ratio in 2007: 106.1 percent
Debt to GDP ratio in 2012: 170.6 percent

The Eurozone As A Whole
Debt to GDP ratio in 2007: 68.4 percent
Debt to GDP ratio in 2012: 87.3 percent

Japan
Debt to GDP ratio in 2007: 172.1 percent
Debt to GDP ratio in 2012: 211.7 percent

So how does all of this end?

Well, it is going to be messy, but it is very difficult to say exactly when the system will collapse under the weight of too much debt.  Some nations, such as Japan, are able to handle very high debt loads because they have a very high level of domestic saving.  Up to this point, an astounding 95 percent of all Japanese government bonds have been purchased domestically.  But other nations collapse under the weight of government debt even before they reach a debt to GDP ratio of 100%.  The following is an excerpt from a recent Congressional Research Service report...

It is hard to predict at what point bond holders would deem it to be unsustainable. A few other advanced economies have debt-to-GDP ratios higher than that of the United States. Some of those countries in Europe have recently seen their financing costs rise to the point that they are unable to finance their deficits solely through private markets. But Japan has the highest debt-to-GDP ratio of any advanced economy, and it has continued to be able to finance its debt at extremely low costs.

When a government runs up massive amounts of debt, it is playing with fire.  You can pile up mountains of government debt for a while, but eventually it catches up with you.

Over the past 10 years, the U.S. national debt has grown by an average of 9.3 percent per year, but the overall U.S. economy has only grown by an average of just 1.8 percent per year.  That is unsustainable by definition.

There is going to be a tremendous price to pay for the debt binge that the U.S. government has indulged in over the past decade.  During Barack Obama's first term, the amount of new debt accumulated by the federal government breaks down to about $50,521 for every single household in the United States.  That is utter insanity.

If you can believe it, we have accumulated more new government debt under Obama than we did from the inauguration of George Washington to the end of the Clinton administration.

And most Americans realize that something is seriously wrong.  One recent poll found that only 34 percent of all Americans believe that the country is heading in the right direction, and 60 percent of all Americans believe that the country is heading in the wrong direction.

If we keep piling up so much debt, at some point a moment of great crisis will arrive.  When that moment arrives, we could see havoc throughout the entire global financial system.  For instance, most people don't really understand the key role that U.S. Treasuries play in the derivatives market.  The following is from a recent article posted on Zero Hedge...

This time around, things will be far worse if nothing is solved. If the US loses another AAA rating, then the financial markets could face systemic risk. The reason for this is that US Treasuries are one of the senior most forms of collateral used by the banks to backstop the $600+ trillion derivatives market.

As any trader who trades on margin can tell you, when the value of your collateral is called into question, those on the other side of the trade come looking for you to put up more capital on your trades. This can result in assets being sold en masse (similar to what happened after Lehman failed) and things can get very ugly very fast.

For much more on the danger that derivatives pose to our financial system, please see this article: "The Coming Derivatives Panic That Will Destroy Global Financial Markets".

Once again, nobody knows exactly when the sovereign debt bubble will burst, but if we continue down the path that we are currently on, it will inevitably happen at some point.

And according to Professor Carmen Reinhart, when this bubble does burst things could unravel very rapidly...

"These processes are not linear," warns Prof. Reinhart. "You can increase debt for a while and nothing happens. Then you hit the wall, and—bang!—what seem to be minor shocks that the markets would shrug off in other circumstances suddenly become big."

At some point the global financial system will hit the wall that Professor Reinhart has warned about.
Are you ready?

Source

New Ruling on Mortgage Putbacks a Potential Huge Win for Banks

Even though, for most people, the housing crisis is a thing of the past, the fight over who should bear the cost of sloppy and openly fraudulent mortgage origination and securities sales continues to grind through the courts.

We’ve written now and again about mortgage putback cases, which are also called representation and warranty, or “rep and warranty” litigation. Investors in mortgage-backed securities were not quite as dumb as the crisis aftermath had made them look. The sponsors of the securitizations made promises in the offering documents (called representations and warranties) about the quality of the loans. It turns out they lied.

Normally, when a loan is found to be worse than the sponsors promised, the remedy is a putback. The originator is required to take the bad loan back and replace it, either with cash or buy replacing it with a loan that was of the quality that the investors were promised. However, the mortgage securitizations put hurdles in front of the investors: it took a minimum level of investors (usually 25%) to demand putbacks and it was hard for any investor to know who else had bought a particular deal. Even then, the trustee (who was the party who was responsible for putting back the loan) almost always ignored and fought investor putback requests. They have ongoing relationships with the sponsors, so they don’t want to ruffle big meal tickets, plus the margins for acting as a mortgage securitization trustee are thin, so they don’t lift a finger unless they absolutely have to.

Investors have thus been going to court to enforce their putback rights. We haven’t been enthusiastic about these suits. It isn’t that the investors weren’t harmed or that the banks really didn’t lie about their wares. But we have always been of the view that ultimately, if these suits get anywhere, the plaintiff would have to show on a loan by loan basis that the default was due not to normal underwriting losses (as in death, disability, job loss) but specifically because the loan was bad (as the loan was so badly underwritten that default was highly likely). That is, the plaintiffs don’t just have to show that their contracts were breached (the loans were worse than they were supposed to be) but that the breach was what caused damages.

What makes these cases potential duds, or at best unlikely to produce damages within hailing distance of investor losses is the fact that they will likely require a loan by loan fight. Imagine the cost of each side doing discovery on a loan, and telling its version of the story as to why the borrower defaulted. Multiply that by thousands of loans and the cost of proving how much you are owed becomes very costly relative to what the plaintiff might recoup. That’s why the people we know who have experience in rep and warranty litigation have expected these cases to settle for comparatively small percentages of likely losses suffered (now having said that, in an important ruling last year in Syncora v. EMC, the judge agreed that misrepresentations about loan quality would increase the risk of an insured loan pools, meaning Syncora would not need to get into a huge analysis of how many loans defaulted and why. But that ruling was based on insurance statues, so that doesn’t help mortgage bond investors).

The cases that are furthest along are those involved monoline insurers, since they had stronger putback rights in their contracts than bond investors. In MBIA v Countrywide, the judge agreed to allow MBIA to construct a sample of the loans (the two sides will now fight over what is an adequate sample) but even within that sample, we’d expect both sides to do a loan level analysis, which would probably include loan level discovery. Ugh.

Alison Frankel of Reuters points to a new ruling which could make this investor-unfriendly picture even uglier. A new ruling has told bond investors to file separate cases on each loan they think was misrepresented. No, I am not making that up. From her post:

I did a double take Wednesday, when I noticed a pair of new suits by Lehman Brothers Holdings in federal court in Colorado. The complaints, which are almost identical, claim that the mortgage originator Universal American Mortgage breached representations and warranties about loans it sold to Lehman, which subsequently suffered losses as a result of those breaches. But here’s the thing: Each suit addresses only one supposedly deficient loan! Lehman’s lawyers at Akerman Senterfitt allege that Lehman sustained about $100,000 in damages on one of the loans and $120,000 on the other — numbers that are light years apart from the multibillion-dollar claims we’ve seen from groups of mortgage-backed securities investors who band together to assert contract breaches in thousands of loans at a time.

The Lehman complaints each also contained a curious paragraph, noting that the claims at issue were previously asserted as counts in an eight-loan put-back case Lehman was litigating in federal court in Miami. The judge in that case, Lehman said, had decided after a pretrial conference last week that “each loan must be filed separately, rather than joined within one action.”

That notation sent me to the docket in the Florida case, and to the order entered by U.S. District Judge James King on Jan. 9. It’s true: King ruled that every allegedly deficient loan has to be addressed in its own suit, not in a block case. “The lack of commonality among the various factual circumstances pertinent to each of the eight individual loans makes them all but impossible to be adjudicated together,” King wrote. “That lack of commonality flows from, among other things, the facts that each of these loans was made at a different time, to different borrowers, in different locations involving different purchases of different real properties; most fundamentally, each loan requires separate proof as to whether a breach occurred, what damages, if any, flowed from any such breach, and what the amounts of any such damages are.”

To add insult to injury, the eight loan case was far enough along that it was scheduled to go to trial in March. And even though this conclusion may seem barmy to some readers, it may have precedential value since few investor putback cases have gotten very far:
Universal American’s lawyer, Philip Stein of Bilzin Sumberg Baena Price & Axelrod, told me Wednesday that if other judges

following King’s lead, the ruling could have profound implications for put-back litigation, since it significantly increases the cost of asserting breach-of-contract claims. (Stein also blogged about the order at Bilzin’s Mortgage Crisis Watch site.) Few put-back cases, Stein said, have reached final pretrial conferences, so few judges have considered the kind of commonality challenges he raised back in 2011 in Universal American’smotion to dismiss the Lehman suit. The judge denied the dismissal motion in order to permit discovery, Stein said, but was receptive when Universal American revived its argument at a pretrial hearing on Jan. 4.

If this ruling does establish what Frankel correctly calls “a new paradigm”, you’d need your head examined to ever invest in anything other than government guaranteed mortgage bonds. And of more immediate import, investors who had hoped they would recover some of their losses will find, yet again, that they’ve spent a lot on lawyers to find out that they don’t have much protection under the law.

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Will New Consumer Financial Protection Bureau New Rules for Struggling Homeowner Stop Predatory Servicing?

The Wall Street Journal gives a teaser, in the form of excerpts from a speech to be made later today, on new rules the Consumer Financial Protection Bureau will be implementing to regulate how servicers treat homeowners who become severely delinquent on their mortgages. Unlike past efforts to stop servicer abuses, the CFPB’s new rules will cover all servicers, as opposed to bank-affiliated ones.

On paper, the proposed changes sound like a big step forward:

Under the rules laid out by the agency, lenders would be barred from starting the foreclosure process until borrowers have missed at least four months of payments, a move designed to give borrowers time to submit applications for help. This requirement would end so-called dual-tracking—starting foreclosure if a borrower has applied for help.

They are required to send a written notice to borrowers within 15 days of a second missed payment that includes examples of alternatives to foreclosure and information about housing counseling. Servicers are barred from completing a foreclosure if a borrower submits an application for aid more than 37 days before the home is scheduled to be repossessed.

The consumer regulator will have the power to police whether loan services are following these mandates.

The article noted that both consumer groups and investors wanted even stronger requirements for servicers to offer modifications in particular circumstances.

I’m highly skeptical that these new measures will make much of a difference unless the CFPB has aggressive monitoring and tough penalties, and those details have yet to be released. The sorry history of the servicing industry is, again and again, various servicing standards have been promulgated and are routinely violated, even with consent orders in place. Look at the state/federal mortgage settlement put in place early last year, which also put in place supposedly improved servicing standards, including an end to dual tracking.

Yet dual tracking still lives. As the Huffington Post reported last October:

The five big banks that agreed in a $25 billion mortgage settlement to reform foreclosure practices have continued to “dual-track” homeowners, an abusive technique that pushes families out of homes they thought their bank was trying to help them save, according to a new report by a monitor overseeing the settlement in California.

And if you think that was because banks were having trouble implementing new procedures, think again. Look at this pathetic bleat from the national settlement monitor, Joseph Smith, on January 4 (hat tip Lisa Epstein):

Translation: the banks are still fucking over borrowers, not sure what we’ll do, but we gotta look like we are doing something, so stay tuned!

Why aren’t these bad practices being stopped? As we discussed at depressing length last year (aided by Abigail Field’s close reading of the often mind-numbing exhibits on metrics), the state/federal settlement was a joke, in that its metrics allowed for remarkably high error rates, including an astonishing 1% wrongful foreclosures. Field estimated that had the rules been in place as of 2008, over 33,000 illegal foreclosures would have been deemed tolerable by regulators. Of course, we had more than that, but with even higher error rates allowed in other categories, it’s not hard to imagine that in the rare event a servicer was subjected to close scrutiny, he’d be able to get away with even more wrongful foreclosures by virtue of artful classification of the abuses (ie, if a foreclosure resulted from forced place insurance, the servicer no doubt would argue that the foreclosure would belong in a category relating to excessive fees rather than “wrongful foreclosure”).

And the bigger reason that regulators for now a full decade have had no success in cleaning up the servicing morass is that servicers aren’t paid enough to service delinquent loans well, let alone do loan mods, which requires even more effort and highly skilled staff. The only way for them to earn decent incomes on delinquent borrowers is by collecting more fees on them when they go into the foreclosure process and otherwise ignoring them. On top of that, servicers have terrible software both as a result of antiquated but widely used platforms like LPS’ Desktop Manager, notes passing through multiple servicers as a result of mergers and bankruptcies, and lousy database management and integration. I’ve asked repeatedly why borrower data can’t be ported into new systems, and I’m told by servicing industry insiders is not just a matter difficulties in resolving data field parameters, but that in the older systems, a lot of data is just not there.

So until the industry gets together (and this means, at a minimum, the “sell side” as in the originators, the servicers and investors) and comes up with a new fee structure for servicing, I don’t see how anything changes (I won’t elaborate here, but that would be a massive undertaking, and I’ve not seen this idea floated even as a wild-eyed aspiration). Servicers will abuse customers and argue to regulators that they can’t do better because doing better would lose them boatloads of money, so regulators will continue to enforce only weakly (the threat is they’d abandon the business, although I’m told a servicer can’t abandon its servicing obligation, but I would not underestimate banks trying to argue that parent organizations aren’t liable for the problems in servicing subsidiaries, and if the servicing sub goes broke, no one will take up the servicing rights if all it is is a license to lose money. I’m not sure they will have managed the corporate entities on enough of an arm’s length basis for that legal dog to hunt, but a regulator might also be loath to get into a pigfight that it might lose).

So the test of the effectiveness of these new rules will be whether, when they details are published, they elicit howls of pain from the banking industry, since proper servicing of loans gone bad loses money. If not, rest assured that the most long-suffering borrowers will see is marginal improvement, not badly needed large-scale reforms.

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The Trillion Dollar Trick

The birth, and the apparent death, of the trillion dollar platinum coin idea may one day be recalled as a mere footnote in the current debt crisis drama. The ultimate rejection of the idea (which was to use a loophole in commemorative coinage law to mint a platinum coin of any denomination) by both the President and the Federal Reserve seems to offer some relief that our economic policy is not being run by out-of-touch academics and irresponsible congressmen. In reality, our government has been creating more than one trillion dollars out of thin air every year for the past five. The only difference is that the blatant dishonesty of a trillion-dollar platinum coin is so easy to understand that the public simply couldn't be expected to swallow it.

The American people are more than willing to be fooled, but they won't tolerate so simple a ruse.
People have a long and intimate history with coins. Some of us collected them as kids, and we all touch and see them every day. Unlike currency bills, we know intuitively that a coin's value is supposed to come from its metal content. That's why quarters are bigger than dimes. As a result, most people have viscerally rejected the platinum coin idea. To assign an arbitrary, sky high, valuation to a small piece of metal strikes most people as a deceitful, desperate act. They are right.

However, the same people have no problem with images of thousands of crisp paper notes flying off the printing presses. The acceptance is not impacted by how many zeroes the bills contain. People simply believe that paper money derives value from the numbers, not the paper. This was not always so. Paper money originally entered the public awareness as promissory notes to pay different amounts of gold. Once people got used to the paper, few really cared when the gold backing was finally removed. As a result, the public would likely have been much more accepting of the Fed printing a trillion dollar bill than the government minting a trillion dollar coin. But there was no legal pathway for the Fed to simply give that money to the government.

The government, not the Fed, mints coins, so they did not have to rely on the Fed to create value out of thin air. That is why the platinum coin idea was so seductive, if ultimately unsellable.

But the Fed does the exact same thing all the time using sophisticated accounting and state of the art computing. The Fed "expands its balance sheet" by buying government bonds from private banks. In exchange for these securities, the Fed credits the banks with funds it creates out of thin air. The banks then pass the funds to the general public through loans. But it's important to realize that the Fed does not have any money to actually buy the bonds in the first place. The funds are "created" by a Fed computer. The process is easier (and equally duplicitous) than minting a trillion dollar coin (which at least requires the production of something other than computer code). The only difference is the lack of window dressing. It's a shame that the platinum coin episode did not result in a wider recognition of this brutal truth.

A similarly silly and meaningless distinction is being made with respect to raising the debt ceiling. In his press conference yesterday, President Obama said the Republican reluctance to raise the debt limit was the equivalent of a diner who had ordered and enjoyed a meal who then decides to leave the restaurant without paying the bill. The President is actually arguing that if the diner had no cash on hand, it would be much more responsible to simply use a credit card. In taking this moral high ground, the President ignores the fact that the diner (who has indebted himself through habitual restaurant meals) intends to pay his credit card bill with another card, and then repeat the process until he runs out of cards. So in the end, it's not the restaurateur who gets stiffed, but the issuer of the last card the diner is able to acquire. As with the platinum coin, this is a distinction without a difference.

Currently the Federal Government counts more than $16 trillion in funded obligations. Over the next 10 years we are expected to add another $10 trillion or more. At no point in the foreseeable future are we expected to approach balance in our annual budget. All of our future bills are expected to be paid by future borrowing on a massive scale. Anyone with an ounce of integrity would have to plan for the possibility that an ever-increasing debt rollover is a limited prospect. Such an understanding will mean that eventually someone will get stuck with the bill. How is this any more responsible than dining and ditching?

In truth, a failure to raise the debt ceiling is not a commitment to renege on obligations. It is simply a decision to stop borrowing. The government could still meet obligations by cutting spending, raising taxes, or making reforms to entitlements. But it chooses not to take this difficult step.

More important than that is the message America is sending its creditors. By informing them that the United States will not use its taxing power to repay its debts, but will only rely on its ability to borrow more (ironically from the same creditors), it signals its refusal to tackle our fiscal deficiencies through responsible means. It's a shame that more people can't seem to grasp these very simple truths.

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