Decline of the Empire

Fannie And Freddie? No Resolution In Sight

We recently had some "good" news about losses at mortgage giants Fannie Mae and Freddie Mac.

WASHINGTON (AP) -- Government-controlled mortgage buyers Fannie Mae and Freddie Mac narrowed their losses in the final three months of last year. But they are asking for more money from taxpayers as the real estate market braces for what could be a new wave of mortgage defaults.

Fannie Mae on Thursday posted a loss of $2.1 billion for the October-December quarter, after payment of $2.15 billion in dividends to preferred stock that is mostly owned by the federal government. It has requested an additional $2.6 billion in federal aid, slightly more than the $2.5 billion it sought in the previous quarter.

Freddie Mac managed a $1.7 billion loss for the final quarter of last year, after the payment of $1.6 billion in preferred dividends. It has asked for an additional $500 million in federal aid -- up from the $100 million it sought in the July-September quarter of 2010.

All told, the government estimates that total mortgage agency losses will be $259 billion. In the two years 2009 and 2010, Fannie and Freddie lost $141.6 billion. What's going to happen next?

"The good news is that their losses are shrinking," said Anthony Sanders, a professor of real estate finance at George Mason University in Fairfax, Va.

The bad news? "This is just the calm before the storm. ... They're going to be hit with some staggering losses," Sanders said.

The continuing erosion of the housing market, and a coming wave of foreclosures that had been put on hold because of widespread problems with lenders' documents, could bring significant losses for Fannie and Freddie in the near future, Sanders said.

That could help explain why the companies asked for more federal aid even as their losses shrank. Sanders suggested that they could be seeking the help in anticipation of future travails, knowing "what's around the corner."

Well — that doesn't sound good! You will recall that the Obama administration has backstopped all Fannie and Freddie losses through the 4^th quarter of 2012. Conveniently enough, those working for the O-Man  will likely be leaving public service at the beginning of 2013.

The current administration recently put forward a set of proposals trial balloons for restructuring the housing market and phasing out Fannie and Freddie. Here's all you really need to know—

Administration officials said the process of transitioning to a post-Fannie and Freddie world would take at least five to seven years, in part because the housing market remains too fragile. Many analysts say the process, which includes dismantling, moving, or reassembling the firms' infrastructure, could take even longer.

The long-awaited proposal was thin on specifics about what would replace Fannie and Freddie, which the government took over in 2008, and which have racked up $134 billion $141.6 billion in taxpayer losses. Instead, it outlined three options that were designed to frame what promises to be a prolonged and heated political debate over how to structure the nation's $10.6 trillion mortgage market.

As with every other large problem facing the Empire, there is no resolution in sight for restructuring the housing market. This seems like a good time to trot out America's Wheel of Suffering.

 As problems become more intractable over time, our resistance to making real changes to confront those problems, our social inertia, becomes more entrenched. Thus the problems get worse, and nothing is ever resolved. Around and around it goes, and where it stops nobody knows.

What did Talking Heads say? Same as it ever was...

 

On Wall Street, Nobody Goes To Jail

Signs that the Empire is in decline are everywhere you look, but you won't find anybody on Wall Street or Washington who will acknowledge it. Nor will you find such admissions among people with a vested interest in the status quo. If you visit the offices of the New York Times, don't expect to find many people who are willing to say the United States is going down the tubes.

But Matt Taibbi doesn't work for the New York Times, where he would definitely not be welcome. He works for Rolling Stone, an outcast in a cultural ghetto where he can be ignored by the Powers That Be. His latest question is Why Isn't Wall Street In Jail? That's an excellent question. On Wall Street, nobody goes to jail. Not a single Master of the Universe has been put in prison, yet that would be highly effective in deterring fraud.

To understand the significance of this, one has to think carefully about the efficacy of fines as a punishment for a defendant pool that includes the richest people on earth — people who simply get their companies to pay their fines for them. Conversely, one has to consider the powerful deterrent to further wrongdoing that the state is missing by not introducing this particular class of people to the experience of incarceration. "You put Lloyd Blankfein in pound-me-in-the-ass prison for one six-month term, and all this bullshit would stop, all over Wall Street," says a former congressional aide. "That's all it would take. Just once."

But that hasn't happened. Because the entire system set up to monitor and regulate Wall Street is fucked up.

How fucked up is it? Taibbi asked Lynn Turner.

The systematic lack of regulation has left even the country's top regulators frustrated. Lynn Turner, a former chief accountant for the SEC, laughs darkly at the idea that the criminal justice system is broken when it comes to Wall Street. "I think you've got a wrong assumption — that we even have a law-enforcement agency when it comes to Wall Street," he says.

In short, the regulators and the regulated have formed a cozy club. They all know each other on a first-name basis, and there is a revolving door—one week you're a regulator, but next month you might be one of the regulated, or vice versa. Taibbi tells a typical story to illustrate how non-regulation works.

The pattern of inaction toward shady deals on Wall Street grew worse and worse after Lynn Turner left, with one slam-dunk case after another either languishing for years or disappearing altogether. Perhaps the most notorious example involved Gary Aguirre, an SEC investigator who was literally fired after he questioned the agency's failure to pursue an insider-trading case against John Mack [left], now the chairman of Morgan Stanley and one of America's most powerful bankers.

Aguirre joined the SEC in September 2004. Two days into his career as a financial investigator, he was asked to look into an insider-trading complaint against a hedge-fund megastar named Art Samberg. One day, with no advance research or discussion, Samberg had suddenly started buying up huge quantities of shares in a firm called Heller Financial. "It was as if Art Samberg woke up one morning and a voice from the heavens told him to start buying Heller," Aguirre recalls. "And he wasn't just buying shares — there were some days when he was trying to buy three times as many shares as were being traded that day." A few weeks later, Heller was bought by General Electric — and Samberg pocketed $18 million.

After some digging, Aguirre found himself focusing on one suspect as the likely source who had tipped Samberg off: John Mack, a close friend of Samberg's who had just stepped down as president of Morgan Stanley. At the time, Mack had been on Samberg's case to cut him into a deal involving a spinoff of the tech company Lucent — an investment that stood to make Mack a lot of money. "Mack is busting my chops" to give him a piece of the action, Samberg told an employee in an e-mail.

A week later, Mack flew to Switzerland to interview for a top job at Credit Suisse First Boston. Among the investment bank's clients, as it happened, was a firm called Heller Financial. We don't know for sure what Mack learned on his Swiss trip; years later, Mack would claim that he had thrown away his notes about the meetings. But we do know that as soon as Mack returned from the trip, on a Friday, he called up his buddy Samberg. The very next morning, Mack was cut into the Lucent deal — a favor that netted him more than $10 million. And as soon as the market reopened after the weekend, Samberg started buying every Heller share in sight, right before it was snapped up by GE — a suspiciously timed move that earned him the equivalent of Derek Jeter's annual salary for just a few minutes of work.

The deal looked like a classic case of insider trading. But in the summer of 2005, when Aguirre told his boss he planned to interview Mack, things started getting weird. His boss told him the case wasn't likely to fly, explaining that Mack had "powerful political connections." (The investment banker had been a fundraising "Ranger" for George Bush in 2004, and would go on to be a key backer of Hillary Clinton in 2008.)

Aguirre also started to feel pressure from Morgan Stanley, which was in the process of trying to rehire Mack as CEO. At first, Aguirre was contacted by the bank's regulatory liaison, Eric Dinallo, a former top aide to Eliot Spitzer. But it didn't take long for Morgan Stanley to work its way up the SEC chain of command. Within three days, another of the firm's lawyers, Mary Jo White, was on the phone with the SEC's director of enforcement. In a shocking move that was later singled out by Senate investigators, the director actually appeared to reassure White, dismissing the case against Mack as "smoke" rather than "fire." White, incidentally, was herself the former U.S. attorney of the Southern District of New York — one of the top cops on Wall Street.

Pause for a minute to take this in. Aguirre, an SEC foot soldier, is trying to interview a major Wall Street executive — not handcuff the guy or impound his yacht, mind you, just talk to him. In the course of doing so, he finds out that his target's firm is being represented not only by Eliot Spitzer's former top aide, but by the former U.S. attorney overseeing Wall Street, who is going four levels over his head to speak directly to the chief of the SEC's enforcement division — not Aguirre's boss, but his boss's boss's boss's boss. Mack himself, meanwhile, was being represented by Gary Lynch, a former SEC director of enforcement.

Aguirre didn't stand a chance. A month after he complained to his supervisors that he was being blocked from interviewing Mack, he was summarily fired, without notice. The case against Mack was immediately dropped: all depositions canceled, no further subpoenas issued. "It all happened so fast, I needed a seat belt," recalls Aguirre, who had just received a stellar performance review from his bosses. The SEC eventually paid Aguirre a settlement of $755,000 for wrongful dismissal.

Rather than going after Mack, the SEC started looking for someone else to blame for tipping off Samberg. (It was, Aguirre quips, "O.J.'s search for the real killers.") It wasn't until a year later that the agency finally got around to interviewing Mack, who denied any wrongdoing. The four-hour deposition took place on August 1st, 2006 — just days after the five-year statute of limitations on insider trading had expired in the case.

It's damn near impossible to make this kind of stuff up. What did Senate investigators conclude about the case?

"At best, the picture shows extraordinarily lax enforcement by the SEC," Senate investigators would later conclude. "At worse, the picture is colored with overtones of a possible cover-up."

Covered with overtones of a possible cover up? That seems to understate the problem, don't you think?

I was going to write that we have two criminal justice systems in the United States, one for Them and one for Us. But that's all wrong! There is only one criminal justice system in the United States—one for Us.

I urge you to read Taibbi's long article, which is rich in juicy details. But let us stand back for a moment and think about this. Even without the damning details, the mere fact that nobody on Wall Street has gone to jail tells us that the fix is in. I often write about corruption on this blog, but my focus has always been on the Congress and campaign contributions.

Taibbi has done us an enormous service by exposing the corruption among regulators like those in Securities And Exchange Commission (SEC). Think about the implications of this. For example, the corrupt Congress passed a financial "reform" bill recently. This bill passed a large part of the burden for making the rules governing the banks onto the regulators. But the regulators are corrupt, too! The whole situation is utterly hopeless. It can't be fixed. There is no one left for us to turn to.

Corruption has always existed in this country and all other countries, but it is a matter of degree. As the Empire declines, the simple rule "I'll scratch your back and you scratch mine" becomes the normal way of operating, not just an occasional problem. The line between the Good Guys and the Bad Guys is not just blurred, it has disappeared altogether. The revolving door becomes the rule, not the exception.

Don't hold your breath waiting for the New York Times to get the message.

Bonus Video — Watch Amy Goodman's interview with Matt Taibbi. Remember as you watch it that there's nothing to be done about any of this.

Remedy du Jour -- February 26, 2011

Today we have a tribute to Stanley Kubrick, with clips from his films in this order: Dr. Strangelove, The Shining, Full Metal Jacket, and 2001: A Space Odyssey. Enjoy.

 

 

 

 

Saturday Oil Report -- February 26, 2011

The international oil markets are in disarray following the revolt in Libya, where the oil-rich eastern half of the country is in the hands of rebels trying to overthrow the crazy Colonel Muammar Gaddafi. The Nymex front-month price settled at $97.88, but is up to $98.23 in afterhours trading. Nymex WTI stands alone below $100/barrel. Brent sells for $112.39, Bonny Light (Nigeria) is at $115.04, and so on. It's time to raise the alarm level (green, yellow, orange, red).

Oil Alarm Level — Red

Earlier this week, I wrote Oil And The Revolt In Libya — What If? I am not going to rehash that material, so read it separately for background.

Here is the situation as I understand it from current reports. Estimates for the daily flows of crude currently shut-in range from 500,000-700,000 barrels (IEA, Goldman Sachs) to 1 million barrels (Barclays) to 1.2 million barrels (Paolo Scaroni, Eni SPA chief executive officer) as reported in the Oil & Gas Journal. This information is a day or two old, and various operators (Repsol, Inpex, Total, CNPC, etc.) are still evacuating their workers from troubled areas. If the higher estimates overstate the situation now, they'll surely be accurate after this weekend.

Saudi Arabia has reportedly raised production by 700,000 barrels per day to meet the crisis.

The International Energy Agency confirmed on Friday that Saudi Arabia was stepping in to cover the fact that many platforms producing high-grade oil from Libya have been completely shut down because of the unrest.

A source told Reuters that the Saudi state oil company increased its production to more than 9 million barrels per day – a rise of more than 700,000 barrels.

The worsening situation in Libya has seen about 1.2 million barrels of production out of Libya's 1.6 million barrels daily output lost.

European refineries have been particularly worried about a shortage of high-grade crude, of which Libya is a key supplier...

IEA figures show that Saudi Arabia has 3.5 million barrels a day of spare capacity, while the United Arab Emirates could add 330,000 barrels, Qatar could put on 180,000, and Kuwait 230,000. While not all of this would be likely to come on stream at once, Middle East production is still 1.7 million barrels per day lower than it was at the height oil price spike in mid-2008.

The IEA says Saudi Arabia has 3.5 million barrels of spare capacity, but an anonymous Saudi source puts the number lower.

A Saudi oil ministry official said the kingdom, in coordination with OPEC members, was ready to cover cuts from Libya. "We have a surplus of 2.5 million barrels a day," the official said on condition of anonymity in line with regulations.

I am not going to argue about Saudi spare capacity today—this is a lot like Thomas Aquinas arguing about how many angels can dance on the point of a needle. The "point" right now is that the Saudis have got plenty of spare capacity at the moment, but raising output 700,000 barrels is probably not enough to replace all the lost Libyan crude in the international markets. And to those like economist Jeff Rubin (or Kevin Drum) who claim that the Saudis do not have any spare capacity, I suggest that you stop trying to sell your book and try growing up.

As James Hamilton observes, the Libyan shortfall is relatively small as supply shocks go. As long as any further geopolitical contagion is contained, that will remain true. However, the national average gasoline price is now $3.333 per gallon, and prices won't be going down anytime soon. Gas at these prices in February makes one wonder what gas might cost in May. In any case, these high gas prices are bound to curtail spending on other goods & services (like rent or food) in poor and lower middle-income households.

The longer prices remain elevated, the greater the impact on households will be. Various economists have argued that the current price spike is not much of shock to households because their models tell them that relative to the 2008 price shock, the current rise is small potatoes. Here's Hamilton—

Next let's take a look at the likely economic consequences for the U.S. Americans consume about 140 billion gallons of gasoline each year. I use the rough rule of thumb that a $10/barrel increase in the price of crude oil translates into a 25 cents per gallon increase in the price consumers will eventually pay for gasoline at the pump. Thus $10 more per barrel for crude will leave consumers with about $35 billion less to spend each year on other items, consistent with a decline in consumption spending on the order of 0.2% of GDP in a $15 trillion economy. The recent turmoil in North Africa has been associated with perhaps a $20/barrel increase in the price of crude and so might be expected to shave half a percent off GDP from this rough calculation...

Having recently seen $4 gasoline, I don't think creeping back above $3 has the same psychological shock value. That suggests to me that the erosion of consumer confidence should be less severe. The gains in employment that I believe are underway are another important offsetting plus in terms of what's going to happen to consumer sentiment.

The particular dynamic model from which the above Brookings figure came builds in quite strong nonlinearities and threshold effects. Interestingly, according to that specification, one wouldn't begin to anticipate significant effects on U.S. GDP until the price of oil got above about $130 a barrel, or until the second half of this year. Prior to that, according to that specification, we're still ok.

I don't want to make too strong a claim about those particular details. It's very hard to claim precise statistical evidence in support of one choice of a threshold over another. But, this particular model has held up fairly well since its original publication in 2003. So I'm not about to abandon it just yet.

My bottom line is that events as they have unfolded so far are not in the same ballpark as the major historical oil supply disruptions, and are unlikely to produce big enough economic multipliers that they could precipitate a new economic downturn. 4

They might shave a half percent off annual GDP growth, but I don't anticipate a whole lot worse than that.

What a crock! The 77% of Americans living paycheck-to-paycheck and the 29% who find it difficult to afford food will no doubt be comforted that Hamilton's model says we're all "ok" so far. One really does wonder why the outcomes such models are meant to capture are important to anyone other than their creators or government propagandists extolling the virtues of GDP growth. These absurdities arise when one talks about "the economy" as a monolithic entity instead of acknowledging that America has two economies, one where the well-off or rich folks reside, and another where everyone else tries to eke out a living.

My next Saturday oil report is due in two weeks. Lots can happen between now and then. There's no way of knowing how events will unfold. Since the current oil price is always the best predictor of the future oil price in the very short-term, I predict that Nymex WTI will be priced in the $95-$100 range on March 12^th.

The Propaganda Blitz Continues

I initially warned you about a propaganda blitz coming from government officials and our co-opted media in The Coming Propaganda Blitz (December 27, 2010). Yesterday afforded us an excellent example of how this campaign works. Bloomberg duly reported on the remarks of Treasury Secretary Timothy Geithner during a Bloomberg Breakfast with reporters in Washington.

The U.S. financial system is in better shape than it was before the recession and is well placed to provide the funding needed for the economic expansion, Treasury Secretary Timothy F. Geithner said.

“The core of the American financial system is in a much stronger position than it was before the crisis,” Geithner said today during a Bloomberg Breakfast with reporters in Washington.

U.S. banks had net income of $87.5 billion in 2010, the highest since 2007, the Federal Deposit Insurance Corp. said today. The Standard & Poor’s 500 index has jumped 64 percent since March 2009, and corporate bond spreads have narrowed.

“We can say with much more confidence now that the U.S. banking system and the U.S. capital market are much more likely to be in a position to finance the capital needs that come with a recovery,” Geithner said.

The world’s largest economy is projected to grow 3.2 percent in 2011, the most since 2004, according to the median forecast of 61 economists surveyed by Bloomberg from Feb. 2 to Feb. 8

As Henry Blodget and Aaron Task point out in the Tech Ticker video below, every policy the Obama administration pushed over the last 2 years was designed to throw money at the the banking system. Now that the banks are fat again, it's time for over-leveraged American "consumers" and small businesses to line up for new loans so they can get even deeper in debt. Of course, they can't get those loans because credit is tighter than George Will's asshole, or they don't qualify for credit because they've got too little income or too much debt already.

And with home prices plunging again, now is an especially good time to burden yourself with a long-term mortgage. As you sign on the dotted line—let's assume a miracle occurred and you were able to get a loan—you might also ask yourself whether those massive interest payments will be tax deductible in the future.

This would be a good time for you to read Inequality, Debt And The Financial Crisis if you have not already done so. Or even you have. And what about those soaring oil prices? Not to worry!

Geithner played down concerns that the surge in oil prices will derail the U.S. recovery. “By almost any measure you look at, the economy is gradually getting stronger,” he said.

Crude for April delivery traded up 2.8 percent to settle at $98.10 a barrel on the New York Mercantile Exchange as Libya's uprising threatened to disrupt oil exports. Earlier, it touched $100, the highest level since Oct. 2, 2008. Futures are up 24 percent from a year ago.

But never mind those seventeen insurmountable crises besetting the Empire. All is well because the financial system is stronger than ever before, according to our estimable Secretary of the Treasury. But perhaps we shouldn't blame this mediocre, brown-nosing servant of Big Finance for the sorry state of the economy. As head of the New York Fed, perhaps he just forgot to regulate those Wall Street Banks.

Perhaps the man who appointed him should shoulder the blame—Mr. Change We Can Believe In.

Here's the video.

 

Watching America's Decline In Real-Time

I often ridicule garden-variety economists and government functionaries, as I did yesterday regarding the CBO's job and economic growth fantasies. I do so because knee-jerk optimism does not help us face the future. Motives vary in these cases, but all such talk has a common theme: the world has changed—not for the better—and these pollyannas have failed to recognize it, preferring to talk about "business cycles" and other nonsense. In these times, complacency is a recipe for disaster.

The Nymex front-month price rose above $101/barrel yesterday, and it may be a very long time before we see prices back in the $80s. Brent hit $115, and prices are comparable in the other international markets. If one looks on the surface, as most people do, it's easy to blame these high oil prices on unexpected geopolitical shocks—Nassim Taleb called such events black swans. Beneath the surface, the world oil market has been anything but stable for several years now, so there was always a considerable risk that random events could create the situation we see today. Taleb's point was that such risks have been grossly underestimated in today's complex, fragile financial and commodity markets.

If prices remain high for an extended period, and there is a good chance they will, we may see another "official" recession in the United States later this year. Lacking that—entitlements and government transfer payments inflate GDP numbers—we will have a large slowdown in an already anemic economy. I will talk about the oil markets at greater length in this coming Saturday's oil report.

Today I want to focus on the housing market. Unlike the oil market, where prices are going up, house prices are crashing, which is a devastating development for millions of American households. As with oil, this market has been anything but stable for a long time now, and a "double-dip" in housing was predictable because the fundamentals in the market are worse, not better, than they were before the financial meltdown.

Robert Shiller of the famous Case-Shiller Home Price Index (below) now believes another big swoon in house prices is possible—

At this dismal point, some economists and analysts say that the damage has been done, and there is nowhere to go but up. Many others argue that the market has still not finished falling.

And then there are those who maintain that, possibly, things are about to get a whole lot worse. Robert Shiller, the Yale economist who is the author of “Irrational Exuberance” and who helped develop the Standard & Poor's/Case-Shiller Home Price Index, put himself in this last group. Mr. Shiller said in a conference call on Tuesday that he saw “a substantial risk” of the market falling another 15, 20 or even 25 percent.

Graph from Tim Iacono

Even now, after five straight months of declines in the Case-Shiller, there are economists and analysts who think there is nowhere to go but up. It is a matter of paying attention to Reality, as opposed to cheerleading and wishful thinking. So many people simply can not bring themselves to acknowledge just how screwed up things are.

In so far as realists in the general case are few and far between, I always ascribe unwarranted, delusional optimism to Human Nature. Sometimes that light at the end of the tunnel is the headlight of an oncoming train hurtling right toward you. This is one of those times.

I found out that Hyperion Group's Lew Ranieri is not one of these delusional optimists. I recommend you watch the video below if you want to understand the problems the housing market faces, and where house prices are likely to go. Listening to Lew, it is easy to see why Robert Shiller thinks house prices may fall another 15, 20 or even 25 percent.

We've had some good news recently. Unemployment claims dropped for the third consecutive week. But even if we're having a tepid recovery in the part-time jobs market, how long can it last? The headwinds in energy and housing—just to name two ongoing diasters—make any such recovery very fragile indeed. These days, as I read the various reports pouring in every day, it feels like I'm watching the Empire decline in real-time.

Here's Lew Ranieri on the state of the housing market.

 

The CBO's Budget Fantasies

By now everybody knows the size of America's public debt—it's really, really Big—and perhaps you also know that the 2011 deficit is expected to come in at 1.5 trillion dollars (1,500,000,000,000). Obama's proposed budget, if passed intact, would create a deficit of $1.6 trillion in fiscal year 2012.

That's hardly likely in the current political atmosphere. Among other significant money savers, cutting heating subsidies for the poor and taking Sesame Street off the air will surely allow the Congress to pare down the 2012 deficit to $1,553,000,000,000 and pocket change.

I don't know about you, but I'm feeling much better already knowing Big Bird won't be out there poisoning impressionable young minds. This belt-tightening stuff is intoxicating. It's a lot like sniffing glue, and not just any old glue—I'm talking about the good stuff!

I thought it might be entertaining to cruise over to the non-partisan Congressional Budget Office (CBO) to see what they have to say about current and future deficits. It turns out the CBO has been sniffing glue, too.

Here's the only graph in the The Budget And Economic Outlook: Fiscal Years 2011 To 2021.

The alert reader will immediately see that Federal revenues soar toward the heavens just like a big Atlas rocket starting in 2012. Up and up they go, way beyond average revenues during the 1971-2010 period. Clearly, the CBO expects the economy to rebound in a big way over the next decade.

As the recovery continues, the economy will add roughly 2.5 million jobs per year over the 2011–2016 period, CBO estimates. However, even with significant increases in the number of jobs, a substantial reduction in the unemployment rate will take some time. CBO projects that the unemployment rate will gradually fall in the near term, to 9.2 percent in the fourth quarter of 2011, 8.2 percent in the fourth quarter of 2012, and 7.4 percent at the end of 2013. Only by 2016, in CBO’s forecast, does it reach 5.3 percent, close to the agency’s estimate of the natural rate of unemployment (the rate of unemployment arising from all sources except fluctuations in aggregate demand, which CBO now estimates to be 5.2 percent).

Source The unemployment rate falls from 8.2% in 2012 to 5.3% in 2016

To inflate Federal revenues into outer space after 2012, those new jobs we're going to create can't be like those part-time crappy jobs serving caffè lattes and cleaning up hotel rooms we've been creating up to now. No siree! They're going to be high-paying, high-status jobs that make life worth living. But that is all I can tell you about it at the moment, because I have no idea where those jobs are going to come from, and neither does the Congressional Budget Office.

Now, if we turn back to the first graph, we see that Federal outlays come down some after 2012, but remain elevated (at about 23-24% of GDP) from 2013 until 2021. Outlays continue to be far above the 1971-2010 average.

I am only a humble blogger, a person of little knowledge, even less acuity, and no insight at all. Dare I inquire about, dare I question, the CBO assumptions? Yes, Yes, Yes! I'm going to go for it—

What if those terrific jobs and that miraculous GDP growth don't materialize?

Oh, my! What if the future isn't so bright? Such a dark thought. That certainly would open up a can of worms, wouldn't it? For instance, most Americans won't be able to afford to drive to work by 2021, and will have no other way of getting there. But why quibble?

To give you some idea of what the near-term future looks like, let's consult USA Today's Obama's budget: Tax revenue rising, deficit declining from January 7, 2010.

Americans are paying more taxes, a sure sign of economic recovery — and one that has the federal budget deficit declining ever so slightly.

That's the word from the non-partisan Congressional Budget Office (CBO), which just released its review of the first quarter of fiscal year 2011, which began in October.

The good news: Revenue increased 9% from the same period a year ago, while spending grew only 3%. That translated into a $371 billion deficit for three months, $18 billion less than in October-December 2009.

Biggest reason for the improvement: a $33 billion increase in taxes withheld "as a result of strengthening economic conditions," the CBO says.

Strengthening economic conditions? Clearly, the well-off are making more money and paying more taxes. Love it, love it, love it! But why the paltry decrease in the deficit in the last quarter of 2010?

Biggest reason for only a small improvement: interest payments on the national debt, [which is] fast approaching $14 trillion, rose 10%, while defense spending was up 7%, mostly for procurement as well as operations and maintenance.

In addition, spending for Medicaid rose 13%, but unemployment benefits declined by 15% because of fewer new claims and lower average benefits.

Revenues were up 9% year-over-year on a quarterly basis, but increased spending on interest on the debt, defense, and health care meant that the resulting savings was a whopping $18 billion dollars.

I love budget economics, and I hope you share my enthusiasm. I mean, don't you find it liberating, don't you find it exhilirating, to be so completely, unalterably screwed?

Oil And The Revolt In Libya — What If?

Libya is one of the smaller oil exporters in OPEC. They were producing 1.65 million barrels per day in 2010 (through October) according to EIA data. However, the very serious political upheaval in this North African country poses a genuine threat to that production.

NEW YORK (CNNMoney) -- Libya is the first oil exporting nation to be engulfed in the political upheaval spreading across North Africa and the Middle East, and investors are worried that further chaos in the region will drive crude prices even higher.

U.S. oil prices surged 6% Monday following violent protests in Tripoli, Libya's capital, that claimed an estimated 200 lives over the weekend. The unrest is part of a wave of antigovernment protests that started in Tunisia earlier this year and spread to Egypt and other nations in the region.

Unlike in Egypt, where the revolt seemed almost orderly and never exhibited this level of violence, the situation in Libya could quickly escalate out of control. I take it seriously and suggest you do the same.

Let's look at a worst case scenario in Libya, ignoring for the moment the contagion that might spill over from Bahrain into eastern Saudi Arabia among the Shia' populations there. Let's assume Libya's oil output has been reduced to zero. What would happen? From the CNNMoney article—

"Although Libya is an OPEC member, it is still a relatively small player," said Julian Jessop, an economist at Capital Economics. Libya, he added, ranks ninth on the list of output among the 12 members of the Organization of Petroleum Exporting Countries.

"In principle, any shortfall on global markets could easily be offset by an increase in output from Saudi Arabia," he said, adding that the OPEC leader is currently producing 3 million barrels per day less than its estimated capacity.

Jessop said the rise in oil prices since last summer has been driven largely by increasing global demand, rather than political tensions or potential supply problems.

And from the Wall Street Journal's Libyan Unrest Gets Oil Market's Attention—

World oil markets have sufficient stocks and spare capacity to absorb even a full loss of Libyan output. The country's oil production of 1.58 million barrels per day in January makes it the seventh-largest producer in the Organization of Petroleum Exporting Countries, but Saudi Arabia alone had 3.5 million barrels per day of spare capacity last month; any Libyan shortfalls could be comfortably covered. So far, the International Energy Agency reports output of only 50,000 barrels of oil per day has been suspended in Libya.

So there's your standard answer: the world's swing producer Saudi Arabia will seamlessly replace lost oil from Libya. According to the JODI data, Saudi Arabia produced 8.37 million barrels per day in December, 2010.

(Bloomberg, February 19, 2011) -- Saudi Arabia’s exports fell to 6.05 million barrels a day in December from 6.36 million in November even as Saudi production rose to a two-year high of 8.37 million barrels a day, JODI said.

“This is a huge difference,” said John Sfakianakis, Chief Economist at Riyadh-based Banque Saudi Fransi, noting the 2.32 million barrel per day difference between what Saudi Arabia produced and its exports.

“It’s not clear if Saudi Arabia consumed the full 2.32 million barrels locally during that month, but what’s clear is that rise in local consumption is becoming eminent,” he said.

Let's not worry for the moment about Saudi Arabia's growing internal consumption eating into its export capacity, although that's a very worrisome longer term issue. Any new oil the Saudis produce now will be available for export. In my February 12 Saturday oil report I noted that OPEC had recently raised its total production by 400,000 barrels per day. Most of that had to come from Saudi Arabia, so let's set the Kingdom's current crude output at 8.67 million barrels per day.

Libya produced 1.58 million barrels per day in January according the Wall Street Journal report. If their output falls to zero, Saudi Arabia must produce 10.25 million barrels per day to completely cover the loss. I have no doubt that the Saudis can produce that much, but will they? The historical fact of the matter is that—

Saudi Arabia has not produced 10 million barrels per day since the early 1980s*

* look at this EIA data set

This all may sound farfetched to you, and perhaps it is. If not next week or next month, there will come a day in the medium-term when the Kingdom will be called upon to produce 10 million barrels per day or more. I pointed out the obvious dangers of the Saudis having almost all of the world's spare production capacity in my post Peak Oil—Where Do We Stand?

Apparently, the concerns I voiced about whether the giant Khurais field could produce 1.2 million barrels per day in a pinch have been assuaged, if Trade Arabia's Khurais pumps around 1 mbpd can be believed. I have no reason to doubt this report. The story sounds convincing.

However, we are still left with a big unanswered question: when the world needs Saudi Arabia to pump 10 million barrels of crude oil day in and day out, will they answer the call? Or will they let the oil price rise and rise as they did in 2007-2008 when the Kingdom's vaunted spare capacity failed to rescue us? Even if we don't get the answer next week or next month, we will surely know the answer by 2013.

If Libya falls apart, and Saudi Arabia does not step up to the plate, the next oil price shock will begin now, not in 2013 ± 1 year according to my latest forecast. That is the real geopolitical significance of the revolt in Libya.

Bonus Video on contagion in the Middle East

 

Inequality, Debt And The Financial Crisis

A remarkable IMF Working Paper has come to my attention which should be Front Page News all across America (hat tip, Kevin Drum). Published in November, 2010, the paper is entitled Inequality, Leverage And Crises, and was written by two IMF economists Michael Kumhof and Romain Rancière. I first broached this subject explicitly in a recent post Part Of The Truth Is Better Than None At All. Rather than sum up the IMF paper, I will quote extensively from the introduction and conclusion of the paper, adding emphasis and making comments where appropriate.

I want you to read the easy parts of this study so you will understand how income inequality, debt and the financial meltdown are all linked together. In my view, if you understand these issues, you will also broadly understand what happened to our economy over the last 30 years, what happened to working people in the United States, and why the Empire is in decline. I've included some graphs from the paper in the text below.

The United States experienced two major economic crises over the past century—the Great Depression starting in 1929 and the Great Recession starting in 2007. Both were preceded by a sharp increase in income and wealth inequality, and by a similarly sharp increase in debt-to-income ratios among lower- and middle-income households. When those debt-to-income ratios started to be perceived as unsustainable, it became a trigger for the crisis.

In this paper, we first document these facts, and then present a dynamic stochastic general equilibrium model in which a crisis driven by income inequality can arise endogenously. The crisis is the ultimate result, after a period of decades, of a shock to the relative bargaining powers over income of two groups of households, investors who account for 5% of the population, and whose bargaining power increases, and workers who account for 95% of the population.

The model is kept as simple as possible in order to allow for a clear understanding of the mechanisms at work. The key mechanism is that investors use part of their increased income to purchase additional financial assets backed by loans to workers.

By doing so, they allow workers to limit their drop in consumption following their loss of income, but the large and highly persistent rise of workers’ debt-to-income ratios generates financial fragility which eventually can lead to a financial crisis.

Prior to the crisis, increased saving at the top and increased borrowing at the bottom results in consumption inequality increasing significantly less than income inequality. Saving and borrowing patterns of both groups create an increased need for financial services and intermediation. As a consequence the size of the financial sector, as measured by the ratio of banks’ liabilities to GDP, increases. [graph below]

The crisis is characterized by large-scale household debt defaults and an abrupt output contraction as in the 2007 U.S. financial crisis. Because crises are costly, redistribution policies that prevent excessive household indebtedness and reduce crisis-risk ex-ante can be more desirable from a macroeconomic stabilization point of view than ex-post policies such as bailouts or debt restructurings.

I hope things are clear so far, but I want you to pay particular attention to what the authors just said. Crises are costly, as we have found out to our regret, but redistribution policies that prevent excessive household indebtedness and reduce post-crisis risks can be more desirable than bailouts or debt restructurings. And what was the political response to the financial meltdown? Bank bailouts and debt restructuring programs initiated by the Obama administration.

The bailouts succeeded spectacularly—the too-big-to-fail banks are doing just fine—while the mortgage modification programs failed miserably. Thus we have basically returned to where we were before the crisis, with an even bigger, politically powerful financial sector and a mountain of household debt.

To our knowledge, our framework is the first to provide an internally consistent mechanism linking the empirically observed rise in income inequality between high income households and poor to middle income households, the increase in household debt-to-income ratios among the latter group, and the risk of a financial crisis.

It is simply astonishing that economists had not done a formal study of the common sense contained in this paper. Still, there has been some related discussion.

While not formally modeled there, the link between income inequality, household indebtedness and crises has been recently discussed in opinion editorials by Paul Krugman, and in books by Rajan (2010) and Reich (2010). Both authors suggest that increases in borrowing have been a way for the poor and the middle-class to maintain or increase their level of consumption at times when their real earnings were stalling. But these authors do not make a formally consistent case for that argument. Our model allows us to do so.

There are of course other candidate explanations for the origins of the 2007 crisis, and many have stressed the roles of excessive financial liberalization and of asset price bubbles. Typically these factors are found to have been important in the final years preceding the crisis, when debt-to-income ratios increased more steeply than before. But it can also be argued, as done in Rajan (2010), that much of this was simply a manifestation of an underlying and longer-term dynamics driven by income inequality.

Rajan’s argument is that growing income inequality created political pressure, not to reverse that inequality, but instead to encourage easy credit to keep demand and job creation robust despite stagnating incomes.

Rajan, R. (2010), Fault Lines: How Hidden Fractures Still Threaten the World Economy, Princeton: Princeton University Press.

Reich, R. (2010), Aftershock: The Next Economy and America’s Future, New York: Random
House.

There it is—the Housing Bubble and its collapse depended on underlying and longer-term dynamics driven by income inequalty. This is precisely the position I have staked out on this blog. It is a key to the Empire's decline. I discussed Rajan's work in my Part Of The Truth post, which is linked in above. And now the paper's conclusion—

This paper has presented ... facts and a theoretical framework that explore the nexus between increases in the income advantage enjoyed by high income households, higher debt leverage among poor and middle income households, and vulnerability to financial crises. This nexus was prominent prior to both the Great Depression and the recent crisis.

In our model it arises as a result of increases in the bargaining power of high income households. The key mechanism, reflected in a rapid growth in the size of the financial sector, is the recycling of part of the additional income gained by high income households back to the rest of the population by way of loans, thereby allowing the latter to sustain consumption levels, at least for a while.

But without the prospect of a recovery in the incomes of poor and middle income households over a reasonable time horizon, the inevitable result is that loans keep growing, and therefore so does leverage and the probability of a major crisis that, in the real world, typically also has severe implications for the real economy.

More importantly, unless loan defaults in a crisis are extremely large by historical standards, and unless the accompanying real contraction is very small, the effect on leverage and therefore on the probability of a further crisis is quite limited. By contrast, restoration of poor and middle income households’ bargaining power can be very effective, leading to the prospect of a sustained reduction in leverage that should reduce the probability of a further crisis.

As we've seen after the crisis, the "bargaining power" of poor and middle-income households has decreased even further, while the influence of high-income households has surged once again. This is exactly the opposite of what we might have hoped for. Thus the prospects for another crisis, or for a very long continuation of stagnation in the "lesser" of our two economies accompanied by very high underemployment, have been enhanced by the political response to the crisis. But as you all should know by now, our politics is corrupt through and through, with few of our leaders willing to represent the interests of poor and middle-income Americans.

Those of you who have come to know me can be sure that I will refer to this IMF working paper in the future. That's enough to chew on for today.

Failing The Tests Of The 21st Century

Earlier this year, climate scientists measuring the Earth's average surface temperatures found that 2010 was either tied with 2005 as the warmest year in the recent record or the 2nd-warmest year.

Difference in degrees farenheit compared to the 20th-century average:

Rank	Year	Difference (°F) from average
1 (tie)	2005	1.12
1 (tie)	2010	1.12
3	1998	1.08
4 (tie)	2003	1.04
4 (tie)	2002	1.04
6 (tie)	2006	1.01
6 (tie)	2009	1.01
8	2007	0.99
9	2004	0.97
10	2001	0.94
11 (tie)	2008	0.86
11 (tie)	1997	0.86
13	1999	0.76
14	1995	0.74
15	2000	0.7

Source: NOAA's National Climatic Data Center

There is no question that the Earth is warming, especially in the Arctic. But many Americans refuse to accept that the warming is anthropogenic—it is caused by human activities (mostly burning fossil fuels) that release greenhouse gases (CO₂, CH₄, N₂O) into the atmosphere. The science is as clear about this as science ever gets. Multiple lines of evidence point to human activities as the culprit. It is getting to the point where there is nearly an equal probability that these two hypotheses will be overturned—

• gravity as a fundamental force in the Universe, as opposed to some other explanation for why apples fall
• anthropogenic warming, as opposed to some undetected natural variability in the Earth's climate

And yet, Americans continue to believe in the Tooth Fairy. When the Wall Street Journal noted the record warming in 2010, here is how "journalist" Gauam Naik reported it—

The latest findings were seen by some as further evidence of a link between human activities and global warming.

"In my mind, it reinforces the notion that we're seeing a signal from increasing greenhouse-gas emissions," said David Easterling, a NOAA researcher. "If that weren't a fact, we'd see temperatures tapering off and cooling, but we're not seeing that."

Not all scientists agreed. John Christy, a climatologist at the University of Alabama in Huntsville, said natural long-term variability in climate, rather than greenhouse-gas emissions, could play a greater role in warming.

In addition, Dr. Christy said, "If greenhouse gases are causing warming, the climate system is not very sensitive to carbon dioxide because the warming is not very dramatic."

Dr. Christy helped develop a global temperature data set based on satellite measurements going back to 1979. His approach indicates that 1998 was the warmest year.

Dr. Christy noted that despite disagreement about how fast the earth is warming, most scientists agree global temperatures are, indeed, rising...

In July, an international study by 300 scientists concluded that the Earth has been getting warmer over the past 50 years and that the past decade was the warmest on record.

Those conclusions broadly matched the findings of the most recent report by the United Nations' Intergovernmental Panel on Climate Change, published in 2007.

The Wall Street Journal devoted more space to John Christy than to anything else! But John Christy is not an honest man or he's a lousy scientist, or both. And being a devout Christian, he has an axe to grind, at least the way he seems to have figured things out—there is no natural antipathy between religious belief and doing science. If you would like to know why Christy is not a reliable scientific source, read (and follow the links in) Joe Romm's post Should you believe anything John Christy and Roy Spencer say? 

During "Climategate" at the end of 2009, Wolf Blitzer interviewed Christy and NASA GISS researcher Gavin Schmidt (video below) as if they were both experts on climate science, as if they were equally competent to talk about the causes of global warming. On his side, Schmidt had his own climate modeling work, and decades of research by thousands of other scientists working independently all over the world. On his side, Christy had cooked satellite data and Jesus on the Cross.

Tragically, an uninformed layman watching this interview has no way of knowing which of these scientists knows what he is talking about, and which is a biased headcase whose chief talent lies in leading Bible Study groups. And remember, the scientific method is self-correcting. Bad science does not survive for long, especially with a hot-button issue like climate.

Here in America, we are entering a Dark Age, the antithesis of the Enlightment. It will be an Age of Ignorance in which mean or stupid or crazy people reign supreme. One of the first things to go will be any science which inconveniences our unquestioned faith in the possibility of unlimited economic growth, or any science which threatens those with large, entrenched economic interests in the status quo.

The 21st century presents a number of tests for humanity. Will we stem the massive problems attending our attempts to exploit this planet without limit? Will we realize the inherent impossibility of this project? Or will Homo sapiens commit suicide, or destroy its best achievements, as it seems to be doing? In short, are we going to clean up our sorry act?

At least in the United States, the ascendancy of the blissfully ignorant guarantees that humankind will fail the tests of the 21st century. That is our track record so far, and there isn't any reason to believe that some miraculous change in our behavior is coming. The possibility for wisdom and maturity in our species will be gone.

And so by the end of this century, the Earth's climate, oceans, inventory of species, and the rest will in no way resemble what existed during the Holocene—the last 10,000 years—the time which nurtured the birth of agriculture, metallurgy and the long, long climb to where we stand today. So many human beings can not bring themselves to tell their children and grandchildren this:

• The Earth started warming in the late 20th century.
• The science clearly showed that we were causing it.
• We were unwilling to even try to do anything about it—we went into denial instead.
• Sorry about that! Good luck.

And if you doubt this total lack of concern for future generations, consider the public debt burden we have bequeathed to them here in the United States. Or consider the overfishing of the oceans, which virtually guarantees that by 2050 few alive then will ever know what it was like to taste tuna fish or eat a natural shrimp. And so on.

Ultimately, this lack of concern for future generations is rationalized by the absurd belief that human populations and economies will grow and grow without limit. I know what depth psychologists like Sigmund Freud and Carl Jung, or insightful writers like Mark Twain and Kurt Vonnegut, would have called this self-destructive delusion—not to mention many paleontologists, ecosystem scientists and evolutionary biologists. I call it the same thing—a pathology or maladaption on a grand scale which clearly points to an "advanced" primate species without much of a future.

As you watch this video, remember what I told you here.