Both Simon Johnson, in his most recent post at Project Syndicate, from Wednesday, and Paul Krugman, in Friday's NY Times, are telling us the same thing: "The Austerity Delusion" (Krugman) is leading us down "The Road to Fiscal Crisis" (Johnson).
Meanwhile, farther down below, Yves Smith provides us with the skinny on another potential $100- to $200 billion in hidden Wall Street losses and taxpayer bailouts, as the corporate kleptocratic beat goes on.
"Nothing to see here. Move along..."
From Princeton, the Nobel Prize-winning Professor Krugman...
The Austerity Delusion
PAUL KRUGMAN
New York Times
March 25, 2011
Portugal’s government has just fallen in a dispute over austerity proposals. Irish bond yields have topped 10 percent for the first time. And the British government has just marked its economic forecast down and its deficit forecast up.
What do these events have in common? They’re all evidence that slashing spending in the face of high unemployment is a mistake...
Krugman continues on to note that "you're not considered serious in Washington unless you profess allegiance to the same doctrine that’s failing so dismally in Europe."
He asks: "How’s that story working out so far?"
He points to Greece, England and Ireland...
...Just ask the Irish, whose government — having taken on an unsustainable debt burden by trying to bail out runaway banks — tried to reassure markets by imposing savage austerity measures on ordinary citizens. The same people urging spending cuts on America cheered. “Ireland offers an admirable lesson in fiscal responsibility,” declared Alan Reynolds of the Cato Institute, who said that the spending cuts had removed fears over Irish solvency and predicted rapid economic recovery.
That was in June 2009. Since then, the interest rate on Irish debt has doubled; Ireland’s unemployment rate now stands at 13.5 percent...
He closes out his column in today's Times telling us that a truly serious plan for our country would include tax increases and effectively addressing skyrocketing health care costs.
Yes, bailing out "runaway banks", as the Irish are now learning, does nothing but waste limited taxpayer resources. At the end of the day: "The confidence fairy won’t save us from the consequences of our folly."
From M.I.T., author and former International Monetary Fund chief economist Johnson...
The Road to Fiscal Crisis
Simon Johnson
Project Syndicate
March 23, 2011
WASHINGTON, DC – It has become fashionable among Washington insiders – Democrats and Republicans alike – to throw up their hands and say: We ultimately face a major budget crisis in the United States, particularly as rising health-care costs increase the fiscal burden of entitlements like Medicare and Medicaid. But then the same people typically smile and point out that investors from other parts of the world still want to lend the US vast amounts of money, keeping long-term interest rates low and allowing the country to run big deficits for the foreseeable future...
Copyright 2011. Project-Syndicate.org.
Johnson tells us: "This view is seriously flawed."
He continues on to point out that this is all based upon the concurrent, wishful notions that, at least over the next few years, the U.S. will maintain dollar hegemony, and the Fed will continue to keep interest rates low. He notes...
...But this consensus misses an important point: the financial sector in the US and globally has become much more unstable in recent decades, and there is nothing in any of the reform efforts undertaken since the near-meltdown in 2008 that will make it safer...
Johnson recalls the traditional, recent history that is now instilled within the financial services sector, on both sides of the Atlantic: the ongoing privatization of profits and socialization of losses by the status quo.
What both Krugman and Johnson focus upon is the reality that struggling governments throughout the western world, from Ireland to the U.S. (and many in-between), are putting everything on the table--including the well-being of their taxpayers--to prop up their, essentially insolvent, big banks.
Both agree: This support of the status quo at all costs, inevitably, just takes us down a path to even greater instability.
Johnson provides us with a bit of a deeper dive than Krugman as he notes the governmental push in support of these respective countries' financial services sectors--again, at the expense of the rest of their respective citizenry--as these countries continue along a "bust-boom-bailout," downward economic spiral, which he refers to as a "doom loop."
He points to how powerful banks, already in control of their respective governments from the get-go, simply regain the ability to risk even greater resources (i.e.: increase their respective leverage)...
...The idea is that every time the financial system is in trouble, it receives a great deal of support from central banks and government budgets. This limits losses to stockholders and completely protects almost all creditors.
As a result, banks have even stronger incentives to resume heavy borrowing...
And, why is this so? The answer's quite simple: Higher leverage allows bankers to stuff more cash into their own pockets. In one word it's: greed.
Johnson concludes that banks end up taking on even more risk in societies that run on boom-bust-bailout cycles. And...
...America’s too-big-to-fail banks are well on their way to becoming too big to save.
Eventually, we're told, "That point will be reached when saving the big banks, protecting their creditors, and stabilizing the economy plunges the US government so deeply into debt that its solvency is called into question, interest rates rise sharply, and a fiscal crisis erupts."
Johnson points to present-day examples of this before our very eyes, as we blog. He tells us to just take a good look at Iceland, Ireland and Greece, "for starters."
IMHO, we really don't even have to leave our own 50 states to see this failed mentality manifesting itself in numerous ways throughout the U.S. financial sector, right now.
Yes, while the bipartisan austerity meme is saturating the Beltway mindset, the MSM coverage of our economy, and generally undermining the hopes of most on Main Street, here's the latest example of this pretzel logic, uncovered over the past 72 hours: Another stealthy, $100- to $200-billion bailout of our nation's mortgage and banking sectors.
Question: What do you call it when one entity pays another entity to insure something, and the payer knows the insurance company that's being paid is insolvent and could not honor a claim if one was presented to it?
Conspiracy? Fraud?
What would you say if I told you I was describing virtually the entire Private Mortgage Insurance (PMI) market in the U.S., today?
More austerity for Main Street. More bailouts and stealthy moves by our government on behalf of Wall Street...
(Diarist's Note: Naked Capitalism Publisher Yves Smith has provided written authorization to diarist to republish her blog's posts in their entirety for the benefit of the DKos community.)
Fannie and Freddie Hiding Over $100 Billion of Losses?
Yves Smith
Naked Capitalism
March 23, 2011 5:34 AM
Bank expert Chris Whalen has a little bombshell in his current newsletter. It’s so obvious that it should not only have occurred to me but pretty much everyone on the real estate beat. And that begs the question why no one has even mentioned it.
One of the actors in the subprime/Alt A market was private mortgage insurers. For those of you lucky enough to be unfamiliar with this concept, PMI is insurance paid for by the borrower for the benefit of the lender. It is used to insure the property value on highly levered transactions. Lenders were quite happy to lend up to 80% of appraised value based on semi-decent income; it was considered unlikely before the crisis that home values would fall all that much in a specific geography even in a recession. But for the amount in excess of 80%, the lender wanted extra protection. In steps the PMI insurer. If the borrower wants to make only a 10% downpayment, he would need to get a PMI policy to insure against the possibility that the value of his house might fall below the 90% he had borrowed against it, down to the 80% risk that the lender was prepared to shoulder.
Given the prevalence of PMI insurance, their thin capitalization, and the big wipeout in home values, they should be as dead as the monolines. But they aren’t. That’s because they are engaging in insurance fraud, namely, refusing to pay out legitimate claims.
And perversely, as Whalen tells us, they are getting quite a bit of help from Fannie and Freddie not making claim at all. Why not? Well, if the GSEs did put in claims, the PMIs would quickly go bust and Fannie and Freddie would report losses. So the failure to put in claims is yet another variant of “extend and pretend”. But in this case, there’s good reason to believe the numbers are very large:
Both investors and Congress need a lot more details about the purchases of defaulted loans by Fannie and Freddie. We need to know exactly how many dud loans have migrated back to the GSEs, what their loan loss reserve is, how much of that loan loss reserve is “covered” by the MIs and how much “capital” the MIs have against these exposures. The GSE are letting dead loans sit on their books in part to avoid recognizing the losses, an event that would drive many of the MIs into bankruptcy. If you look at how slow the process of final loss recognition by Fannie and Freddie is proceeding, then you’ll understand why the publicly disclosed loss rates reported by Fannie and Freddie have been falling.
Instead of demanding insurance payments, the GSEs are doing everything in their power to keep the MIs looking like going concerns so that they can count the MI “receivable” as a good asset. This is why the GSEs direct LTV based LLPAs to the MIs, to keep some cash flowing their way, and…
If there was a proper mark-to-market on the MIs (like all proper insurance/reinsurance businesses do), then the MIs would be massively insolvent. The GSEs would have to take another huge amount of capital from Treasury. Geithner and the GSEs are trying to avoid it, and to date are getting away with it. Sad to say, nobody at the FHFA seems to have a clue about this issue. But we understand that a certain independent minded committee chairman on Capitol Hill is preparing for hearings on this monumental act of fraud against the taxpayer, not to mention the holders of GSE debt.
Now the losses on the underwater PMI (or MI as Whalen prefers to call it) are only one part of the picture. An even uglier part of the equation is the dead loans still being carried at face value:
At the GSE warehouse of delinquent and defaulted loans grows by billions of dollars each month, there is still no demand for payment from the MIs by the FHFA. As we noted in an earlier comment, we figure that there is as much as $200 billion in defaulted loans sitting on the books of Fannie and Freddie at cost — that is, close to par value.
Loss severities are now running at 70%. They are only going to rise as housing prices are forecast to fall further in most markets and more borrowers are fighting foreclosure, which increases the cost of foreclosing. But if you take Whalen’s $200 billion top estimate and take a conservative 70% in loss severities, that gets you to $140 billion in unreported losses at the GSEs. So an estimate of north of $100 billion seems plausible.
Whalen also tells us how the latest round of stress tests are even more divorced from reality than the first iteration:
...we review the Fed’s latest stress test exercise and discuss what it means for the banking industry and the US economy. While the US central bank did not provide results for specific institutions, the assumptions in the Comprehensive Capital Analysis and Review (CCAR) are more instructive than the Big Media seems to notice. Indeed, a close reading of the CCAR document provides a compelling argument for why the Fed should not be supervising financial institutions.
For example, the Fed has a down 6% for housing prices in its “stressed scenario,” but that is about where we are now. Incredibly, the central bank also has a down 5% for HPI [housing price inflation] in 2012, again in a “stressed” scenario. This implies that the Fed’s “normal” estimate for HPI is positive for 2011-2012? Hello?
I’ve said it repeatedly, but it seems I can never say it enough: the financial power that be have long ago ceased being in the business of anything remotely connected with reality. They honestly seem to believe if they can get enough people to believe their propaganda, reality will come to conform to it.
In my entryway, I have some Rockwell Kent prints, namely, his Apocalypse series, on display (yes, I’m sure readers will regard that as fitting). One, which didn’t strike me as particularly apocalyptic when I bought them, is called “Degravitation” and shows Wall Street people flying to the sky. Maybe I can sell copies to the Fed and Treasury as motivational pictures, since it does seem to depict the business they are really in.
Checkout Yves' follow-up post on how Wall Street banks are also sitting on a significant portion of these unbooked losses in: "Are Fannie and Freddie Giving Banks Yet Another Bailout by Not Pursuing PMI Claims?"
Think about this: Taxpayers are buying mortgage insurance from monoline insurance companies and banks (see the story linked to Yves second post, immediately above, for more on the bank profits), wherein, eventually, taxpayers MAY end up paying the claims on those policies, as well.
Yes, don't look too closely at what's going on in D.C. because it'll undermine the austerity meme everyone's selling around town. One way or another, it's just another step along the road to our next fiscal crisis.