naked capitalism

Larry Summers, in a Financial Times comment “We need to bring climate idealism down to earth“, takes up “the best is the enemy of the good” theme as it applies to global warming. He argues that the Kyoto accords haven’t accomplished much because neither the targets nor the penalties are binding, that carbon markets run the risk of being another “pork-barrel corporate subsidy”, and that the Kyoto protocols do not extend to developing countries that soon will account for 75% of the greenhouse gas emissions.

Confirmation of part of Summers’ thesis comes from a BBC story, “Canada sets reduced climate goal.” Canada, a Kyoto signatory, has not met its emissions reduction targets and has published a climate change strategy which will also fail to meet the standard. The Canadian move is likely to expose Kyoto as an empty commitment:

The Canadian government has published its strategy on climate change, which acknowledges that the country will not meet its Kyoto Protocol commitment….
Environment groups have labelled the strategy a sham, and say that when combined with industrial policies, the country’s emissions could rise.

Canada is the first nation to publicly abandon its Kyoto target without leaving the protocol….Many other nations inside the protocol, such as Spain and Ireland, are a long way from their own targets; and the Canadian decision opens up the possibility that others will follow suit and choose not to meet their commitments….

The Canadian strategy has emerged at a time when the international community is struggling to find a new path to reducing emissions when the current Kyoto targets expire in 2012.

It is also grappling with the knowledge that the treaty has been far less effective than was envisaged by its architects – and that it contains no effective mechanism for compelling member countries to meet their commitments.

With a number of major governments publicly opposed to binding international targets, and with voluntary agreements such as the Asia-Pacific Partnership on Clean Development and Climate springing into existence, Canada’s decision will make the development of a meaningful new global deal even more difficult.

On another Summers point, that the third world will soon be the biggest source of carbon emissions, Stormy at Angry Bear has a lengthy and worthwhile post on China’s development targets and plans. It’s worth reading in its entirety. Some relevant points:

[E[ach year China publishes "China's Modernization Report."....

Each year, China carefully measures its progress against 131 countries, each of which is in a different state of development. For China, modernization is a competition, replete with charts, indices, and other measurements in a wide variety of areas….

For China, modernization is a science. Because it is a science, operating on laws similar to physics, there is a path that of necessity must be followed. I have a couple of reservations here:

1. Modernization theoreticians deal primarily with the past, how particular countries succeeded, etc. The past may not be prologue of what is to come….We all remember the Victorian industrial horrors Dickens described. If I were China, I would try to leapfrog into 21st century technology. But clearly, China has chosen the old—and very dangerous—path.

2. While the information and digital revolution will quicken, of necessity another revolution may be coming into play: Sustainable development, which may require China to think carefully about its concept of perpetual growth.

3. China accepts the principles of globalization. I have deep reservations that the principles of the WTO can be sustained in the face of global warming and resource depletion. Something is going to give. And it will not be nature.

Resource depletion needs further elaboration. I speak here not only of depletion of material resources—oil, water, some metals, etc—but also of biological resources connected with food. Bioengineering is in its infancy, a revolution in itself. As we deplete the natural environment of its life—fish, for example—and as we struggle to make plant and animal life more amenable to our growing needs, we are using the principles of privatization to embark on a very dangerous bio-genetic path: neutered salmon, seedless seeds, pigs with the hides of cows, chickens with no brooding instinct, etc. Are we prepared to completely refashion the natural world precisely at the time when are facing monumental challenges? I leave it at that. What path will China take in terms of resource depletion?

To return to the topic at hand: China’s goals. Below are some of the mile markers it intends to achieve….

And now to Summers:

With the accumulation of scientific evidence and its persuasive presentation to the public, the global warming debate has reached a new stage. Those who still deny that human activity is warming the planet, or claim that “business as usual” can continue indefinitely without profoundly adverse consequences, are increasingly seen as the moral and intellectual equivalent of those who deny that tobacco has adverse consequences for human health.

While there is probably excessive euphoria in some quarters over the economic benefit of green policies, it is now beyond debate that there are huge opportunities to reduce emissions with economic benefit or negligible economic cost. It has been estimated that worldwide subsidies to energy use approach $250bn.

The real question for debate is not whether something should be done – that debate is over among the rational. The crucial question now is what should be done so as to leave our descendants with the highest possible quality of life. Answering it effectively requires vision and ambition. But, as the example of Woodrow Wilson’s League of Nations teaches painfully, utopian vision and ambition unmoored from political, economic and social reality can be counterproductive.

There is a very real danger that the global cap and trade approach directed at achieving the rapid emissions reductions enshrined in the Kyoto protocol – now favoured by most European governments – could be ineffective or even counterpoductive by substituting for more realistic approaches to the problem. Kyoto is now the only game in town for those who do not want to be ostriches with respect to global climate change and so one has to hope for its ultimate success. But it is surely useful to try to be clear about the potential pitfalls, as I am in this column, and as a matter of prudence to consider alternative approaches if the Kyoto approach does not succeed, as I will in my next column.

First, the Kyoto approach depends on the questionable premise that nations will, in fact, be bound by binding targets or penalties for not meeting them. It is instructive in this regard to consider the history of the Maastricht Treaty within the European Union. It addressed fiscal targets directly under the control of governments over the relatively short term within a group of countries that had already achieved a high degree of cohesion. It broke down almost immediately when it looked like the targets would not be binding for big countries, with the goals abandoned and no payment of even the modest penalties.

There is to date little evidence that Kyoto is driving behaviour. Whatever evidence there is of impressive emissions reductions comes from countries such as the UK, Germany and the former communist states, where coal use was being phased out for other reasons. The limited impact of Kyoto is evinced by the fact that carbon permits are now selling in the range of a negligible one euro a ton.

Second, carbon markets are invitations to engage in pork-barrel corporate subsidy politics on a massive scale. If greenhouse gas emissions are to be substantially reduced, the value of the associated emissions rights will be in the tens of billions of dollars. While in principle emission permits could be auctioned, in practice they are always allocated administratively. It should not be surprising that businesses that can pass on carbon costs to their consumers are excited about schemes that compensate for these costs by allocating them permits related to their existing emissions levels. As investigations by this newspaper have highlighted, the clean development mechanism has resulted in substantial payments for emissions reductions that would have occurred anyway or could have been achieved at negligible cost. There is even reason to think that certain industrial gas emissions may have been increased so that credit could be claimed for their abatement.

Third, the most serious problem with the Kyoto framework is that it is unlikely to generate substantial changes in developing country policies. As my Indian hosts explained on a recent visit, developing country policymakers are not likely to accept binding targets on their energy use or greenhouse gas emissions that fall way short on a per-capita basis of emissions levels in the industrial world.

Nor is it reasonable to expect them on the basis of dubious projections of economic trends and future technological developments to commit to energy use goals that fall short of patterns observed in the rich countries.

The truth about climate change policy is that developing countries are where most of the future action has to be. They will account for 75 per cent of the increase in emissions over the next quarter century and are now making the infrastructure investments that will shape their future economies. Moreover, any international regime that does not include them will not work because emissions reductions in the industrial world will be offset as energy intensive activities relocate to the developing world. The 1997 vote cast by all the Democrats in the Senate suggests that approaches that do not involve the developing world are unlikely to command political support in at least some parts of the industrialised world.

Perhaps these problems and others, like the difficulty of establishing emissions targets given the magnitude of economic uncertainties, can be overcome with goodwill and extensive thought. But next month I shall suggest approaches that, while less dramatic in their immediate claims for emissions reductions, may over time provide a more secure foundation for the progress that the world must have.

That’s what Lewis Ranieri, who can lay claim to founding the mortgage-backed securities market, said in presentation at a Milken Institute conference last week. He asserted that 50% of the subprime borrowers qualified for loans from the FHA, Freddie Mac, or Fannie Mae on much more favorable terms.

Tanta at Calculated Risk looks to see whether the available data support Ranieri’s view. She does find some evidence that a significant number of subprime borrowers had loan terms that would have qualified them for at least an Alt-A loan, perhaps even prime. But it is hard to be definitive about the proportion:

1. We looked at this chart a couple of weeks ago. It doesn’t, of course, give all of the loan-level characteristics you would need in order to say for certain that some of these loans are “over-qualified” for a subprime program, but it is certainly not inconsistent with that idea. Note that it is referring to original CLTV and FICO, not current.

2. We also looked at this chart from Fitch on subprime loans that experienced first-year defaults, versus the ones that survived the first year. If you assume that most of the specuvestors, flippers, and outright frauds are in the former category, let’s focus on the second half of the chart.

One thing it implies to me is that average FICOs are improving, over time, in these subprime pools. Certainly, if you posited that there are actually individual loans that resemble the average loan, you would have to wonder why a conforming-dollar 625 FICO 80/85 LTV/CLTV full doc that isn’t in CA couldn’t qualify for a GSE or FHA loan. You do have to ask why those average FICOs in subprime pools are improving over the vintages. Of course it is not clear from looking at averages like this whether the best loans in these pools are getting near-prime interest rates or not, but you still have an average coupon here that is significantly higher than an average prime coupon….The data we’re looking at here cannot decide these questions, but it is not inconsistent, as far as I can see, with the hypothesis that “steering down” is going on.

3. This is an excerpt from Fannie Mae CEO Daniel Mudd’s testimony before congress:

Right now, we’re getting at least 15,000 applications for subprime refinancing coming into our system per month. Because we have been adhering to our own prudent standards throughout, even before our new enhancements, 80 percent got a “yes.” Altogether, we estimate that about 1.5 million homeowners who face resetting ARMs and potential payment shock this year and next could be eligible for our loan options. Certainly, lenders may choose someone else to buy or securitize the loans, but 1.5 million would be eligible for our options; we think this will also help establish a benchmark in the market for safe loans. These are also good alternatives for first-time homebuyers as the riskier “affordability” loans dry up.

Now, you can say any number of things about this, including wondering out loud how choosy Fannie is being lately; that’s fair enough. I will simply observe that no loan ever gets a “yes” if it’s a jumbo, remember, so we are not talking about the highest-balance loans in the bubble markets. Nor are we necessarily talking about “prime,” here. Fannie Mae has a near-prime/better-than-average subprime program called “Expanded Approval” which will accept some of these loans with a healthy, but not outrageous, increase in the interest rate. My own experience with Expanded Approval tells me that the hypothetical conforming-dollar 625 FICO 80/85 LTV/CLTV full doc that isn’t in CA is a loan it would love. But this isn’t just a risk-shift out of a subprime pool into a Fannie Mae pool, since Fannie will not accept toxic loan terms in the Expanded Approval program. These loans are overwhelmingly fixed-rate, with some longer-initial-period hybrid ARMs (5/1 or 7/1) that amortize and don’t have deep teasers.

It remains to be established, as far as I’m concerned, that there is a substantial number of loans which are in trouble only because they received toxic terms or predatory interest rates up front, and that would become reperforming if they were modified or refinanced down to a more reasonable rate and more stable terms. However, I can’t say that I’ve seen any hard evidence lately that is inconsistent with this idea….

The debate among some serious academics on the economic models, their merits, and what they say about who might win or lose from trade continued over the weekend. While informative, it was also oriented heavily towards theory.

Dani Rodrik tries to sum up:

Can we all agree on these?

1.Trade policy works through its effect on the relative prices of goods, not through the price level.
2. Depending on what side of the change in relative prices they find themselves, any specific group of consumers or producers can be made worse off by a move to free trade.
3. A corollary: there is no guarantee that free trade raises real wages.
4. The Carlos Diaz-Alejandro rule: For almost any particular conclusion you want to arrive at, there is some economic model that will take you there.
5. Throw in some scale economies (dynamic or otherwise), and then just about anything can happen (including free trade making some countries worse off).
6. The positive spin: This does not diminish the value of economic modeling; it simply means we have to be more careful with generalizations and be more explicit about the assumptions that lie behind our reasoning.
7.Bottom line: It is possible to have an illuminating (sometimes), intelligent (mostly), and entertaining (almost always) economic debate in the blogosphere.

Paul Krugman offers a pragmatic perspective at Mark Thoma’s Economist’s View:

Another thought or two on distribution and trade policy:

The problem of losers from trade isn’t new, obviously, either as a fact or concept. But if you look at the history of trade policy – say, in Matt Destler’s book it’s hard to avoid the sense that the issue has gotten bigger and harder. His final chapters have a definite sense both of nostalgia for the good old days and foreboding.

I’d put it like this: in the old days, when GATT negotiations were mainly with other advanced countries, the groups hurt tended to be highly specific and local – the left-handed widget makers of Northern South Dakota, worried about competition from their counterparts in Upper Lower Swabia. Economists could in good conscience argue that while individual groups were hurt by trade liberalization in their specific sector, the great majority of Americans benefitted from general trade liberalization. And politicians made trade deals by packaging together the interests of exporters, to offset the parochial interests of import-competing industries

But now we’re talking about broad swaths of the population hurt by trade. It’s a good bet that almost all US workers with a high school degree or less are hurt by Chinese manufactured exports, at least slightly. You could in principle put together win-win packages – say, trade liberalization together with an increase in the EITC paid for with higher taxes on high-income Americans, who come out winners from trade. But the reality is that we don’t make those deals.

For those who like their jargon, by the way, I’m basically saying that the right model for thinking about this has gone from many-good specific factors to Heckscher-Ohlin.

I don’t have answers to this. The moral case for open markets is their importance to poor countries: America would do OK even in a highly protectionist world, but Bangladesh wouldn’t. The domestic politics of trade, however, are now very hard, and getting harder.

Thanks to Tanta at Calculated Risk, we have a rush transcript from a presentation by Lew Ranieri at the Milken Institute conference on financial innovation. Ranieri is credited with creating the mortgage backed securities business, has continued to be active in the industry, and has sounded warnings on subprimes.

I found three points to be particularly interesting.

First, while the explosion in subprimes has often been discussed in the press as a 2005-2006 phenomenon, I had suspected that the growth might have had something to do with the new bankruptcy law, which was signed at the end of April 2005 and became effective on October 24 of that year. The reason I had thought there might be a link was because the law made it much harder for individuals declaring bankruptcy to shield their homes from creditors. Under the new law, a house purchased less than 5 years before the declaration of bankruptcy was fair game. I had dismissed the idea because I had assumed the profligate lending had started before the law was signed, hence no link (or at least no strong link).

Ranieri says that the aggressive phase of subprime lending started at the end of the third quarter of 2005. Thus the new bankruptcy law may well have played into it.

Second, Ranieri says that roughly 50% of the mortgages extended to borowers could have been issued through traditional channels (FHA, Fannie Mae, Freddie Mac) at much lower cost to consumers. He estimates these borrowers would have gotten 6.5% mortgages versus the effective 9.5% (the average across the first and second mortgages on the same asset). Ranieri is saying that many consumers were exploited by lenders, and may also say that some of the ones who are defaulting due to high interest charges might well have been able to support the mortgage balance had the mortgage been at a market rate for their credit risk, as opposed to an extortionate rate. Thus much of the subprime problem may very well be self inflicted damage by greedy lenders. If this factiod gets the coverage that it deserves, just wait until the powers that be get hold of it. This is an invitation for the imposition of regulations against predatory lending.

We’ve argued that it makes sense to protect borrowers. If products are so complex that buyers can be suckered into paying well above market for a loan when other, considerably cheaper options were available to them, something is drastically wrong.

Third, Ranieri goes into more detail on a problem that has been discussed before, namely, the difficulty of renegotiating these subprime loans. In the old days when Ranieri helped create the industry, a MBS would be issuer specific, so if you had a problem, you could go back to one bank, which had one mortgage agreement, and either renegotiate the terms of those loans, or identify a problem group within the pool and figure out how to deal with them. But now the mortgages from different mortgage companies have been pooled before before packaging them into securities, and these securities have then often been further recombined into collateralized debt obligations. It’s well nigh impossible to even find what security a single mortgage is in, and on top of that, it is too costly, even if you could find where various mortgages reside, to renegotiate them on a case by case basis (you need waivers from all the bondholders in a pool….)

From Ranieri’s remarks:

People asked, you know, is financial innovation, you know, reaching a stabilization point in housing and I think the last four years shows that’s not true. It’s been a halcyon period in terms of taking financial innovation and using it to put housing much more deeply into the population. I mean, we’ve been able to franchise many, many more lower middle income and minority home–individuals into home ownership, over the last four years, than probably, in the 10 or 15 years prior to that.

Unfortunately, we’re now facing a trial, which in many ways, I think, will determine how well we can continue to innovate into the future and part of it is [subprime] . . . And we also have the typical regulatory reaction to a potential series of risks, in terms of passing somewhat more restrictive legislation. And some might argue [this] is exactly the point in the cycle where we don’t, particularly, need it but I think the real key of navigating through this is being able to deal with what is euphemistically called the subprime mess.

The subprime mess is simply – and first, I think the important thing to understand, is this a creature of a very narrow window. It starts at the end of the third quarter of ’05 and carries through, principally, the fourth quarter of ’05 and ’06. And what it is, is that in those five or six quarters, a series of attributes which were largely in existence already, took on a life . . . of their own and in combination, created risk layering, which on one hand, enabled many, many people to get into housing who might not otherwise have.

And on the other hand, unfortunately, put many, many people into houses they couldn’t afford and not simply lower middle income people but combination, the layering, was also attributable to many middle income borrowers. In fact, at – we had a two-day conference in Washington yesterday, which was called the Housing Round Table. It’s all the participants in housing and we get together three times a year and at that there was an argument from a number of the economists in the room.

As I said earlier, we’re in a housing recession but more importantly, they argued that looking at the production, the subprime production, in those five or six quarters that as much as 50 percent of that production could have gone to the agencies, meaning, Fannie, Freddie and FHA. That’s a pretty profound statement because a subprime loan is, at best, [an] eight plus coupon.

And usually, there’s a second mortgage with a 12 coupon, so you’re talking about an average coupon, a little bit over nine and you know, an agency piece of paper would’ve been a 6.5, so if you translate that into what he said, in another way, he was arguing that half these loans, the homeowner could have been put into a coupon at 6.5 versus 9.5 and that led to the question, the 800-pound gorilla in the room we dealt with, is the system broke?

Is there a problem, you know that it’s not simply a function of normal economics but is there a break in the system, you know, what is the responsibility of the system to deliver . . . the appropriate, you know, housing finance structure? The real dilemma for me and I think the real issue . . . will be, we’ve never had to do substantial restructurings in housing in mortgage securities.

They were always in portfolios, and that made it very easy or at least, we didn’t have to get 409 people or we didn’t have to rent the Nassau Coliseum to have a bondholders meeting; we could do it very quickly. The vast majority of these loans, all of these theoretically, problem loans, are in securities, which have been tranched and then tranched and then re-tranched . . . [in] mortgage securities and then some tranch is put in CDOs. In a very long meeting, last Monday, where we tried to collect virtually everybody in a room, it became evident that there are a whole host of unforeseen technical problems if you try to restructure or do large amounts of restructuring within the security, some of which, we had never even heard of or thought about.

One of the accountants – you know, it will not be unusual, in some of these pools to have to restructure a third or more of the pool and we only have four [big accounting] firms and we had three of them in the room and one of them raised his hand and said, well you can’t do that. If you restructure that many loans, you’re going to taint the Q election and FAS 140 and what he was basically saying in English for the rest of [us] poor fools, was that there is a presumption when you – when a bank sells loans, into a securitization that it sold the loans . . . And what he was saying is wait a minute, if you guys can restructure all these loans without going back to bondholder, you obviously have control and you’ve just tainted 140 and Q election.

Boy that was a big deal and I’ll use that as a simple example of one other I’ll give you, is the ability to put everybody in a room, even if you could find them all and get their assent, is slim – I mean it’s not very practical.

Well, wait a minute; we have to restructure the loans. The worst thing you can think of is freezing the pool and not being able to do what we need to do and I don’t know how long it would take us. I mean, you know you’ve just basically told us we now have a problem that we don’t quite exactly know how we’re going to fix – and another example of how crazy we can get is, when we restructured mortgage loans, in the past and we’ve done this many times, we actually really know what to do.

We restructured the loans and it was always better to negotiate around the borrower, assuming there was a borrower and for purposes of this conversation, we’re talking about homeowners, not speculative buyers, flipper and all the other guys playing games; we’re talking about people who bought a home and live in it and we, historically, structured those loans. We never send out a 1099.

We basically assume that was a renegotiation, end of story because it was in our best interest, as the lender, to do that but in a mortgage security, you don’t have that freedom because you’ve got get the outside accountants to sign off and the outside lawyers and the outside accountants and lawyers said, time out and I volunteered and said, well, wait a minute. I’ve been doing it this way all along and one of my friends [who is] now running one of the best of the combat servicing operations says, well, I’m doing that now, too and we were told, well you’re doing it wrong. You’ve got to send out a 1099.

That’s an incredibly dopey idea. We’re restructuring a loan around a borrower; he can’t afford the loan and now we’re going to take the NPV of the change and send him a tax bill so the IRS can chase him . . .?

Tanta provides additional insight:

Someone who is considered “the father of MBS” did not anticipate the difficulties of modifying securitized loans, given the constraints of the true-sale requirement (which means that the sponsor/servicer cannot “control” the collateral, and you’d have to get 400 bond holders in the Coliseum to vote on a loan modification). This is to say that a mortgage financing mechanism intended to mitigate risk is less able to respond quickly enough and efficiently enough to stave off losses than an unsecuritized portfolio or a simple agency pass-through.

Bondholders who may well understand that it is in their best interest to allow modifications of loans will discover what it will cost in legal and accounting fees to do that, costs that are there only because these loans are securitized; a similar restructure of a portfolio would not have those costs. Risk “dispersion” means never being able to get all your risk holders into the same room to hammer out a plan.

Some senior bondholder is going to sue some issuer for SFAS 140 violations (modifications, with or without a 1099) that were intended to cut the losses for the subordinate holders, but which would have the effect of maintaining some credit support for the senior notes, too. Besides the simple extraction of legal fees here, you have a situation in which losses will simply continue to mount while each tranche and the sponsor argue in court about whose interest is or is not being served. Meanwhile, borrowers get further behind.

Yesterday, we featured a post from Dani Rodrik which observed that free trade doesn’t necessarily lower prices (it will lower prices of imports and increase prices of exports, so it depends on the mix of goods purchased).

What is interesting about the debate that unfolded is that it tells us something not just about free trade, but also about the nature of discourse in America.

As we learned courtesy Angry Bear, this was sufficiently heretical so as to earn a retort from Greg Mankiw:

When people complain about trade, it usually about the alleged job-destroying effect of imports. This partial-equilibrium complaint naturally encourages a partial-equilibrium retort: imports lower prices for consumers. The losses to producers in these markets are more than offset by gains to consumers from lower prices. True, the full story can only be told in general equilibrium, where it is relative prices that matter for the allocation of resources.

Dani did not take this lying down:

Now, neither of Greg’s arguments is exactly right. On his first point, there is no theorem that guarantees that the partial-equilibrium losses to import-competing producers “are more than offset by gains to consumers from lower prices.” My wheat-and-beef example in Argentina is exactly an instance where this supposition fails. And on his second, trade theory does not guarantee that real wages of workers rise as a result of free trade, as Stolper and Samuelson showed long ago. (Greg knows this of course, which is why he qualifies his statement by referring to the basic Ricardian model, which is a highly special model where labor is the only factor of production and gains from trade have to show up as higher real wages.)

But the real reason for this post is different. I want to take issue with the general philosophy behind Greg’s argument, which is that a less than full (and possibly misleading) story in support of your argument is OK as long as it helps disarm your opponents in public debate. His position seems to be this: Look, these anti-trade guys don’t understand comparative advantage anyhow, and it is pointless to waste our breath trying to explain it to them. So let’s instead argue our case in “their” language and within “their” framework. Never mind that Professor Greg Mankiw would flunk us if we ever gave the same answer in Ec. 10.

I am not sure I like this stance very much. For one thing, it goes against the grain of what I think is the most important job of economists in public debate–to educate and not simply to be an advocate. Second, it is bound to backfire, and ultimately undercut the credibility of economists….

There is a broader and potentially quite useful discussion to be had here on the manner in which economists should engage in the public debate. Many of my colleagues are of the view that economists should just stick to their bottom line, and not “confuse” the public with the caveats and limitations of their arguments. Moreover, since anti-market views have enough supporters out there, economists often see their role as one of unqualified advocacy of the opposite position. I tend to disagree with this, which is why I am often accused of “giving ammunition to the barbarians.”

While it’s great to hear Dani speak up for intellectual integrity, but (and no disreapect intended) consider the forum and the participants. They are both tenured professors having a pointed conversation on the Web. They can be more candid than just about anyone in public or private life.

Dani’s idealism is refreshing, but I wish he would widen his frame of reference. The quality of debate has degenerated in every area I can think of. While politics by nature is contentious, the debate has become more shrill, less fact based, less concerned about coming up with good or fair solutions and more interested in ideology and favored interests. And critical thought seems to be a dying art.

We have a combination of further, and generally not positive, analysis of the disappointing first quarter GDP growth report (1.3%).

Consider that personal consumption expenditures, the strongest item in the report, grew at a 3.8% rate, but that was still a decline from the previous quarter’s 4.2% level. Now add in the fact that spending isn’t sustainable at this level because consumers are spending beyond their means. Consumer savings was a negative 1%, and that despite $50 billion of bonuses falling in the first quarter.

In addition, MarketWatch tells us April is looking no better: “The sluggish growth in the U.S. economy likely persisted into April, economists said ahead of a busy week on the data calendar….”

While most US readers believe that the Journal’s ideological bias is limited to its editorial pages, we have repeatedly seen (and commented on) skewed reporting as well. Specifically, the Journal tends to put a positive spin on economic (as opposed to company-specific) reporting.

Today’s object lesson is the Bank of England’s latest edition of its twice-a-year Financial Stability Report. The Journal’s and the Financial Times’ stories on it are leagues apart, and the FT, which clearly has the better grasp, hones in on the worrisome aspects.

By contrast, while the Journal did have the right title (“Bank of England Study Cites Rise in Risk-Taking“), the body put greater emphasis on the positive elements of the report. In addition, it implied the study pertained only to UK institutions. The first sentence reads:

The U.K. financial system is “highly resilient,” but strong and stable macroeconomic conditions have led to greater risk-taking, increasing the system’s vulnerability to shocks.

Nice try. While technically correct, any major financial institution worth its salt is licensed to do business in the UK. In fact, the Bank of England analyzes the activities of LCFIs (large complex financial institutions), which currently consists of ABN Amro, Bank of America, Barclays, BNP Paribas, Citi, Credit Suisse, Deutsche Bank, Goldman, HSBC, JP Morgan Chase, Lehman, Merrill, Morgan Stanley, RBS, Societe Generale, and UBS. Of this group of sixteen, only three are British. Moreover, the report analyzed markets, not merely market participants, again giving it broad relevance. The report cited six major risk factors, only two of which are UK specific (and both happen to operate in the US):

Unusually low premia for bearing risk
High and rising leverage in parts of the corporate sector
Rising systemic importance of large complex financial institutions
Dependence of UK financial institutions on market infrastructure and utilities
Large financial imbalances among major economies
High UK household sector indebtedness

The first paragraph of the report is a splash of cold water (you seldom see anything this blunt from regulators):

The UK financial system remains highly resilient. But strong and stable macroeconomic and financial conditions have encouraged financial institutions to expand further their business activities and to extend their risk-taking, including through leveraged corporate lending, and the compensation for bearing credit risk is at very low levels. That has increased the vulnerability of the system as a whole to an abrupt change in conditions. Financial innovation and the growing use of credit risk transfer markets have increased the risk-bearing capacity of the system – but also bring some risks. Recent developments in the US sub-prime mortgage market have highlighted how credit risk assessment can be impaired in these markets and how participants can be hit by sharp reductions in market liquidity. Similar problem in a more significant market, such as corporate credit, could have more serious consequences.

Not surprisingly, the FT didn’t shy away from troubling content:

When the Bank of England released its latest, half-yearly Financial Stability Report yesterday, it featured an array of striking charts: leveraged lending is exploding, credit spreads are collapsing, securitisation is surging – and market volatility is hitting yet more lows.

Perhaps the WSJ reporter was inexperienced in bureaucrat-speak. But that is still a journalistic failing. Admittedly, the Financial Times article is more of an analysis, but the references to the report in other news stories gave the key finding: risk is on the rise, which the Journal endeavors to play down.

To see for yourself, here is the balance of the WSJ story:

Changes in the structure of the financial system and increasing use of credit derivatives have increased risk-bearing capacity. But such innovation also means that risks might emerge in new forms, the central bank said in its latest biannual Financial Stability Report.

“Financial markets have continued to be vibrant, core institutions are highly profitable and the economic outlook is favorable,” said John Gieve, deputy governor for financial stability at the central bank. “But risk-taking is increasing, including through higher leverage, lower margin requirements and relaxation of covenants.”

Mr. Gieve said the rapid growth of credit-risk-transfer markets is making more investors dependent on the continuation of market liquidity, which “could amplify the impact of shocks like a sharp reversal in credit spreads from their current low levels.”

It also might be affecting the depth and quality of risk assessment. Those organizing loans might be less concerned about credit quality if they bear little of the risk, the report found.

While the trading of credit risk allows for better diversification of risk, recent events in the U.S. subprime-mortgage markets have demonstrated that weaknesses can occur, the bank said.

Several vulnerabilities were judged to have edged up since the last report in July.

The bank cited a slight increase in the likelihood of significant stress occurring because of “unusually low” risk premiums.

“Benign current economic conditions, the greater dispersal of credit risk and confidence that market liquidity will remain high may have weakened risk assessment standards,” the report found.

Here is the rest of the Financial Times’ story:

But, for my money, the most thought-provoking image of all was a graphic I have never seen before – the size of global investment banks’ balance sheet. In recent years, this data has not attracted much attention, since analysts tend to focus on issues such as profits these days and measuring the banks’ assets is often hard.

However, the Bank has produced some estimates, based on reported accounts, and they make staggering reading; this decade, the assets of large complex financial institutions (LCFIs) have apparently swelled from $10,000bn to about $23,000bn. Most growth has occurred since 2003.

At face value, this looks extremely odd. After all, the golden mantra of the modern banking world is that LCFIs are currently removing risky assets from their balance sheets, in the name of improved risk management. Thus while banks used to hold loans on their books – leaving them exposed to associated default risk – they now often sell these to outside investors, either through direct loan sales or securitisation.

The consequence is a business model known as “originate and distribute”. And it should imply that the LCFIs are becoming slimmer beasts – not fattening up.

So what on earth is going on? Some of the Bank’s brightest brains have been puzzling about this recently, and think the main source of growth lies in an expansion of the banks’ trading assets. That may simply reflect the fact that the pool of tradeable instruments has grown this decade – giving bankers more toys to play with.

But the Bank also suspects that trading assets are rising because LCFIs are now taking much bigger trading bets, in an effort to boost returns in a low volatility world. The banks themselves deny this is any cause for concern since the time-honoured tools they use to measure trading risk – namely “value at risk” (VAR) models – are not signalling problems. However, the Bank, quite rightly, suggests these VAR models are being distorted by low market volatility. Moreover, the sheer speed at which banks’ revenues are rising implies that somebody, somewhere must be taking bigger punts. After all, it is hard to produce an annual 35 per cent rise in trading revenues on the basis of innovation alone.

In addition to this, however, the Bank also sees a second reason for the rise in trading assets: the “warehousing” effect. This is when banks use the “originate and distribute” model, they temporarily hold originated assets before selling them on. In theory, a warehousing period should be small. But if something ever made it hard to sell assets, these could unexpectedly back up on the banks’ books, giving them a nasty shock – of the sort that occurred, on a small scale, when the sub-prime securitisation market temporarily shut down.

Of course, any sensible bank would respond to this risk by carefully limiting the volume of business it originates and distributes. But that is not how Wall Street or the City works. After all, bankers win bonuses by making hay when the sun shines — not for crying wolf. Hence the pressure to keep ratcheting up risk. Or as the Bank says: “The incentive structures faced by managers may be contributing to a heightened emphasis on scale, revenue growth and market share.”

Since central bankers are an understated species, the Bank carefully avoids sounding too alarmist about this. Perhaps that is wise: right now I cannot see anything likely to spoil this frenetic credit party, at least in the short term. Moreover, a veritable army of bankers keeps telling me that innovation and risk transfer is changing how leverage works – meaning some of the old rules about the credit cycle no longer apply. Some policymakers appear to believe this, too, particularly in Washington. But whenever I listen to these arguments about how we have moved into this Brave New World, I also hear uncanny echoes of the last internet boom. It is hard to read today’s report from the Bank and not feel worried. Page 31 – and the chart titled “LCFIs’ total assets” – is a good place to start.

One of the obstacles often cited in reining in US medical costs is that doctor salaries would have to fall, and therefore good people would no longer come into the profession (they’d either launch a hedge fund or go into the unregulated, better paid part of the business, like plastic surgery).

But that assumes that doctors have to be the main service providers, or patient health will suffer. But that assumption is false. A post in Overcoming Bias (which we found via The Stalwart) tells us:

Primary care doctors eat a big chunk of our medical budget (median salary 155K$), yet (confirming previous findings) a randomized trial published in JAMA in 2000 found docs no better than nurse practitioners (median salary 77K$):

1316 patients who had no regular source of care and kept their initial primary care appointment were enrolled and randomized with either a nurse practitioner (n = 806) or physician (n = 510). … No significant differences were found in patients’ health status … at 6 months … hypertension … was statistically significantly lower for nurse practitioner patients (82 vs 85 mm Hg; P = .04). No significant differences were found in health services utilization after either 6 months or 1 year. There were no differences in satisfaction ratings following the initial appointment (P = .88 for overall satisfaction). Satisfaction ratings at 6 months differed for 1 of 4 dimensions measured (provider attributes), with physicians rated higher (4.2 vs 4.1 on a scale where 5 = excellent; P = .05).

But docs are taught more medicine than nurses; why are they no better at primary care? Probably because docs are famously overconfident. For example, one study found that on average when docs were 88% confident that their patient had pneumonia, in fact only 20% of such patients had pneumonia. And overconfidence is fatal in primary care.

Another testament to nurse competence: emergency room triage is done by nurses. And conversely, another sign of the dangers of the God syndrome among doctors: residents seldom question senior physicians, even when it seems apparent that they have made a mistake, because their observations are not welcome.

The diagnostic abilities of doctors, or any front line medical professional, are limited. Of the roughly 8,000 recognized ailments, only about 2,000 are common, so if you happen to suffer from one of the obscure 6,000, it is almost certain that a primary physician won’t make a correct diagnosis. It will take considerable trial and error (and likely visits to many specialists) before you (hopefully) get a correct diagnosis. Again, no harm will be done, and considerable costs will be saved if the intial screen was performed by a nurse who can eliminate certain possibilities and order tests for the most likely diseases.

The reliable Barry Ritholtz of The Big Picture provides his take (and note he expects a downward revision, as with the fourth quarter):

GDP came in way below consensus. Given recent revision history, its very likely this will not be the final number.

The economy slowed to its weakest pace of gains in 4 years, when GDP was 1.2% during Q1 2003.

Housing gets most of the blame (duh), but do not ignore the accelerating inflation factor as a key element. Most traders realize the Fed is watching that component closely; Hence, why you are not hearing the usual “Rate Cut” chants from the cheap seats. PCE rose 3.4% (it decreased 1.0% Q4) Even the nonsensival core PCE (ex food and energy) was plus 2.2% (following 1.8% Q4).

International trade, Business Capex spending, Inventory growth, and decreased government spending all weighed on the economy to produce that 1.3% number.

The one bright spot: Durable goods. Plus 7.3% in Q1 follows +4.4% in Q4. Pretty much everything else was punk.

Calculated Risk elaborates on housing’s impact, and confirms Ritholtz’s reservations:

MarketWatch has the headlines: GDP slows to 1.3% growth in first quarter, Inflation rages at fastest pace in 16 years, data show

This graph shows Residential Investment as a percent of GDP since 1960. The median is 4.5% of GDP. Currently RI is still above 5% of GDP.

RI peaked at 6.3% in the second half of 2005.

If this housing bust is similar to previous busts, RI as a percent of GDP will bottom in the 3.5% to 4.0% range.

So why did stocks close up for the day? Because the commentators are great at denial, um, teasing a positive story out of the figures. The Financial Times tells us:

The data show that unexpected weakness in net exports and government spending added to the anticipated severe drag on growth from housing construction during the first quarter.

Corporate spending was also subdued. But consumer spending remained very strong, with real personal consumption rising at an annualised rate of 3.8 per cent.

Most economists expect the surprise weakness in net exports and government spending – for which there is no obvious macro-economic explanation – will reverse in the months ahead.

I could just as easily make the reverse argument: GDP growth was poor despite an unexpectedly high and likely unsustainable level of personal consumption. But advertisers much prefer a preponderance of bullish talk on financial TV, so we shouldn’t be surprised that we hear more of those viewpoints.

This is a nice post from Dani Rodrik. The short answer is it depends. Free trade increases the price of export goods and lowers the price of imports:

[A]nyone who understands comparative advantage knows that free trade affects relative prices, not the price level (the latter being the province of macro and monetary factors). When a country opens up to trade (or liberalizes its trade), it is the relative price of imports that comes down; by necessity, the relative prices of its exports must go up! Consumers are better off to the extent that their consumption basket is weighted towards importables, but we cannot always rely on this to be the case.

Consider your typical Argentinian for example, who consumes a lot of wheat and beef. Since these are export products for Argentina, free trade implies a rise in the relative price of the Argentine consumption basket….And in the U.S., the Wal-Mart effect has to be qualified to take into account the fact that the relative price of the goods that the U.S. exports (including for example agricultural commodities) is higher than it would have been absent trade. Similarly, when the U.S. gets better market access abroad for its agricultural exports (a key demand under the Doha round), you can be sure that this will raise domestic prices for these goods, not lower them.

Of course, if you are running a huge trade deficit like the U.S., you can have cheaper prices all around—for all to go on a consumption binge as long as the party lasts. But this is hardly the argument we make when we teach the benefits of free trade.

Australian economist John Quiggin posted a high level event chart of the how Seriously Bad scenarios might play themselves out (from a talk by sustainability expert Chris Moran) and what the policy response might be. It includes probability estimates from 80 students.

However, as the chart shows, the rational calculus doesn’t bode well for forestalling a crisis. Doing nothing or free riding dominate as strategies. Quiggin takes us through the logic:

Last Tuesday 17th of April, the Environmental Engineering Sustainability Seminar Series hosted Chris Moran, from the Centre for Water in the Minerals Industry (CWiMI) and Sustainable Mineral Institute, University of Queensland, on the intriguing topic of sustainability in a doomed world. The main message from Moran’s talk is probably summarised in this figure:

The figure describes a series of events, starting now to an unspecified future. The numbers are average subjective probabilities assigned to the outcomes of each event by a sample of 80 students in engineering. The tree starts with considering the probability of an event of global and catastrophic consequences, such as climate change, oil scarcity, or meteor impact, etc.. According to the sample, it is a very likely event (94%), while there is only a 6% probability that it isn’t and that it is good to keep doing the same things (Business As Usual).

If a catastrophe is looming, an Action Plan A is clearly needed–say a binding, reinforced Kyoto protocol. The outcome of plan A is a Light/Soft feet society, that is a society that drastically reduces its footprint on the planet. Would it work? The sample is quite pessimistic. They assigned a probability of 26% to successful global plan to save the planet. If Plan A doesn’t work, would Plan B? Only with a 29% probability. And the outcome is a New Global Order, probably accompanied by resource conflicts. The failure of plan B would either bring human extinction or survival by sheer luck.

Leaving aside the actual numbers in the figure, the event tree makes clear that there are no strong reasons to adopt a plan. If you are optimistic and believe there is no real global treat, no plan is needed. But if you are pessimistic all the way, a plan is pointless. Survival would be a matter of luck. And if you partly pessimistic–that is, you believe in a global threat and are optimistic on the success of plan A¬–your best move is free-riding. But then, how could you be optimistic on plan A? If free-riding is best for you, it is also for anyone else, and plan A cannot succeed. What is left is plan B. Conflicts over resources, environmental crisis and a new, unstable world order are its outcomes. Can we call it a desirable plan?

We are left with a pretty dismal picture. Not surprisingly, as remarked by Moran, lots of people in the mining industry are digging as fast as possible.

The cliche is that the market climbs a wall of worries, but the specter of the Dow breaking 13,000 was accompanied by a chorus of arguments from informed observers that the enthusiasm was overdone.

Roughly six weeks ago, in “How long will the markets be able to defy gravity?,” the Financial Times’ Martin Wolf looked at equity valuations over a long period and concluded that despite the February 27 dip, equities were still considerably overpriced. The conventional response to that is that US equities are cheap if you compare earnings yields to corporate bond yields (and the retort it is that that either implies that equities are cheap or bonds are overpriced, and there is strong evidence that risk premia are too low, hence bond prices too high).

One of the reasons for optimism Tuesday was the durable goods report. But William Trent at Seeking Alpha tells us that it isn’t what it’s cracked up to be. While the month-to-month increase may have appeared to be good, longer-term comparisons showed otherwise:

If you believe the headlines, March durables orders were surprisingly strong:

New orders for costly and long-lasting U.S.-made manufactured goods climbed by a surprisingly strong 3.4 percent….The pickup in March durable goods orders followed a revised 2.4 percent February gain and handily surpassed Wall Street economists’ expectations for a 2.5 percent increase….

Of course, we don’t automatically believe the headlines. For one thing, the change in durable goods statistics can be volatile from month to month. For another, the headline numbers reflect seasonal adjustments that may result in errors when the economy is at turning points. As is our practice, we looked at the durable goods report comparing non-seasonally adjusted numbers and focused on the year/year change. The difference between what we saw and the headlines was surprising, to say the least.

Instead of rising, the shipment and order growth has been decelerating and actually is not growth at all – it is a decline year/year.

Excluding transportation, the trend is smoother but otherwise the same. Clearly slowing and possibly even declining.

Ditto for non-defense capital goods ex aircraft. In contrast to the breathless headlines, all three measures show an economy that is slowing down considerably.

The one area that does appear to be strong is electrical equipment. Investors may want to look to this area for ideas.

Similarly, the Fed’s monthly Beige Book report wasn’t particularly cheerful. From MarketWatch:

There were few signs of a pickup in the U.S. economy in the early days of the second quarter, the Federal Reserve reported Wednesday in its Beige Book.

Most of the 12 Federal Reserve district banks “noted only modest or moderate expansions in economic activity,” the Beige Book said. Economists have enough information about the first three months of the year to know that it was pretty much of a bust.

Growth was described as nothing special, but not worse than that.
Economists surveyed by MarketWatch expected first-quarter growth to rise at a slim 1.8% annual rate, the lowest since Hurricane Katrina.

Another Seeking Alpha post, this one by Andrew Horowitz, highlights the well known but not often mentioned fact that the Fed is in a bind. If it increases rates, it will further damage the housing market but help support the dollar, and if it cuts rates to stimulate the economy, it will tank the dollar. This dilemma has become more acute as the dollar has fallen during a period when the Fed has taken no action on rates.

And all of these are before we get to the usual prime suspect in a bearish scenario, the housing slowdown. Barry Ritholtz at the Big Picture gives us a his list of sectors affected by the slump (the post has commentary and links for each one) and Nouriel Roubini has asked readers to add to it:

RV Sales
Thoroughbred horse auctions
Convention Centers
Lawnmower mfrs
Outdoor Power Equipment and the small-engine manufacturers
Contractors
Condo/Homeowners’ Associations
Furniture companies
State property and sales tax receipts
Building Materials
Airlines
Auto Suppliers
Construction Equipment
Truckers
Autos

In today’s op-ed piece, “Gilded Once More,” Paul Krugman picks a few factoids to show how our Gilded Age compares to the 19th century original. He finds that even though ours has a kinder face (due no doubt to the proliferation of TVs, fast food, and other creature comforts that make modern poverty look more bearable), the gulf between the top and the average earner is even greater than before.

From Krugman:

One of the distinctive features of the modern American right has been nostalgia for the late 19th century, with its minimal taxation, absence of regulation and reliance on faith-based charity rather than government social programs. Conservatives from Milton Friedman to Grover Norquist have portrayed the Gilded Age as a golden age, dismissing talk of the era’s injustice and cruelty as a left-wing myth.

Well, in at least one respect, everything old is new again. Income inequality — which began rising at the same time that modern conservatism began gaining political power — is now fully back to Gilded Age levels.

Consider a head-to-head comparison. We know what John D. Rockefeller, the richest man in Gilded Age America, made in 1894, because in 1895 he had to pay income taxes. (The next year, the Supreme Court declared the income tax unconstitutional.) His return declared an income of $1.25 million, almost 7,000 times the average per capita income in the United States at the time.

But that makes him a mere piker by modern standards. Last year, according to Institutional Investor’s Alpha magazine, James Simons, a hedge fund manager, took home $1.7 billion, more than 38,000 times the average income. Two other hedge fund managers also made more than $1 billion, and the top 25 combined made $14 billion.

How much is $14 billion? It’s more than it would cost to provide health care for a year to eight million children — the number of children in America who, unlike children in any other advanced country, don’t have health insurance.

The hedge fund billionaires are simply extreme examples of a much bigger phenomenon: every available measure of income concentration shows that we’ve gone back to levels of inequality not seen since the 1920s.

The New Gilded Age doesn’t feel quite as harsh and unjust as the old Gilded Age — not yet, anyway. But that’s because the effects of inequality are still moderated by progressive income taxes, which fall more heavily on the rich than on the middle class; by estate taxation, which limits the inheritance of great wealth; and by social insurance programs like Social Security, Medicare and Medicaid, which provide a safety net for the less fortunate.

You might have thought that in the face of growing inequality, there would have been a move to reinforce these moderating institutions — to raise taxes on the rich and use the money to strengthen the safety net. That’s why comparing the incomes of hedge fund managers with the cost of children’s health care isn’t an idle exercise: there’s a real trade-off involved. But for the past three decades, such trade-offs have been consistently settled in favor of the haves and have-mores.

Taxation has become much less progressive: according to estimates by the economists Thomas Piketty and Emmanuel Saez, average tax rates on the richest 0.01 percent of Americans have been cut in half since 1970, while taxes on the middle class have risen. In particular, the unearned income of the wealthy — dividends and capital gains — is now taxed at a lower rate than the earned income of most middle-class families.

Those hedge fund titans, by the way, have an especially sweet deal: loopholes in the law let them use their own businesses as, in effect, unlimited 401(k)s, sheltering their earnings and accumulating tax-free capital gains.

Meanwhile, the tax-cut bill Congress passed in 2001 set in motion a complete phaseout of the estate tax. If the Bush administration hadn’t been too clever by half, hiding the true cost of its tax cuts by making the whole package expire at the end of 2010, we’d be well on our way toward becoming a dynastic society.

And as for the social insurance programs —— well, in 2005 the Bush administration tried to privatize Social Security. If it had succeeded, Medicare would have been next.

Of course, the administration’s attempt to undo Social Security was a notable failure. The public, it seems, isn’t eager to return to the days before the New Deal. And the G.O.P.’s defeat in the midterm election has put on hold other plans to restore the good old days.

But it’s much too soon to declare the march toward a New Gilded Age over. If history is any guide, one of these days we’ll see the emergence of a New Progressive Era, maybe even a New New Deal. But it may be a long wait.

In an interview with the Financial Times, Larry Fink, the CEO of BlackRock, one of the world’s largest fund management groups, warns of burgeoning risk in the leveraged loan market, arguing it has the potential to go the way of subprimes, and urges the Fed to take interest.

Now this story has more significance than it might seem. Too many investors have been chasing yield, and the result has been that speculative credits, including borrowers that probably shouldn’t be funded at all, are getting loans on very generous terms. But the real news is that someone as prominent as Fink would point to dangers in a particular market. Remember, it’s not in his business interest to raise either investor or regulatory concerns. He must believe it is worth breaking some china in the interest of warding off even worse problems.

However, it seems unlikely his warning will get much of an audience in the US. The Wall Street Journal not only did not pick up on his comments (or independently report on the leveraged loan market), but in a separate story, also put a positive spin on a Bank of England report that warned of increasingly lax lender behavior.

From the Financial Times:

Lenders to highly indebted companies are making the same mistakes that undermined the US subprime mortgage market, suggesting the leveraged loan market will become “tomorrow’s problem”, says the chief executive of BlackRock, the $1,000bn-plus fund management group.

The comments from Larry Fink highlight the rising debt levels, falling risk premiums and loosening standards in loans made to leveraged buy-out vehicles and other junk-rated groups.

“If I was the chairman of the Federal Reserve, I’d be paying more attention to that because, to me, this is going to be tomorrow’s problem,” Mr Fink said in an interview with the Financial Times. “Standards have deteriorated to levels that we never even dreamed that we would see.”

His comments coincide with a warning from the Bank of England which says today that the surge in cheap corporate lending with looser credit standards “has increased the vulnerability of the [global financial] system”. The Bank also cautions against weakening standards of risk assessment when bank loans are repackaged and sold on to the rest of the financial system….

The biggest reason for weakening lending standards is plentiful liquidity and consequent strong investor demand, Mr Fink said.

He said he was also worried that so many investors are moving into illiquid “alternative” investments such as hedge funds and private equity, a potential concern in any downturn.

Aggressive lending is also supporting the private equity industry, and Mr Fink said any credit slump would have a knock-on effect on private equity groups such as Blackstone.

This is four years too late, but for those readers (particularly those outside the US) who wonder how Americans were conned into believing going into Iraq was warranted and desirable, watch this video (or read the transcript). The Bush Administration disinformation wouldn’t have worked if the press had exhibited any backbone. This documentary goes through this sorry chapter, one which is far from over:

http://www.pbs.org/moyers/journal/btw/watch.html