naked capitalism

Submitted by Edward Harrison of Credit Writedowns.

Down 1.5% was the consensus expectation. But Q1 was revised down to minus 6.4% from 5.5%. The GDP Deflator for Q2 came in at 0.2%, which shows that disinflation risks tipping into deflation still.  The dollar is weaker and the short end of the treasury curve is up massively on these data and revisions.

Also, as I indicated Wednesday, the 2008 numbers were revised down. Q1 2008 was revised from positive 0.9% to negative –0.7%. Q2 2008 was revised way down as well from 2.8% to 1.5%.  Q3 2008 was also very negative, now –2.7%. This confirms the December 2007 recession call.

There was a $140 billion reduction in inventories in Q2.  I have been saying for some time that this would set us up for lots of upside come Q3 and Q4 as the inventory purge dissipates.  So, we will get a technical recovery in my opinion. The question is whether there is any underlying demand uptick behind the inventory changes. In the data below from the BEA website, you can clearly see highlighted in red on the right that consumers are not even spending on basic items.  Spending on non-durable goods was down 2.5% annualized.  That is not good.

My overall take here is this:

• The downward revisions to 2008 should have been expected. They confirm how deep the mild depression was.  It started in December 2007, creating a weak economy early in 2008, and only intensified due to the meltdown post-Lehman.  Those like Larry Kudlow who were saying well into 2008 that no recession was going to occur were misguided.
• Because inventories have been purged so much in Q1 and Q2, I fully expect much better numbers in Q3 and Q4.  Remember, a less negative inventory number translates into a net ADD to GDP.  So, we don’t need to build inventories, only purge them less.  That’s a guarantee for Q4 if not Q3.
• However, the fly in the ointment is consumer demand. It  is still weak.  Look at non-durable spending.  If we don’t see a significant uptick come Q3, you should be worried.
• My call for Q4 2009 or Q1 2010 end to the recession still stands.

BEA release:

Real gross domestic product — the output of goods and services produced by labor and property located in the United States — decreased at an annual rate of 1.0 percent in the second quarter of 2009, (that is, from the first quarter to the second), according to the "advance" estimate released by the Bureau of Economic Analysis. In the first quarter, real GDP decreased 6.4 percent.

The Bureau emphasized that the second-quarter advance estimate released today is based on source data that are incomplete or subject to further revision by the source agency (see the box on page 3). The "second" estimate for the second quarter, based on more complete data, will be released on August 27, 2009.

The estimates released today reflect the results of the comprehensive (or benchmark) revision of the national income and product accounts (NIPAs). More information on the revision is available on BEA’s Web site at www.bea.gov/national/an1.htm, including links to an article in the March 2009 issue of the Survey of Current Business that discussed the changes in definitions and presentation that have been implemented in the revision and to an article in the May Survey that described the changes in statistical methods. The September Survey will contain an article that describes the results of the revision in detail. The Web site also contains FAQs and other information about the revision.

Submitted by Leo Kolivakis, publisher of Pension Pulse.

Last week, I reported on PSP Investments’ terrible 23% loss in FY 2009. I think it is worth going over the FY 2009 annual report to try to understand where they lost money.

Let’s begin on page 4, the Chair’s report, where Mr. Cantor states the following:

Our continuing diversification could not entirely shelter PSP Investments from the worst effects of the financial crisis. PSP Investments recorded a 22.7% loss during fiscal year 2009. We continue to believe that our portfolio represents solid long-term value and we expect our unrealized losses to recover when markets eventually return to health.

A critical question is how is PSP Investments positioned to respond to what happens next? For the next 21 years, PSP Investments’ inflow of funds is expected to exceed our obligations to pensioners. Unlike many funds, we have no pressing short-term obligations to pensioners that will force us to sell assets today at distressed prices. In this highly fluid and uncertain market environment, it is extremely important to remain patient and grounded in our decision making if we are to take advantage of our substantial liquidity for the benefit of our stakeholders. To do so, it is critical that we move ahead on our goals and objectives.

Could not entirely shelter PSP? Mr. Cantor, PSP got whacked in FY 2009 as diversification failed miserably (except for government bonds)! The Fund underperformed its policy portfolio by 5.1% (-22.7% vs. -17.6%; click on image above to view results). This isn’t just a bad year; it’s a disaster.

Yes, PSP will have inflows over the next 21 years but if you continue losing these amounts, it will take you many years before you recoup those losses. In the meantime, I guess you can continue compensating your senior managers the big bucks based on some “soft objectives”.

On page 5, you state:

PSP Investments’ Compensation Policy is designed to attract and retain talented employees, reward performance and reinforce our business strategies and priorities. As is the case throughout the investment industry, variable incentive compensation is the most important component of the total compensation offered to executives and portfolio managers.

Attract and retain talented employees? I know of a few who warned you about the credit crisis and the failure of diversification but they were let go on dubious grounds. What exactly was the turnover rate at PSP Investments in the last five years and what were the key departures at the senior management level over that period?

Let’s move on to the President’s report. On page 7, Mr. Fyfe opens up by stating:

After three years of first quartile performance amongst large Canadian Pension Plans, outperformance is lagging that of our peers in fiscal year 2009. Our four-year average, on the other hand, remains at the median when compared to our peers.

Ah, the old peer argument. When you are wrong, seek refuge with the rest of the pension herd who performed miserably. Well not all your peers were chasing alpha in high risk assets. Some of them had the foresight to protect their downside risk by investing in bonds. And none of PSP’s peers underperformed their policy portfolio by a whopping 5%.

On that last point, Mr. Fyfe states the following on page 8:

Our Policy Portfolio’s benchmark had a return of negative 17.6%, primarily as result of the sharp decline in global public equity markets. While we are disappointed with our relative performance, our underperformance is mainly attributable to additional write-downs on our asset-backed commercial paper and collateralized debt obligations investments which impacted our total return by negative 3.0%. Our Real Estate portfolio, with an annual return of negative 16.8% also underperformed its benchmark of positive 6.6%, impacting our relative return by negative 2.4%. Over a five-year period, our Real Estate portfolio has recorded an annualized return of 9.3%, outperforming its benchmark by 2.2%.

So 3% of that 5% underperformance relative to the Policy Portfolio came from their asset-backed commercial paper (1%) and collateralized debt obligations (2%). Interestingly, there was no mention of the credit portfolio losses in the highlights of the report. When I went over FY 2008 losses last year, I noted the following statement from PSP’s president:

There are very little, if any, credit losses in both ABCP and CDOs and the possibility of recovering the nominal investment value in a subsequent period is probable if general credit conditions improve. The losses were not allocated to any particular asset class but are included in PSP Investments’ total return.

Oops, general conditions did not really improve and they had to write these assets down further. But hey, no worries, these assets were not allocated to any particular asset class so nobody is responsible for that investment blunder!

Moreover, why does PSP insist on using the politically palatable term “collateralized debt obligation” portfolio when Diane Urquhart clearly demonstrated that PSP was taking undue risks selling credit default swaps?

But 2.2% of the underperformance was attributable to the -16.8% return in the Real Estate portfolio. Wow, what a shocker! Back in 2005, when I was still employed at PSP, I remember sending an article to the then First VP Real Estate, André Collin, and senior management, on how Tom Barrack, the world’s best real estate investor, was cashing out.

My actions drew an irate response from Mr. Collin, but I trusted my judgment and Mr. Barrack a lot more than I trusted Mr. Collin. There was something that Mr. Barrack said that still rings true today: “There’s too much money chasing too few good deals, with too much debt and too few brains.”

And where is Mr. Collin today? He is long gone from PSP Investments after cashing in on a couple of exceptional years where he handily beat his bogus benchmark. He signed off and left the organization right before the real estate crisis hit. It would be interesting to know exactly why he left PSP and where he landed after reaping a few million dollars in bonuses.

Let’s go back to Mr. Fyfe’s comments on page 8 on the FY 2009 annual report:

Private Market investments had a positive impact on overall results as they outperformed public equities. For instance, our Infrastructure portfolio, the result of our diversification strategy which began in 2004, recorded a positive return of 6.0% outperforming its benchmark of 5.8% for a three-year return (since inception) of 5.5%, 2.2% above its benchmark. Private Equity returned negative 32.3% below its benchmark of negative 31.6% for the year, but is outperforming its benchmark by 0.6% since inception.

Our Private Market investments suffered from fair-value or mark-to-market adjustments which require us to value our assets as if they were for sale as of March 31, 2009. We continue to hold effectively all of the investments for which we have recorded unrealized losses and remain confident in the quality of our assets. In a period when there are few buyers and weak sellers as well as limited transactions, we have to value our private market assets as if they had to be sold during the crisis and in a market with very few comparables. As long-term investors with no pressure to sell our investments in the short term, we measure the progress of our investments by improvements in the fundamentals such as cash flows and earnings. Our principal private market assets are continuing to perform well and according to plan.

And which plan is this? Because from my vantage point, private markets remain vulnerable to further downside risks. Private equity is in a deep freeze and the amount of troubled U.S. commercial real estate loans may double to $100 billion by year end as delinquencies rise and financing remains hard to find. Infrastructure deals are also getting pricey as more pension funds pile into this asset class.

Bottom line: there really is no plan when it comes to private markets. Moreover, PSP still refuses to publish its benchmarks for private markets citing “competitive reasons”. What competitive reasons? Are they afraid someone will poach all their “top talent” away?

But let me not be too cynical, after all, PSP has 21 years to go where their inflow of funds is expected to exceed their obligations to pensioners. By that time, all of the current senior managers will be long gone with enough money to enjoy a golden retirement.

Dear readers, I really did go looking for material, but I didn’t find anything that got my juices going enough to be post-worthy. Apologies.

Fresh hope for world’s fisheries BBC

World’s first computer may be even older than thought Short Sharp Science

Barclays and the monoline minuet FT Alphaville (hat tip Richard S)

Compensation Committees To Be More Like Audit Committees: Okie-Dokie Francine McKenna

China’s corporate world ruled by princes Elite Chinese Politics and Political Economy (hat tip reader Paul S)

Marc Faber: China’s numbers are fake Ed Harrison

Wall Street Analysts Keep Telling Big Earnings Lie David Pauly Bloomberg

The (almost) dollar crisis of 2007 … Brad Setser

Letter to the Queen: Why No One Predicted the Crisis Thomas Palley

Fiscal Policy and Banking Sector Repair Synergies Menzie Chinn

After Rescue, New Weakness Seen at A.I.G. New York Times. The fact set in the article is uglier than the headline.

GSEs Unlikely to Repay U.S. in Full Wall Street Journal (hat tip reader DoctoRx) Quelle surprise!

Billions in Lehman Claims Could Bury an Elusive Insurer New York Times

Bank Bonus Tab: $33 Billion Wall Street Journal

Japan logs record deflation as demand slides Financial Times

Rudd’s essay is on the money Steve Keen (hat tip reader Don B). Today’s must read. On how much we need to delever, and how long it will probably take. The example is Australia, but the implications are pretty sobering for the US. The US private debt to GDP ratio is higher than the level shown for Oz. Makes this humble blogger look like a raging bull.

Antidote du jour (hat tip reader Matthew E):

A wildfire in Santa Barbara, California last month helped forge some unlikely bonds. Rescued from the Jesusita Fire, a 3-week old bobcat kitten and 3 day old fawn became fast friends. The animal rescue in California brought predator and prey together. But these babies simply took comfort in each other’s company, snuggling under a desk at a dispatch office for hours.

The bobcat and fawn would not normally be placed together, due to regulations, but the rescuers had no choice. They snagged the bobcat kitten first, finding it dehydrated and near death. Later, they brought in the fawn and discovered they didn’t have a crate large enough for it. No matter – the kitten ran right over to the fawn, and the two became fast friends.

The organizations that rescued these and other animals in the fire are struggling:

All of these Santa Barbara area animal rescue organizations have put out a national plea for donations because of the overwhelming need for animal food, medicines, and space to house displaced animals. ART currently leases a 1.5-acre plot of land that houses rescued animals in enclosures on the property, which require around-the-clock care, and the organization is desperate to purchase the land. The morning after Di Sieno – along with an insanely cute bobcat cub and fawn photo – appeared on the Ellen Degeneres show – the landowner decided he needed to sell it and she’s concerned for the future of the animals she and her fellow workers just rescued. The WCN also seeks funds for their Oiled and Injured Seabird Rehab Center, and receive no City, State or federal funding. One of their volunteers, Nancy Callahan, runs W.I.L.D.E. Services which focuses on raccoons and opossums, had her home and facility burnt to the ground and must start over from scratch. After rehabilitation, the groups reintroduce rescued animals to the wild.

If you’d like to assist to the tireless dedication of volunteer efforts of the Animal Rescue Team, and the Santa Barbara Wildlife Care Network, please click on the one of the links and make a donation. Every little bit helps.

Submitted by Lune

(N.B.: this post, and a subsequent Part II regarding the legislative process, are focused on the political processes of DC rather than economics per se. However, to the extent that the future of the financial world is now being determined in Washington, I figured there might be some value for Naked Capitalism’s readers in better understanding the processes that are reshaping the economy and the financial industry.)

As the government becomes increasingly involved in the financial world, finance- and economics-types have by now become well acquainted with America’s answer to Japanese Kabuki: the Congressional hearing. Just as Kabuki is famed for its focus on dramatic poses and stylized maneuvers over story or plot, so the modern Congressional hearing now appears to be nothing but a set of ritualized maneuvers and poses (such as the Feigned Outrage, the Somber Gravitas, and the occasional Sleepy Grandfather), performed for the audiences, followed by a quick exeunt with little insight gleaned into the topic at hand.

While both can be highly valued for their entertainment value, Congressional hearings are supposed to have a higher purpose. That hearings have degraded so egregiously is indeed troubling. Yet to really understand the problem, one must place hearings within the context of the larger issue of how Congress informs itself about the issues of the day and uses that information to create policy. In that context, the Congress of today is doing both better and worse than the Congresses of before.

But first to answer the pressing question of the day: are hearings today really so much worse than hearings of yesteryear? Yes. At least the ones we’re interested in. And that’s primarily for two reasons:

1) C-SPAN: Hearings used to be about allowing Congress to gather information from experts / relevant sources so as to inform a committee’s actions; and in the absence of any means to score direct points with the public, that’s what most hearings used to be. But with the intense media coverage that important hearings get these days, they’ve turned into nothing more than scripted media events, with witnesses called not for their ability to illuminate an issue but to make political points, and questions and opening statements all crafted beforehand by staff and fed to the Congressperson for recitation (with appropriate Kabuki-esque melodrama) in front of the cameras.

That said, even today, not all hearings are that bad, for the simple matter that the vast majority of hearings get almost no media attention. Congress holds probably a dozen hearings a day when in session, most of which get dutifully taped by CSPAN and filed away in archives with nary a viewer or listener outside the beltway. You can get the schedule for any given day on THOMAS (and yes most of the hearings are as painfully boring as their titles imply…). In my experience, the hearings with the least amount of public interest tended to be closest to the ideal. While the topic may be mundane or arcane, without the pressure of media attention, there’s usually much more of a focus on gaining information. Unfortunately, this means that the most pressing issues of the day, generating the most public interest, tend to get the worst kabuki-type hearings, while the ones of least public interest are conducted in a more worthy fashion.

2) To counterbalance this tendency, however, Congress now has immeasurably better ways of gaining information than conducting hearings. Hearings were a relic of a time before telephones and rapid transit, when no piece of information traveled faster than a horse, and when just getting the experts together for a frank and spontaneous exchange was no small feat. These days, if a Senator wishes to speak with a panel of economists, he could get them on a conference call, if not have them fly in for an impromptu private discussion (not to mention he could read all their papers without having to meet them at all). In other words, part of the reason hearings have become so worthless for their original purpose is because their original purpose is often better served with more modern methods of information gathering.

A useful analogy is to the Library of Congress: originally the LoC was chartered to serve as a central repository of all the world’s information so as to make it easily available to Congress. At the time of the LoC’s founding, if a Congressperson was interested in an issue and wanted to learn how it affected both California and New York, and also read about how France and Britain addressed the same problem, he could write letters to a dozen libraries and government archives around the world, then wait six months as the requested materials slowly arrived, all the while hoping that there wasn’t some critical source that he didn’t know about and consequently didn’t request. Thanks to the LoC, he could instead send one request, and the LoC would search its extensive holdings that it had already painstakingly gathered, and send back an extensive (and frequently exhaustive) package of materials within a few days.

But now, when much of the world’s information can be looked up instantaneously on the internet, a Senator’s access to Google and LexisNexis is far more valuable. Yes, the LoC is still unbeatable when you need to hunt down some obscure or ancient source, but for the important issues of the day, the LoC is no longer needed.

On balance, the volume and quality of information available to Congress now, when all sources are taken into account, are vastly better than they were decades ago. It’s just that hearings are the public face of that information-gathering process, and they have degraded as they’ve become less useful.

So to answer our original question: are hearings useless these days? For the important issues of the day? Yes. But to address the broader point, does Congress have better or worse access to information than before? Undoubtedly better.

And now for a more subtle question: for all this extra information, is Congress actually better informed than before? Not necessarily. And that brings up the final wrinkle in Congress’s information gathering process.

As information has become more voluminous, specialized, and complicated, Congress very rarely uses primary research, since most elected officials and their staff are not academics or able to keep current with nor understand academic research. Conversely, as the process of legislating has become more complex, fewer researchers have a feel for how to translate their findings into policy proposals.

I’d assert that as a result, most staffers in DC get their policy ideas not from original academic work but from think tanks (a term I apply broadly to many foundations and public interest / advocacy groups). This isn’t because staffers don’t value academic work, but rather because it’s frequently difficult to translate academic findings and recommendations to fully fleshed out, politically viable solutions. And that’s frequently what think tanks do.

For example, an academic publishing a paper on the harmful effect of options volatility isn’t nearly as useful as an economist in a think tank who takes that paper and drafts a proposal for changing the CFTC guidelines to reduce that volatility. The academic economist usually doesn’t understand specific CFTC rules (although they probably understand the general regulatory environment), and the staffer usually doesn’t understand the arcana of Black-Scholes equations (although they probably understand the concept of options volatility and its side effects). The think tank economist can bridge that divide.

While this is all well and nice, lobbyists have figured out this weak link, and have taken advantage of it. While it’s fairly difficult for lobbyists to influence academic work (thanks to the long histories of most reputable departments, tenure, peer review, and the inbred nature of the ivory tower), it’s very easy to influence think tanks, and even set up whole think tanks for your own purposes. The conservative movement, for example, figured this out, and rather than fight for influence within “liberal” academic departments, created think tanks like the American Enterprise Institute, the Heritage Foundation, and the Cato Institute to bypass academia.

This hasn’t gone unnoticed by other lobbying firms. The most sophisticated lobbying efforts now center around surrounding policy makers within a world created and sustained by the lobbyists themselves. Thus, you have lobbyist-funded original research in academia, lobbyist-created think tanks translating that academic data into legislative proposals, lobbyist-sponsored mediagenic experts to go on TV / newspapers advocating those proposals and setting the terms of the debate, and lobbyist-generated astroturf (i.e. fake grassroots) campaigns to simulate voter approval and public pressure. Quite a far cry from when lobbyists literally just stood in the lobby of the Senate floor begging for a few minutes of the Senators’ time.

So in summary, hearings have become media non-events because they have been supplanted by more modern information gathering tools (while becoming more useful as PR thanks to CSPAN). The rise of those tools means Congress has access to more and better quality information than ever before. Yet the increasingly specialized and complicated nature of that information (and of the policy process) means there is a longer pipeline to digest that information and translate it to public policy. And finally, the longer that pipeline grows, the more vulnerable it has become to influence from lobbyists and other groups.

How this and other changes have affected the legislative process will be addressed in a subsequent post. Stay tuned!

Submitted by Leo Kolivakis, publisher of Pension Pulse.

The NYT reports on how firms wooed a U.S. agency with billions to invest:

As a New York money manager and investment banker at four Wall Street firms, Charles E. F. Millard never reached superstar status. But he was treated like one when he arrived in Washington in May 2007, to run the Pension Benefit Guaranty Corporation, the federal agency that oversees $50 billion in retirement funds.

BlackRock, one of the world’s largest money-management firms, assigned a high school classmate of Mr. Millard’s to stay in close contact with him, and it made sure to place him next to its legendary founder, Laurence D. Fink, at a charity dinner at Chelsea Piers. A top executive at Goldman Sachs frequently called and sent e-mail messages, inviting Mr. Millard out to the Mandarin Oriental and the Ritz-Carlton in Washington, even helping him hunt for his next Wall Street job.

Both firms were hoping to win contracts to manage a chunk of that $50 billion. The extensive wooing paid off when a selection committee of three, including Mr. Millard, picked BlackRock and Goldman from among 16 bidders to manage nearly $1.6 billion and to advise the agency, which Mr. Millard ran until January.

But on July 20, the agency permanently revoked the contracts with BlackRock, Goldman and JPMorgan Chase, the third winner, nullifying the process. The decision was based on questions surrounding Mr. Millard’s actions during the formal bidding process. His actions have also drawn the scrutiny of Congressional investigators and the agency’s inspector general.

An examination of thousands of pages of e-mail messages and other internal documents obtained by The New York Times shows the other side of the story: the two firms aggressively courted Mr. Millard, so extensively that they may have compromised federal contracting rules or at least violated the spirit of the law, contracting experts said. The records also illustrate the clash between Washington’s by-the-letter rules on contracting and the culture of Wall Street, where deals are often struck over expensive meals.

“Both sides should have known better,” said Steven L. Schooner, co-director of the Government Procurement Law Program at the George Washington University, who reviewed some of the material for The Times. “What happened here is wrong, stupid and probably illegal.”

BlackRock and Goldman, as well as Mr. Millard, all said that nothing improper happened either before the formal competition for the contract started last July, or while the competition, which concluded in October, was under way.

“Among the reasons that Mr. Millard was selected to head the P.B.G.C. is his understanding of the industry, his extensive background and the quality of his professional relationships,” said Stanley M. Brand, a lawyer for Mr. Millard. “He correctly separated his personal relationships from his official actions.”

A review of the documents shows that the third winner, JPMorgan Chase, had contacts with Mr. Millard before and during the competition, but did not display the same intensity as the other two.

Goldman and BlackRock saw Mr. Millard’s selection as a major business opportunity, the records show.

“This is a very big fish on the line,” one BlackRock executive wrote to another, discussing the government official.

Mr. Millard had at least seven meetings with Goldman executives in the year before the bidding started, and 163 phone contacts, the documents show. BlackRock had less frequent contact — 39 phone calls in that 12-month period. But one BlackRock executive told another that Mr. Millard had assured him in April, four months before the bidding, that he wanted to hire the company to help manage some of the money, company documents show.

“It sounds like we may have a tiger by the tail here,” one BlackRock executive wrote in an e-mail message.

The agency takes over pension programs when private companies go bankrupt. For years there was talk it might have to be bailed out by the government, and Mr. Millard, like many others, saw shifting from low-yield conservative investments like Treasury bonds to those with higher risks and higher potential returns as a way to solve the problem.

Before coming to Washington Mr. Millard had been a money manager for Prudential Securities and Lehman Brothers, a senior economic development official in New York City while Rudolph W. Giuliani was mayor, a member of the New York City Council and a Republican nominee for Congress.

Within weeks of his arrival at the agency, he told Goldman Sachs about his plans to shake up the agency’s portfolio.

“I just became head of the pension benefit guaranty corp in dc appointed by pres bush,” he wrote in a June 2007 e-mail message to John S. Weinberg, a vice chairman and a member of the family that has helped run Goldman since the 1930s. Mr. Millard told Mr. Weinberg, a longtime acquaintance, that he wanted to revamp the agency’s investment strategy.

“Is there a team at Goldman that does this and that would be interested in pursuing this business?”

“Yes, absolutely!” Mr. Weinberg wrote back.

Almost immediately, Goldman started to work informally for Mr. Millard by providing one of its top pension analysts at no charge to prepare at least six reports over the coming year, based on internal agency data, detailing possible investment strategies.

Goldman also coached Mr. Millard as he sought to sway skeptics in the Bush administration.

“Here is the sound bite we discussed in this morning’s meeting,” wrote Mark Evans, a Goldman managing director, in a January 2008 e-mail message to Mr. Millard, seven months before the formal competition would begin.

Mr. Millard consulted with other industry experts during this period, but none so much as Goldman. George Koklanaris, Mr. Millard’s chief of staff, said in retrospect that the detailed analytical work Goldman did for Mr. Millard, and the repeated contacts, might have created an appearance that Goldman had a competitive advantage. Even so, he says he believes Mr. Millard did nothing improper.

Mr. Millard’s lawyer and a Goldman spokeswoman disputed that the firm gained any advantage from this work. The spokeswoman, Andrea Raphael, said the firm had no way of knowing that Mr. Millard was giving them more attention than other prospective bidders and that it was the agency’s job to identify potential conflicts.

The most important player in BlackRock’s attempt to win the business was David Mullane, who had known Mr. Millard since the two attended the same high school. The friendship continues; they both live in Rye, N.Y., and attend the same church.

In his conversations and e-mail messages with the agency head, Mr. Mullane often mixed family and business, talking about his golf game, his vacations, their children, their church (“Great job at Mass again this week,” he wrote in one), invariably shifting into a discussion of his interest in the government work.

“Hope to see you at the Beefsteak Dinner tomorrow,” he wrote to Mr. Millard, referring to a Friday night gathering at Church of the Resurrection in Rye. “If you’re going perhaps we can catch up business for a few minutes before I thrash you in ping pong again.”

After a February meeting, months before the contract competition began, Mr. Mullane wrote his bosses: “Money in motion by February.”

There were more meetings through the winter and spring of 2008, as Mr. Millard prepared his plans. That April, there was a charity dinner at Chelsea Piers, along the Hudson River. One BlackRock executive wrote to another, “Try to get Larry seated next to Charles Millard,” referring to Mr. Fink, the company’s chairman and chief.

After the dinner, Mr. Millard wrote to Mr. Fink, “A pleasure meeting you. No need to respond. I will follow up with you briefly in future re our investment policy and with your team re other specifics.”

The e-mail messages show that Mr. Mullane, a managing director at BlackRock, understood that the firm needed to move quickly, before the presidential election.

“He is a lame duck political appointee as soon as the November election occurs,” he wrote to one BlackRock colleague last June, as the bidding was about to start. “When the new man comes in at P.B.G.C., all bets are off for us.”

As he prepared to open the competition, Mr. Millard, working with Mr. Mullane, sought to restrict the bidders to the biggest players by stipulating that the winner must have thousands of employees and a global operation, e-mail messages show. That decision cut out many boutique firms hoping to compete and gave BlackRock, Goldman and other large firms an advantage. “Neither the company nor any of its employees did anything improper or illegal,” Bobbie Collins, a BlackRock spokeswoman, said.

Mr. Millard, through his lawyer, denied telling BlackRock that he wanted to select the company even before the competition started. Mr. Millard’s lawyer also said he told the agency about his friendship with Mr. Mullane. But Jeffrey Speicher, an agency spokesman, said in a written statement that Mr. Millard “did not disclose his relationship with the BlackRock executive.”

While the competition was getting started, Mr. Millard began his job hunt.

He started by contacting Mr. Weinberg of Goldman Sachs, sending him his résumé after meeting with him in New York last June.

Mr. Millard’s e-mail messages show that, while the bidding was under way last fall, he also spoke with Rick Lazio, a former House Republican who is now a senior executive at JPMorgan Chase, to discuss career options.

In both cases, spokesmen for the executives said that while Mr. Millard was at the agency, they did not take actions to help him find a new job.

The e-mail messages show that within two weeks of the selection of the winners, Mr. Millard sought help from Karen Seitz, a Goldman executive involved throughout the process, in getting interviews with prominent industry players.

“I spoke with Dennis Kass after our meeting,” Ms. Seitz wrote last November, referring to the chief executive of a $60 billion asset management firm, one of half a dozen interviews she arranged. “He would love to meet with you in N.Y.”

To date, Mr. Millard remains unemployed. His lawyer noted that Mr. Millard had honored the one-year prohibition in federal law against negotiating a job with a firm that he helped select as a contractor. While still at the agency, his lawyer said, Mr. Millard also paid his own bill whenever he dined out with industry officials, including Ms. Seitz.

But Mr. Schooner, the government contracting expert from George Washington University, said even asking for career help from a company he had just picked as a contractor raised serious questions.

“As a federal official you are not supposed to be discussing, bartering or leveraging a new job while you are involved with parties in a procurement,” he said. “It is a clear black-and-white rule.”

Senator Herb Kohl, Democrat of Wisconsin, plans to seek legislation to require more intense oversight of the agency by an expanded board.

“The whole process was flawed,” said Mr. Kohl, the chairman of the Senate Special Committee on Aging, which oversees the agency.

More intense oversight of the PBGC? It couldn’t come soon enough. We also need stiffer penalties for firms and pension fund managers that routinely cross the ethical boundaries. Remember that old Greek saying, he who has honey on his fingers can’t help but lick them.

Jellyfish help to stir the ocean BBC

Did an ice age boost human brain size? New Scientist (hat tip reader John D)

The Day the President Turned Black (But has he turned back?) Greg Palast

The Health Care Bill Dies? Matt Taibbi (hat tip reader John D)

Flipping Out David Adler, The Big Money. Statistics books need to be rewritten.

Hurrying Into the Next Panic? Paul Wilmott, New York Times

75% Favor Auditing The Fed Michael Shedlock

US 5yr Bond Auction Effectively FAILS Karl Denninger (hat tip reader Scott). Not certain he has this right. BTW.

Should Fed chairmen go around kissing babies? Willem Buiter

Lucrative Fees May Deter Efforts to Alter Troubled Loans New York Times. This is useful, but why has it taken the MSM this long to drill into what the fee and incentives are? The reluctance to do mods has been a political issue for at least a year.

Smaller banks will not make us safer Josef Ackerman, Financial Times. Quelle surprise! The head of a very big bank, Deutsche Bank, defends big banking! I wish I had time to shred this. He has some valid observations, particularly his headline point about interconnectedness, but a fair bit of the rest was spurious.

Washington risks taking China too seriously David Pilling, Financial Times

GFC Cures – Placebo Effects Satyajit Das, RGE Monitor. A colorful and thorough overview.

Squeezing out the exporters Michael Pettis. Important.

Antidote du jour:

Didn’t Henry Paulson promise us the TARP was an investment and the taxpayer might even show a profit? Shows the dangers of buying what an ex-Goldmanite is selling.

The TARP losses, as estimated by Ethisphere, are $148 billion as of June 19, so it is a bit dated. The flip side is I am hearing word that we may have more money disappear into the AIG black hole in the coming months. Since AIG has only used $134 billion of the $180 billion authorized (only with AIG and the DoD can you say something like “only $134 billion”), another leg down may not mean an increase in the commitment.

The TARP tally presents its methodology and has a sense of humor. For instance, it has a category of “Calamity Investments” ( Bank of America, Citigroup, JP Morgan, Wells Fargo and AIG).

From Ethisphere (hat tip Robert Oak):

According to the Ethisphere TARP Index, when markets closed on Friday, June 19, 2009, the government’s Troubled Asset Relief Program (TARP) investment was down approximately $148.2 billion. Created by the Ethisphere Institute, a non-partisan research think-tank, the Ethisphere TARP Index tracks the U.S. Federal Government’s return on its investments under the capital purchase portion of TARP and the government’s accompanying loan guarantees provided to Bank of America and Citigroup. With ten of the nation’s leading banks now having paid back their TARP funds, these investments stand at $510.7 billion. To date, each taxpaying household has lost $1,233.

“The $68 billion pay back of TARP funds caused a drop in the bottom line of the Ethisphere TARP Index, but the overall percent decline didn’t see much change,” said Stefan Linssen, Managing Editor of Ethisphere Magazine and one of the lead research analysts behind the Ethisphere TARP Index. “Aside from the large asset guarantees of Citigroup, the last big heavyweights in the Index now are Bank of America, AIG, Citigroup’s CPP money and Wells Fargo, and unfortunately, they are still weighing down the Index. However, with the pay back of TARP money this past week, taxpaying households did see a decrease in the losses they have suffered under TARP, going from $1,361 to $1,233.”

A new dynamic appears to be emerging on the housing front. Heretofore, foreclosures were strongly correlated with where the mania had been most acute. California, Florida, and Arizona in particular showed dramatic declines in prices. But now as those markets have corrected to a considerable degree, foreclosure activity is now starting to be a function of increasing unemployment.

From Reuters:

Cities in the U.S. Sun Belt states of California, Florida, Nevada and Arizona dominated the record foreclosure spree in the first half of the year, but distress in other regions emerged as joblessness spread, RealtyTrac said on Thursday…

Mortgages have failed the fastest in the areas with the greatest overbuilding, purchases by speculators and reliance on riskier loan products to improve affordability.

But the source of the mortgage trouble has swung from lax lending standards to unemployment.

Some of the areas with the most severe foreclosure activity have started to show improvement as price cuts and first-time buyer tax credits lure purchasers…

More than 20 percent of areas with above-average foreclosure activity were in Oregon, Idaho, Utah, Arkansas, Illinois and South Carolina in the first half of the year. That shift points to growing unemployment more than to fallout from subprime and adjustable-rate loans, RealtyTrac said in its midyear metropolitan foreclosure market report.

While total foreclosure activity kept rising, “some of the markets that had the highest saturation of foreclosures over the past few years have seen declining rates, while new markets like Provo, Utah, and Boise, Idaho, have seen large increases,” James J. Saccacio, chief executive officer of RealtyTrac, said in a statement…

“As unemployment rises, we are seeing a change in the financial profile of the people seeking our help,” Suzanne Boas, president of Consumer Credit Counseling Service of Greater Atlanta, said this week.

“We are serving an increasing number of people who work in professional services and skilled trades,” she said. “These people have maintained solid incomes their entire lives, but are now in financial trouble and are reaching out for counseling to help avoid foreclosure.”.

Submitted by Leo Kolivakis, publisher of Pension Pulse.

The Boston Globe reports that Mass. pension fund posts big loss:

Hurt by the steep decline in the stock market last summer, the Massachusetts state pension fund reported its worst year in its modern history.

The fund lost 23.6 percent, or $12.8 billion, in the fiscal year that ended June 30, according to Michael Travaglini, executive director of the Massachusetts Public Reserves Investment Management Board, which runs the state pension fund. Assets are now down to $37.8 billion.

Historically one of the top public pension funds in the country, Massachusetts is now likely to rank among the worst performers for the past year among all major funds tracked by Wilshire Associates. It is also the first time since 2002 the fund performed worse than average.

The fund’s performance could spell trouble for its chairman, state Treasurer Timothy P. Cahill, as he contemplates a run for governor. Cahill dropped out of the Democratic Party earlier this month and is expected to run as an Independent in next year’s election. He has increasingly criticized Governor Deval Patrick’s fiscal management of the state.

But as pension board chairman, Cahill has taken an active role in the management of the fund. In 2004 Cahill pushed to invest in so-called absolute return hedge funds, which strive to make money regardless of the overall market’s performance. Such investments, he argued, would limit losses during periods when the US stock market posts steep declines.

That has worked–to a degree. The state fund has considerably less of its money invested in US stocks than five years ago, and the hedge fund component of its portfolio declined much less last year than did its stock holdings. But the Massachusetts fund still had a large exposure to stocks of foreign companies–25 percent–greater than what most other public pension funds maintain. Foreign stocks performed just as poorly as US stocks last year, down 31 percent.

Meanwhile Massachusetts has lower levels of bond holdings than other public funds. That investment made money–up 4.3 percent–in the fiscal year.

“Given those weightings,” Travaglini said, the state fund “will outperform during bull markets and underperform during difficult equity markets.”

Travaglini said the board will re-evaluate its investment strategy at its next meeting on Aug. 5.

Some of the poor performance was attributed to failings of fund managers hired by the state agency. Four fund managers were fired within the last year including one–Austin Capital Management–that lost $12 million to convicted swindler Bernard L. Madoff. And in April, the pension fund replaced its long-time alternative funds consultant, Cliffwater of Marina del Rey, Calif., with Ennis Knupp & Associates of Chicago.

Travaglini said the fund would have lost only 20 percent if it had simply invested its money in index funds — rather than hand-picking stocks and other investments.

So how are hedge funds doing nowadays? Bloomberg reports that hedge funds had a record rally last quarter:

Hedge funds had net inflows of $6.2 billion and returned an average 0.2 percent in June, rounding off a record three-month rally, Eurekahedge Pte said.

The advance by the Eurekahedge Hedge Fund Index, tracking more than 2,000 funds, follows 3.2 percent and 5 percent gains in April and May, respectively, and brings its 2009 advance to 9.5 percent, according to a report by the Singapore-based research firm.

Hedge fund managers are making a comeback after suffering their worst year on record in 2008, outperforming global benchmarks including the MSCI World Index, which rose 4.8 percent in the first six months. Hedge-fund assets rose for the second consecutive month in June, the first back-to-back increase in a year, bringing total assets under management to $1.33 trillion, the report said.

Gross inflows to the industry totaled $19.2 billion last month, compared with $13 billion in redemptions that were mainly from so-called funds of hedge funds, as investors sought to lower fees and optimize returns by investing directly, the report said.

Assets of funds invested in Latin America rose 1.8 percent in June from May to $44.7 billion, the biggest percentage increase among five geographical categories, on the view that markets in this region will recover along with the economies as demand for commodities increases, the report showed.

Manager allocations to Japan followed with a 1.5 percent increase to $13 billion, while those for Asia ex-Japan and North America each recorded 0.5 percent increases to $93.3 billion and $877.4 billion, respectively. Assets of funds investing in Europe were little changed at $304.4 billion, Eurekahedge said.

Event-Driven Funds

By strategy, managers of so-called event-driven funds that invest in companies such as those involved in mergers and acquisitions had the largest increase in capital, gaining 1.5 percent with inflows of $2.2 billion, as investors bet that an increase in deals will offer lucrative opportunities, Eurekahedge said. An index tracking the strategy has gained 19.1 percent in the first half of 2009, making it the best performer, the report said.

In May, hedge-fund assets increased by a net $38 billion, the report showed.

Eurekahedge’s global index slid 12 percent last year, the most since Eurekahedge began tracking data in 2000. The firm released a preliminary report last week on June performances.

Hedge funds are mostly private pools of capital whose managers participate substantially in the profits from their speculation on whether asset prices will rise or fall.

Finally, David Prosser of the Independent writes: At last, some good news for hedge funds:

There is good news in sight for the beleaguered hedge fund industry courtesy of our friends in the US.

Grimly aware that a European Commission crackdown on regulation of hedge funds and private equity spells disaster for the EU’s predominantly London-based industry, Treasury ministers have been desperately lobbying their counterparts in Brussels for months, but their pleas have fallen on deaf ears.

Now, however, the Americans have woken up to the fact that many of their hedge funds would find it impossible to do business in the EU under proposals for regulatory reform. In recent weeks, US Treasury officials have thus been touring the EU, letting their displeasure be known.

It appears that the Americans’ involvement is already paying dividends. Sweden, which holds the EU presidency, was quietly letting it be known yesterday that it will ensure some sort of compromise is brokered. The Alternative Investment Management Association, which represents the sector’s interests, now thinks disaster may be averted.

That’s good news for London. Hedge funds and private equity investors have been popular whipping boys in this country for too long. Before the credit crunch, the fashion was to accuse the latter of asset-stripping and profiteering. Once the crisis began, the focus moved to greedy hedge funds and dishonest short selling, though not a scrap of evidence of wrongdoing has ever been produced.

By all means dislike them if you must, but London’s 450 or so hedge funds manage about £250bn and employ, directly and indirectly, 40,000 people. We simply can’t afford to allow the business to go up in smoke thanks to a knee-jerk reaction from European regulators.

The real good news for hedge funds is that the markets keep grinding higher. Most hedge funds charge alpha fees for leveraged beta. Sure, they package it nicely, slap on some “risk management” and peddle it through a network of slick salespeople, but at the end of the day, it’s “disguised beta”.

They also got the politicians in their back pockets so I do not expect any major regulatory reforms. And while they collect 2 & 20 for their “alpha”, the rest of society watches the stock market and their portfolios go up and down like a yo-yo.

The irony in all this is that people’s pension contributions are feeding all this volatility. Great news for hedge funds but I am not so sure what it means for the rest of society.

Scientists sound Oceania extinction warning ABC (hat tip reader Skippy)

Blue M&Ms ‘mend spinal injuries’ Telegraph (hat tip reader John D). I guarantee more of you will read this one than the more important story above.

‘No doubt’ sunbeds cause cancer BBC

Robotic firefighting team debuts BBC

City Aids Homeless With One-Way Tickets Home New York Times

CFTC: Speculators caused 2008 oil price crisis Raw Story. We said something considerably more cautious at the time, but did say it repeatedly, namely, that the price runup could not be explained fully by fundamentals, and we got yelled at a lot, both here and elsewhere.

State Construction Surges on First Day in Shanghai Bloomberg (hat tip DoctoRx) Content is better than title. An overview of state of markets in China.

U.S., China Pledge to Sustain Stimulus, Rebalance World Growth Bloomberg. Um, a lot of talk about more US savings and less China export dependence. But how will the US get manufacturing back? The inattention to the real economy is striking. And the piece make much of US consumer savings rising, when the government debt has risen by a corresponding amount. Earth to base: the US will not delever unless we have a trade surplus or default. Those are the options. We could default through inflation, but we just promised the Chinese we won’t do that.

Three Pictures: China’s Exchange Rate and Trade Balances Menzie Chinn, Econbrowser. Another view.

Japan Retail Sales Fall for 10th Month on Job Losses Bloomberg (hat tip reader DoctoRx)

Subprime mortgage companies warn on U.S. foreclosures Reuters. They are trying to dress it up more nicely, but basically, it isn’t worth their time to do mods. We did say early on the servicer incentives were inadequate. Not that I am keen about bribing them, mind you, a quick kick in the rear would be better.

Wars, plagues, and Europe’s rise to riches Nico Voigtländer, Hans-Joachim Voth, VoxEU

“Why had Nobody Noticed that the Credit Crunch Was on its Way?” Mark Thoma. I take exception to that.

Antidote du jour (hat tip reader Kevin S):

The SEC is pursuing a rather odd case, odd in the sense that while the media is getting very excited about it, it strikes me as having perilous little general applicability.

The broad strokes via the Financial Times:

The US Securities and Exchange Commission’s attempt to use – for the first time – a “clawback” law against an executive who is not accused of any wrongdoing marks a new hard-hitting approach at an agency under pressure to restore its reputation.

Until now, the SEC used the provision in the 2002 Sarbanes-Oxley law to go only after individuals it had accused of being involved in fraud and, even then, made its first settlement invoking that law some five years after it was adopted…

The clawback provision in Sarbanes-Oxley, passed in the wake of massive accounting frauds at Enron, Worldcom and other companies, requires executives to return performance-based pay and bonuses as well as stock sale profits if a company is forced to issue an accounting restatement “as a result of misconduct”.

Last week, the regulator asked a court to order the return of $4m (€2.82m, £2.43m) paid to Maynard Jenkins, former chief executive of CSK Auto, whose profits were allegedly inflated by accounting fraud committed by others: Mr Jenkins was not involved….

Yet it is far from clear whether the agency will be successful. The structure and language of the provision, known as Section 304, are ambiguous and have already prompted debate among lawyers.

Some questions, such as whether the provision could be used by private litigants, were partly resolved when courts ruled that only the SEC could enforce it. Private lawsuits invoking the provision have continued to be filed nonetheless.

“It has always been an open question whether the SEC would use this weapon against a CEO or CFO who did not personally engage in misconduct, and whether such an aggressive claim would be sustained in litigation,” wrote Wachtell, Lipton, the big Wall Street law firm, in a memo criticising the SEC action.

“They are basically going for the strict liability standard,” said Mr Salehi. The SEC has interpreted every ambiguity in the law in the “most aggressive way possible and saying this is the way the ambiguities are going to be resolved”.

OK, I hate to sound dense, but how often do you have fraud cases where the accounting was so distorted that the SEC could argue that a clawback was warranted (that is, the profits were boosted enough that it made a big difference in the bottom line, hence the CEO’s pay) AND the CEO was not in on it?

To put it another way, isn’t there another theory for going after the CEO? It strikes me he would have had to be pretty derelict in duty for a fraud to go on long enough to have a big impact and him not notice that something was amiss. He clearly failed in his duty of care to the corporation and its shareholders. And if his comp was inflated due to phony profits, there is a clear philosophical and policy reason to try to recoup the excesses. It’s a sign of how badly (or more accurately, CEO servingly) that incentive comp is structures that it fails to contemplate and address this possibiility.

Perhaps I am missing something, but I don’t see an SEC victory as significant, in terms of number of cases that there might be in the future like this.

Where this MAY be significant is that it shows that the SEC is willing to be very aggressive in how it reads ambiguities in the regs. But is this really the best use of SEC firepower? I’d much rather see them get creative about verbal misrepresentations in the selling of complex instruments. But many of those were derivatives and hence outside the SEC’s reach.

But the FT thinks otherwise, so perhaps I am wrong here:

“They are taking this tool and interpreting it aggressively. If they are successful, I expect to see them using it often and I bet it would change the way CEOs and CFOs behave when it comes to restatements, though it may also make people even more reluctant to take those jobs,” said Nader Salehi, a partner at Bingham, the law firm.

Yves again, Um, this is hardly a common type of restatement, and I love the notion that it’s hard to find people to take CEO jobs. Please. There are plenty of highly skilled division executives who’d make good CEOs. The problem is that boards (and the search firms that advise them, since a more difficult recruitment justifies the search firm fees) want CEOs from central casting, ideally someone who is a CEO somewhere else.

Served by Jesse of Le Café Américain

“You know, Paul, Reagan proved deficits don’t matter.” Dick Cheney to Paul O’Neill

The mainstream media is reporting that Fed governor Janet Yellen, a noted dove on inflation as Fed governors go, just told a gathering of bankers in Idaho that “deficits do not cause inflation” and summarily dismissed any concerns in that regard.

So, consulting the source material which is included just below, I am struggling to understand what she is saying, and to believe that she said it with a straight face, and was not just jawboning.

What Janet Yellen seems to be saying is:

First, that deficits do not matter unless they are ‘structural’ and not temporary. It does not matter how much, for example, we give to the banks. When the crisis is over, the deficits will remain, but will not grow larger, and will be offset by higher taxes, that will come from the improved economy.

Secondly, that developing countries have independent central banks that know how to and are willing to fight inflation, as opposed to the central banks of undeveloped countries where the government impedes their ability to fight inflation and to monetize the debt.

Thirdly, monetary inflation only occurs where excess demand for goods and services is generated. Until that point, unless there is this demand, increased money supply does not generate inflation. We might call this the reverse Laffer, in that it is a Demand side view of inflation that tends to discount the supply side completely.

One would not think that the US had recently seen the collapse of an enormous housing bubble, following the collapse of a large but less enormous stock bubble. Janet brushes this off faster than a stock strategist on CNBC.

Although she received her Ph.D. from Yale in 1971, she surely must have subsequently studied the stagflation of the 1970′s in the US, where demand remained relatively stable, but a supply shock on the oil side, together with the egregious monetary policy of a pliable Fed that had been accommodating Richard Nixon, finally triggered a rather nasty stagflation that the hairy-knuckled resolve of tall Paul Volcker was finally able to overcome.

Janet Yellen is greatly mistaken, but almost emblematic of the thinking in some circles that can see only the demand side of the equation, which is most common in a layperson relating to their common domestic experience. What is frightening in a way is that she is not some blogger out on the net, or a talking head for the extended infomercial that is financial reporting in the US, but is a Fed governor.

And she is no outlier. Her thinking underpins the basis for Bernanke’s strategy of packing the banks with liquidity, monetizing their assets, but maintaining control of that added liquidity by having the ability to attract bank reserves into the Fed where they can be managed through the ability to pay interest on those reserves.

Can the Sorcerer’s apprentices keep a steady hand on this latest monster from their laboratory? Every time they try this, something unexpected happen, and we go to the brink, to be rescued by another patch, another new experiment, designed to save us from the last one gone wrong.

Her arrogance toward ‘developing countries’ is absolutely appalling, and sure to come back to haunt her at some later date. If one looks at the performance of the dollar and its long term purchasing power under the Fed, it appears that Janet is a proud member of the subjective idealist school of behavioural economics. What we do not admit to be real cannot exist, and will not hurt us.

So, we can inflate our way to prosperity, provided that we control the perception of the results of our actions. Jigger the CPI so its no longer valid, suppress long term interest rates by buying the curve selectively and suppressing gold (See Gibson’s Paradox by Larry Summers), and coerce the world’s central banks through various means to support our monetary inflation step for step. After all, everything is relative. Until it is not.

OMG. Our entire financial system is based on the sufferance and good will of potential adversaries to do what is in our best interests because the fragility of our currency frightens them. And well they might be fearful, when they read this from Ms. Yellen, and see how many true believers in the omnipotence of the Fed take it seriously.

Large deficits don’t cause inflation: Fed’s Yellen
By Greg Robb
Jul 28, 2009, 1:06 p.m. EST

(MarketWatch – Washington) — Concern that the massive federal budget deficit will cause inflation is misplaced, said Janet Yellen, the president of the San Francisco Federal Reserve on Tuesday. Deficits don’t cause inflation, she said. Instead, the worry is that they might cause interest rates to rise. “Right now, private investment spending is extremely weak, so financing for the large federal deficits is readily available. But once private spending recovers, the competition for funds between the government and private sectors could drive interest rates up,” Yellen said in a speech to bankers in Idaho.

Jesse here. The relevant quote from Janet Yellen’s speech to the bankers in Idaho is excerpted below from the San Francisco Fed’s website.

Let me now address another issue that is garnering attention—inflation. This is a subject rife with contradiction. Almost without exception, my business contacts report downward pressure on wages and prices. At the same time, they tell me they worry that the United States is on the threshold of serious inflation. They see large federal budget deficits today and more looming on the horizon. They also note that the Fed has pumped up bank reserves and expanded its balance sheet to fund its financial support programs. They worry that this may amount to financing deficits with money creation. Surely, they say, these things will eventually have to lead to higher inflation.

I’ll begin with budget deficits. The gap in the federal budget for the current and the next fiscal years are projected to exceed $1 trillion, far larger than anything we’ve ever seen before. But a large part of these current deficits are temporary. A portion stems from the impact of the weak economy on the budget. In a recession, tax collections fall and spending on programs such as unemployment insurance rise automatically. A significant portion is due to the fiscal stimulus that has been put in place over the next few years to address the recession. Antirecessionary fiscal policy, in my view, is entirely appropriate. Since that stimulus is temporary by design, the resulting deficits will shrink as the stimulus phases out. But federal deficits will not disappear completely even when the economy has recovered and the stimulus program has phased out. On the contrary, these ongoing or “structural” deficits are anticipated to stretch indefinitely into the future and to escalate over time in a manner that ultimately is not sustainable. The long-term projected structural budget deficit mainly reflects the impact of an aging population and rapidly rising health-care costs on spending for federal entitlement programs, particularly Medicare and Medicaid.

Economists have known, worried, and warned the public about the damaging consequences of escalating long-term budget deficits in the United States for decades. It’s high time for our country to tackle the problem head-on. But the main concern with these deficits relates to productivity and living standards, and not high inflation. Large budget deficits do not cause high inflation automatically. In fact, since World War II, large deficits have been associated with high inflation only in developing countries. That’s because developing countries often have central banks that are under the sway of the government, which sometimes induces them to print money to finance government spending. The connection isn’t found in countries such as ours with advanced financial systems and independent central banks. Remember that, in the 1980s, the United States ran large deficits just as inflation was coming down. And Japan has had huge deficits through much of the past two decades, yet its problem is persistent deflation—precisely the opposite of inflation. The United States and most other industrialized countries have central banks with long traditions of independence and deep-seated support for keeping politics out of monetary policy. In those countries, the monetary authorities generally have stuck to their inflation objectives, even when governments ran large budget deficits.

In advanced countries, the problem isn’t that large deficits cause inflation. Rather it’s that they raise long-term interest rates, thereby crowding out private investment, which holds back advances in productivity and living standards. Right now, private investment spending is extremely weak, so financing for the large federal deficits is readily available. But once private spending recovers, the competition for funds between the government and private sectors could drive interest rates up. A decline in productivity growth is a serious problem—one we should strive to avoid—but it is not the same as inflation.

So what about the Fed’s unprecedented balance sheet expansion? Our strong steps to avert financial and economic meltdown have caused our assets to more than double, from under $900 billion at the start of the recession to over $2 trillion now. This expansion is largely financed by increases in excess reserves that banks deposit with us.

Now we come to the crux of the issue: Will this expansion of credit and bank reserves create high inflation? My answer is no. And the reason again is because of current economic conditions. Monetary policy fosters inflation when it loosens the stance of policy enough to create excess demand for goods and services. Right now, we have exactly the opposite—an excess supply of goods and services. We need more demand—not less—to offset slack in labor and product markets. We have seen a noticeable slowdown in wage growth and reports of wage cuts have become increasingly prevalent. Businesses are cutting prices to boost sales. As a result, core inflation—a measure that excludes volatile food and energy prices—has drifted below 2 percent, a level that I and most of my colleagues consider consistent with price stability. With unemployment already substantial and likely to rise further, and industrial capacity utilization at record low levels, downward pressure on wages and prices isn’t likely to go away soon. I expect core inflation to remain below 2 percent for several more years.

Of course, the economy will eventually recover and we will need to withdraw monetary accommodation. If we were to fail to do so, we would indeed have higher inflation. The Fed is keenly aware of this. We have the tools to tighten policy when the time is right and we have the will to use them. First, many of our emergency programs are already tapering off as market conditions improve. Second, many of the assets that we have accumulated during the crisis—such as Treasury and mortgage-backed agency securities—have ready markets and can be easily sold. Finally, the Fed can push up the federal funds rate and tighten policy by raising the rate of interest paid to banks on the reserves they deposit with us—authority granted by Congress last year. An increase in the interest rate on reserves will induce banks to lend money to us rather than to other banks, thereby pushing up rates in the interbank market and, by extension, other interest rates throughout the economy. This is an important tool because, even if the economy rebounds nicely, the credit crunch might not be fully behind us and some financial markets might still need Fed support. This tool will enable us to tighten credit conditions even if we maintain a large balance sheet for a time. The experience of central banks in Europe, Japan, and Canada suggests that this approach can be effective.

Full Text of Janet Yellen’s Speech to the Idaho Bankers here.

We’ve been told that one of the reasons China is allegedly faring less badly than might be expected, given than big creditors tend to take it on the chin worse in global crises than debtors, who can simply default, is that its economy was actually more reliant on domestic capital spending than exports as a source of growth.

Yet we have also heard reports of shiny new see-through office buildings. Not having been there, we can’t tell how pervasive this is, but some reports say there is a lot of the real estate equivalent of bridges to nowhere that have been built.

This article from China Stakes (hat tip reader Michael) discusses how developers of residential property are engaging in ruses to keep credit coming from banks:

While the real estate market appears to be is in the midst of a boom, defaults among developers are also beginning to rise. Small and medium developers are resorting to faking sales to get bank loans to relieve their funding pressure.

Statistics show that from May 1 to July 24, which seemed to be good days for Shanghai’s real estate market, many housing projects were seeing over 30% cancellations, and the cancellation rate of some projects was as high as 125%. Behind the “boom” of the housing market are irregular behaviors such as getting bank loans by cheating and making fake housing purchasing contracts.

Among the top ten housing projects with the highest cancellation rates, 60% are developments by small and medium real estate companies. “In fact, it is still difficult for small and medium developer to get credit support from banks,” said a sales manager of a medium real estate company.

Now it is common for developers to sell an apartment to an employee as a “reward” and then secure a loan from a bank with the housing purchasing contract signed by the employee. “There’s a window between the sale and the issuance of housing ownership certificate, during which employees can decide whether to keep or cancel the contract,” the sales manager added.

In 2008, when credit was tight, many small and medium developers sought to gather money in this way. “Every developer is doing this. The only differences are scale and method,” said the sales manager.

The high housing contract cancellation rate has also occurred in Nanjing. July statistics show,…

According to figures from Centaline China Property Research, between January and June new residential housing sales in six key cities totaled 55 million square meters, up 88% over the second half of 2008. However…in June, housing sales in Guangzhou, Shenzhen, and Tianjin all saw a decline, but Beijng and Shanghai were still seeing month-on-month growth. Housing sales in Shanghai in June reached 2.84 million square meters, up 6%, month on month, the highest among all the six cities.

Yin Bocheng, director of the Real Estate Research Center of Fudan University, thinks the boom is a mirage. “This is only fake prosperity.” This ploy has been used before to simulate growth in the real estate market. Developers getting bank loans with fake deals will add to credit risk in a long run

Submitted by Leo Kolivakis, publisher of Pension Pulse.
The Times reports British pensioners are among the poorest in the EU:

Britain’s pensioners have the fourth highest level of poverty in Europe, according to figures published today by the European Commission.

The over 65’s in Britain are, on average, worse off than their counterparts in Romania, Poland and France.

The research, which compared relative poverty in the 27 member states, showed nearly one in three UK over-65s were at risk of poverty – the same proportion as in Lithuania (30 per cent).

Only pensioners in Cyprus (51 per cent), Latvia (33 per cent), and Estonia (33 per cent) came out worse. The EU average was 19 per cent.

The figures came ahead of the work and pension committee’s review of government efforts to tackle pensioner poverty, which is due to be published on Thursday.

Michelle Mitchell, charity director for Age Concern and Help the Aged, said the report demonstrated that many older people were being left behind.

“In a country where the richest have incomes five times higher than the poorest, older people are disproportionately bearing the burden of this inequality,” she said.

Steve Webb, the Liberal Democrat Shadow Work and Pensions Secretary, blamed the Labour Party for failing to address poverty in old age. He said: “The basic state pension is simply too little to live on for the millions of pensioners who have no other income. Labour’s complex and undignified system of means-tested benefits has meant that many pensioners do not even claim the extra help that they are entitled to.

“We need a more generous, universal pension based on citizenship that would give pensioners a sense of dignity and a stable income in retirement.”

The EU study found pensioners in the Czech Republic were least likely to be living in poverty, with 5per cent below the threshold of an income of 60per cent of the national median.

Similarly, in Canada, the Calgary Herald reports that Alberta seniors’ need for welfare soaring:

The number of seniors needing provincial welfare to get by has swollen by 36 per cent in a year, likely part of a troubling trend as the country’s population ages.

Federal payment programs such as Canada Pension Plan, Old Age Security and Guaranteed Income Supplement make most seniors ineligible for welfare.

But a steadily growing group has been turning to the province for help in the past year.

Last month, 406 seniors were drawing financial aid from Alberta Works, 108 more than in June 2008, according to Alberta Employment numbers.

The figures are troubling, said Alberta Liberal Leader David Swann.

“It’s only going to get worse, so we need to be putting in place a plan and resources . . . and the staffing to reach out to those who may be at risk.”

Calgarian Ralph DeWeerd said he can’t help but feel time is working against him.

A construction worker by trade, the 58-year-old was laid off last August when the economy tanked. Unable to pay the rent on his basement suite, he was forced to seek shelter at the drop-in centre. A bad hip due to a motorcycle accident in 1981 limits his mobility, and he finds it difficult to compete with the “young guys” for work.

Without some form of government aid, he worries about how he’ll get by.

“My age is against me,” said DeWeerd, who has already had two hip replacements.

“I’m in a no-win situation.” Other aging Albertans face similar dilemmas.

Seniors who qualify for welfare generally don’t get pension payments and don’t have adequate savings to pay for retirement.

The savings issue has landed on the provincial and federal political agenda, in part due to the erosion of many people’s RRSPs as financial markets collapsed last year.

Alberta MP Ted Menzies, the federal finance minister’s point man on pensions, is chairing a provincial-federal task force examining how to get Canadians to save more for the golden years. The group, which met for the first time last week in Calgary, includes finance ministers from Alberta, Ontario, British Columbia, Manitoba and Nova Scotia.

Menzies said they plan to reconvene in October to hear from experts before submitting a report for the country’s finance ministers to consider at their next meeting in December.

“We may find we have a good system,” Menzies said after last week’s meeting. “But if we don’t, then I’m sure there will be recommendations coming out of this on how we can make sure that retirees have enough to retire on.”

Statistics suggest the task force will find Canada’s savings system needs reform. Most Canadians don’t have company pensions to supplement their retirement savings. In Alberta, only one in three workers are offered employer-sponsored pension plans.

The rate of saving is also poor. According to a 2006 Statistics Canada review of wealth, debt and savings, nearly one-third of working Canadians had no retirement savings, while many of the rest weren’t socking away enough money.

At the same time, the country’s population is quickly greying. By 2031, about a quarter of Canadians will be older than 65, compared with 13 per cent in 2005, the federal statistics agency forecasts.

Sally Stuike, a spokeswoman with Alberta Employment and Immigration, said the province doesn’t believe the 36 per cent increase among seniors who need provincial welfare is tied to the economic downturn that took hold last fall.

“It’s been a slow and gradual increase over the last 12 months,” she said, adding the growth likely reflects a societal shift.

Although not completely at fault, the economy’s downward swoop makes the situation even more difficult, Swann added.

“It adds to the extra burdens that seniors have, especially those that either don’t have the income to save or didn’t save in the way they needed to for this time in their lives,” he said.

“This is precisely where the government needs to step in.”

Bill Moore-Kilgannon of Public Interest Alberta is advocating that the province adopt a poverty reduction strategy to address the plight of seniors and others who don’t have enough income to pay for basic needs.

“Seniors are going to be a growing problem with respect to poverty,” Moore-Kilgannon said. “The savings rates are nowhere where they need to be for the vast majority of people who are retiring.”

Pension poverty has arrived. The global pension crisis will leave millions of people poor and destitute. So the next time you see some hedge fund and private equity managers raking billions, or some pension fund managers collecting millions in bonus, I want you to remember the poor and marginalized of our society. They are in dire straights and it seems like nobody is paying attention to their plight.

Wild camels ‘genetically unique’ BBC

U.S. releases unclassified spy images of Arctic ice Reuters

World will warm faster than predicted in next five years, study warns Guardian (hat tip reader John D)

Drugmakers Ramp Advertising Campaign For Health Care Reform Michael Shedlock. It isn’t news that Harry and Louise will be returning to a station near you. What is new are the patently ridiculous claims the industry is making in defense of the campaign.

Wells Fargo Buys Mortgage Bonds as Defaults Rise Bloomberg (hat tip DoctoRx). Why am I reminded of BofA’s enthusiasm for Countrywide, and the way Wall Street firms were buying subprime originators in the fall and winter of 2007?

Lobbyists Gain Upper Hand On Obama In Recent Weeks The Hill. In recent weeks? Where have they been? Were they asleep when the banks were taking ground?

Mark Hulbert: Insiders have quickened the pace of their selling MarketWatch

SEC Whistleblowers? Independent Accountant

California Foreclosures > National New Home Sales EconomPic Data

U.S. Effort to Modify Mortgages Falters Wall Street Journal. Your truly was skeptical when the program was announced, and had plenty of company.

GE Interest Plus Corporate Notes General Electric. Um, isn’t this an offering? And DoctoRx notes: “Net-based advertising to the public to become UNSECURED general creditors of GE or a subsidiary. (I’ll stick w FDIC stuff for trivial yields.”

BofA planning to cut 10 percent of branches: report Reuters, They just opened a ton in Manhattan and I wondered what they were smoking. There are way more bank branches than coffee shops.

Politicians Accused of Meddling in Bank Rules Floyd Norris. While I agree that piecemeal meddling is bad, has no one considered that the accounting authorities might be captive? This report seems to perpetuate the myth that they are merely benevolent umpires.

Martin Meyer on Credit Default Swaps Jesse. Today’s must read.

Antidote du jour (hat tip reader Barbara):

Two little orphaned wallabies become best of friends at Emerald Monbulk Wildlife Shelter, Melbourne, Australia…

…mirroring each other’s behaviour…

..and play-fighting.