naked capitalism

By Jordi Blanes i Vidal, Lecturer in Managerial Economics and Strategy at London School of Economics; Mirko Draca Research Economist at the Centre for Economic Performance, London School of Economics; and Christian Fons-Rosen, Assistant Professor of Economics at Universitat Pompeu Fabra. First posted at VoxEU.

Lobbying in the US, as well as other democracies, is big business. This column investigates the extent to which former government officials “cash in” on their political connections when working as lobbyists. It finds that once the politician for whom they worked leaves office, their revenue falls 20%, or $177,000 per year, suggesting that lobbyists are paid more for “who they know” than “what they know”.

Lobbyists – paid advocates who aim to influence the decisions of legislators or government officials – play an increasingly important role in the political system of the US and other democracies. In 2008, for example, $3.97 billion was spent on lobbying US federal officials – more than twice the amount spent ten years earlier.

The recent US debates on healthcare and financial reform have been marked by sharp criticisms of the role of staffers-turned-lobbyists in watering down the bills. For example, in academic circles, the political economy of financial reform has recently been discussed by Johnson and Kwak (2010), Mian et al. (2010), and Igan et al. (2009) among others.

The movement of political staffers from roles in the government to lucrative jobs in the lobbying industry is often described as a “revolving door”. This flow of money and staffers towards Washington’s lobbying firms has led to concerns that corporations and other organisations are able to buy influence and acquire privileged access to serving politicians. Furthermore, ex-staffers gain private benefits in such transactions, and this may have a negative impact on their incentives before leaving Congress.

To what extent can former government officials “cash in” on the personal connections acquired during their periods of public service? Our recent research (Blanes i Vidal et al. 2010) provides the first quantitative evidence of how former congressional staffers benefit from Washington’s “revolving door”.

Is it what you know or who you know?

The most common criticism of former staffers is that they are simply trading on their political connections. But lobbyists often dispute this notion. They claim instead that their earnings reflect expertise on policy issues and the inner workings of government in general. In other words, they argue that it is “what you know” not “who you know” that matters.

Empirically, the issue of separating the “what you know” from the “who you know” is a challenge for researchers. A plausible argument can be made that former staffers would be high earners even if political connections did not matter. The specific problem here is separating the effects of ability and expertise on earnings from those of acquired political connections. Generally, earnings or revenue data only allow us to observe the effects of both factors together.

Our research addresses this founding of causes by focusing on situations where the knowledge doesn’t change but the connections do. Specifically we look at the impact on lobbyist income when a serving politician’s leaves office. The point at which a politician leaves office provides a window for examining the specific role of political connections. If a politician is no longer serving in Congress, then the political connection held by their former staffers should in effect be obsolete.

This is because the politician in question no longer has direct influence over legislative outcomes or the content of congressional debates. In turn, this means that in cases where gaining access is a goal of special interest groups, lobbying spending will move away from lobbyists affiliated with former politicians and towards those with still current connections.

Our estimates based on this “identification strategy” indicate that the value of political connections to lobbyists is high. Lobbyists suffer an average revenue loss of over 20% when their former political employer leaves Congress. In dollar terms, this translates into $177,000 per year for the typical lobbyist’s practice. Furthermore, this effect is persistent for at least three years – it seems that it is difficult for lobbyists to offset the impact of a lost political connection.

Studying the effects

This impact is demonstrated in Figure 1 which shows the semester-by-semester change in lobbyist revenues for the periods before and after a Senator leaves office. The Figure shows that there is a sharp drop in revenues in the period immediately after the Senator’s exit (around 50%). Furthermore, there is only a small “mean reversion” over the next 5 semesters.

[Yves here. The chart was not included in the VoxEU post; you can find the underlying research paper here]

We believe that our identification strategy is sound. A key concern for our approach is that there may be “shared trends” between politicians and their former staffers-turned-lobbyists. For example, low ability staffers could sort towards employment with low ability politicians whose political fortunes may be in decline. In turn, the revenue shock we pick up may be the result of an ongoing downward trend associated with a particular politician. However, the clear discontinuity we observe at the point of exit rules out the presence of such trends.

Further results indicate that that proximity to power matters for lobbyists. Specifically, we find that the size of the revenue effects increases with the importance of a politician. For instance, Senators are more valuable than Representatives and, even within the two chambers of Congress, more senior politicians – defined in terms of either tenure or committee status – are more valuable than their junior counterparts.
Future research?

Our study points the way to a potential new wave of research using data released under public disclosure laws. The basic data we use were made available as part of the Lobbying Disclosure Act of 1995. Since then, non-partisan organisations like the Centre for Responsive Politics and LegiStorm have done important work improving access and promoting usage of the data.

Researchers now have the possibility of combining datasets across a number of sources to search for statistical patterns such as those we find for politically connected lobbyists. As a result, this takes public scrutiny to a new level. We can try to find important information and behaviours “hidden” in the data. Hence, one major consequence of laws such as the 1995 Act is that they make independent research and evaluation of political questions possible.

By Satyajit Das, a risk consultant and author of Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives – Revised Edition (2010, FT-Prentice Hall).

Detox Cures

In the first half of 2010, angst about European sovereign debt receded and market volatility eased. In the second half of 2010, concerns about Greece, Ireland, Spain and Portugal returned to dominate headlines.

Greece passed its initial inspections on its restructuring plan from the supervising “Troika” (made up of the European Central Bank (“ECB”), European Union (“EU”) and International Monetary Fund (“IMF”)). In truth, there was no choice, as money had to be made available to enable Greece to continue to function.

Despite progress, the Greek economy slipped into a deep recession, impeding the recovery plan. As the government implemented austerity measures, the Greek economy shrank around 3% to 4%. The government is behind on its program to shrink its budget deficit from over 13% to 8%.

Tax revenues are weak, growing 3.3% well below the targeted 13.7%. This is despite tax increases including a rise in the VAT rate to 23 per cent. Faced by a collapsing economy, rising unemployment, increased numbers of Greeks leaving the country and social unrest, the Greek government even announced a cut in corporate tax rates from 24% to 20%. How this was going to help correct the budget deficit remains a mystery.

The “cure” may be worse than the disease. After implementing similar austerity measures, Ireland’s nominal gross domestic product (“GDP”) has fallen by nearly 20%. The budget deficit as a percentage of GDP has doubled to 14% from 7% Government debt as a percentage of GDP has increased to 64% from 44% at the start of the crisis. It is forecast to go to over 100% having been around 25% during the boom years. The cost of bailing out Ireland’s banking system has risen and may reach 20-30% of its GDP. Ireland’s credit rating has fallen.

In late September 2010, Ireland announced that in the second quarter the economy contracted by 1.2%, against expectations for 0.4% growth raising renewed concerns about European sovereign risk. Similar scenarios are playing out in Spain and Portugal.

Slowing growth in North America and China complicates the problems. Even Germany’s recent strong growth appears to be petering out. The effects of a weak Euro, government stimulus packages and exports of machinery as many industries retooled to lower production costs may have run their course. Real underlying demand remains weak.

Negative or low growth, savage budget cuts and economic restructuring will need to continue for years. Despite the Greek Prime Minister’s impossible MBA spin that the crisis represents a “historic opportunity”, it remains to be seen whether this is feasible. The willingness of government to impose and citizens to bear the decline in living standards necessary to avoid a debt restructuring remains uncertain.

The CDO Solution

In an effort to resolve the problems, Europe announced its version of economic “shock and awe”. Steps include an Euro 110 billion package for Greece, a Euro 750 billion “safety net” for all Euro zone members, ECB funding to vulnerable European banks, particularly in peripheral countries, and ECB purchases of around Euro 60 billion of bonds issued by some of the troubled countries. By late September 2010, risk margins on Greek, Irish, Portuguese and Spanish debt (relative to German government bonds) were above to the levels prior to the announcement of the European rescue plan. In short, the problems remain largely unresolved.

European sovereign debt problems are likely to remain prominent. Economic data, like growth, unemployment, budget position, and debt issuance will be key indicators on the trajectory of the crisis.

Increasingly attention may focus on the European Financial Stability Facility (“EFSF”), a key component of Europe’s financial contingency plan. Klaus Regling, the head of the EFSF and known informally as the CEBO (“Chief European Bailout Officer”), had a brief stint at Moore Capital, a macro-hedge fund, consistent with the fact that the EFSF is placing a historical macro-economic bet.

In order to finance member countries as needed, the EFSF will need to issue debt. The major rating agencies have awarded the fund the highest possible credit rating AAA.

The EFSF structure echoes the ill-fated Collateralised Debt Obligations (“CDOs”) and Structured Investment Vehicles (“SIV”). The Moody’s rating approach explicitly draws the analogy and uses CDO rating methodology in arriving at the rating.

The Euro 440 billion ($520 billion) rescue package establishes a special purpose vehicle (“SPV”), backed by individual guarantees provided by all 19-member countries. Significantly, the guarantees are not joint and several, reflecting the political necessity, especially for Germany, of avoiding joint liability. The risk that an individual guarantor fails to supply its share of funds is covered by a surplus “cushion”, requiring countries to guarantee an extra 20% beyond their shares. A cash reserve will provide additional support.

Given the well-publicised and deep financial problems of some Euro-zone members, the effectiveness of the cushion is crucial. The arrangement is similar to the over-collateralisation used in CDO’s to protect investors in higher quality AAA rated senior securities. Investors in subordinated securities, ranking below the senior investors, absorb the first losses up to a specified point (the attachment point). Losses are considered statistically unlikely to reach this attachment point, allowing the senior securities to be rated AAA. The same logic is utilised in rating EFSF bonds.

If 16.7% of guarantors (20% divided by 120%) are unable to fund the EFSF, lenders to the structure will be exposed to losses. Coincidentally, Greece, Portugal, Spain and Ireland happen to represent around this proportion of the guaranteed amount. Greece whilst an Eurozone member will not participate in EFSF’s lending programs as a provider of guarantees for the obvious reason that nobody would seriously place much value on any such guarantee.

Unfortunately, the Global Financial Crisis illustrated that modelling techniques for rating such structures are imperfect. The adequacy of the cushion is unknown. If one peripheral Euro-zone members has a problem then others will have similar problems. If one country requires financing, guarantors of the EFSF will face demands at the exact time that they themselves will be financially vulnerable.

Rubbery Numbers

The rating analysis published by the Agencies highlights subtle but extremely significant features in the structure designed to ensure the desired AAA rating.

Where an Eurozone member draws on the facility, the amount of funds on lent by EFSF will be adjusted by the following deductions:

A 50 basis point service fee
A percentage equal to the net present value of EFSF’s on-lending margin. For example, the Greek financing package had a margin of 300 basis points. This would translate into a deduction of around 13-14% (depending on the discount rate applied).
[1 and 2 constitute a fungible general cash reserve ("the Reserve") which will support all EFSF debt.]

An additional reserve specific to each loan made by EFSF (“the Buffer”) will be created. The exact methodology of determining this buffer has not been disclosed but will determined by several factors. The first factor will be the borrower and it credit condition. The second will be the position EFSF itself and the level of credit support available for its existing obligations.
The Reserve and Buffer are to be invested in liquid AAA rated government, supranational, or agency securities to be available as credit support for the EFSF’s obligations.

The requirement for the Reserve and Buffer significantly reduces the amount of funds available from the EFSF. Standard & Poor’s (“S&P”) estimated that after adjusting for the guarantee overcollateralization and the exclusion of Greece from EFSF’s program, the EFSF can raise up to Euro 350 billion (20% lower than the announced amount). After adjustment for the fact that borrowing governments cannot guarantee EFSF bonds and deduction of the Reserve and Buffer the potential available EFSF lending is further reduced.

Assuming a Reserve of say 13.5% and a Buffer of 10%, this would reduce the amount available to around Euro 270 billion (39% lower than the announced amount). Assuming an equivalent reduction in the IMF component of the package, the total amount available is around Euro 460 billion. The EFSF’s ability to lend compares to the forecast budget financing need of Greece, Ireland, Portugal and Spain of over Euro 500 billion in the period 2009 to 2013.

The structure outlined also increases the cost of the funding for borrowers drawing on the EFSF facility. This additional cost is generated by the fact that the Reserve and Buffer has to be invested in securities that may earn less than the interest paid by EFSF on any issue.

In order to attain the coveted AAA rating, the EFSF structure has been “tweaked” subtly. For example, Moody’s states that “the Buffer is to be sized so that the remaining portion of the debt issue that is not fully backed by cash will be fully covered by contributions from Aaa-rated member states.” In essence this appears to confirm that the EFSF’s rating relies heavily on the support of the guarantees of AAA countries – currently Germany, France, The Netherlands, Austria, Finland, and Luxembourg. In reality this means that significant reliance is being placed on the larger parties such as Germany, France and the Netherlands.

If the EFSF is drawn upon and increasing reliance is placed on cornerstone guarantors such as Germany and France, it is not clear whether politically it will be possible for these countries to continue the facility beyond its original 3-year maturity. Interestingly, S&P state that: “… we consider it likely that its mandate would be extended if market conditions remained unsettled.”

For investors, there is a risk of rating migration, that is, a downgrade of the AAA rating. If the cushion is reduced by problems of an Euro-zone member, then there is a risk that the EFSF securities may be downgraded. Any such ratings downgrade would result in losses to investors. Recent downgrades to the credit rating of Portugal and Ireland highlight this risk.

Given the precarious position of some guarantors and their negative rating outlook, at a minimum, the risk of ratings volatility is significant. The rating agencies indicated that if a larger Euro-zone member encountered financial problems, then the rating and viability of the EFSF might be in jeopardy.

Investors may be cautious about investing in EFSF bonds and, at a minimum, may seek a significant yield premium. The ability of the EFSF to raise funds at the assumed low cost is not assured.

Ironically, the actual structure of credit enhancement encourages troubled countries to access the facility early to ensure its availability. The structure embodies an accelerating “negative feedback loop”.

As market conditions deteriorate, market access becomes limited and countries draw on the EFSF facility (eliminating them from the guaranty pool), increased financial pressure will be exerted on the AAA rated Eurozone countries. The need to maintain adequate coverage to preserve the EFSF’s AAA rating on existing debt will mean that the Buffer will increase and the capacity of the EFSF to lend may become impaired. Moody’s rating analysis indicates that in the event that a large number of countries simultaneously lose market access and draw on the facility, the current lending capacity of the EFSF would likely be overwhelmed. Moody’s believes that it would be unlikely that the EFSF would start issuing under those circumstances.

At this stage, the EFSF have indicated that they don’t plan to issue any debt, as they do not anticipate the facility being used. The facility also has a very short maturity, three years till 2013. The importance of these factors in the grant of the preliminary rating is unknown.

S&P correctly inferred that the “EFSF has been designed to bolster investor confidence and thus contain financing costs for Eurozone member states.” The agency indicated that if its establishment achieved this aim then the EFSF would not to need to issue bonds. However, if as pressures mount and market access becomes problematic for some Eurozone members, then the EFSF and it structure will be tested.

The EFSF’s structure raises significant doubts about its credit worthiness and funding arrangements. In turn, this creates uncertainty about the support for financially challenged Euro-zone members with significant implications for markets.

Inconvenient and Ignored Truths

The real rationale of the European Bailout package and the EFSF is different to that generally assumed. The measures are not designed to assist Greece or the other troubled countries. In reality, they are designed to support banks that have lent heavily to them.

The exposure of Germany and France to troubled European countries remains around $1 trillion. According to the Bank for International Settlements, as at the end of 2009, French banks and German banks had lent $493 billion and $465 billion respectively to Spain, Greece, Portugal and Ireland. Default or restructuring would result in large losses to the banks, potentially triggering a return to the apocalyptic conditions of late 2008.

European banks remain vulnerable. The recent bank stress tests did not seriously test likely losses in case of sovereign debt restructuring and realistic falls in commercial real estate prices. The tests did not apply to the bulk of bank’s holdings, only testing around 20% of the sovereign bonds held, making the test of limited value. The definition of capital was generous. It was effectively a car “crash test” where the testing authority deems the car cannot crash.

In the best case, the measures taken by the EU and ECB will force deeply indebted European countries to take steps to bring their economic houses in order, allowing an orderly debt restructuring. The EFSF and other facilities will also underwrite vulnerable country’s ability to re-finance maturing debt and finance budget requirement.

Banks and other lenders can also build up reserves and capital to absorb any write-offs that are required in such a restructuring. If successful this would minimise losses and limit disruption in the global economy.

The position of Greece highlights the underlying logic. According to the EU’s projection, Greek debt will increase from Euro 270 billion in 2009 to Euro 337 billion in 2014, from 113% of its Gross Domestic Product to 149%, even with the successful execution of the economic actions required. Given that Greece cannot sustain its current level of debt, it is unclear how it will be able to carry 25% additional debt (Euro 67 billion) with an economy that is expected to shrink by 5% during that period.

Discussion about losses lenders to these countries will have to bear are already evident. In extending guarantees of borrowings by its troubled banks, Ireland indicated that junior or subordinated lenders might not receive the face value of their investments. As in any debt restructuring, it is unlikely that lenders will be able to avoid losses entirely.

Major economies have over the last decades transferred debt from companies to consumers and finally onto public balance sheets. The reality is that a problem of too much debt cannot be solved with even more debt. Deeply troubled members of the Euro-zone cannot bail out each other as the significant levels of existing debt limit the ability to borrow additional amounts and finance any bailout. As Albert Einstein noted: “You cannot fix a problem with the kind of thinking that created it.”

A huge amount of securities and risk now is held by central banks and governments, which are not designed for such long-term ownership of these assets. There are now no more balance sheets that can be leveraged to support the current levels of debt. The effect of the European bailout and the EFSF is that stronger countries’ balance sheets are being contaminated. Like sharing dirty needles, the risk of infection for all has drastically increased.

The European bailout is primarily a debt shuffling exercise which may be self defeating and unworkable. George Bernard Shaw observed that “Hegel was right when he said that we learn from history that man can never learn anything from history”. The resort to discredited financial engineering to solve the European sovereign debt problems highlights the inability to learn from history and the paucity of ideas and willingness to deal with the real issues.

Darpa Moves a Step Closer to Its Flying Humvee Wired (hat tip reader John D). This sounds like a joke but it isn’t.

Las Vegas death ray roasts hotel guests Channel Register (hat tip reader John M). This also sounds like a joke but isn’t.

‘Cementgate’ takes off on Twitter Irish Times (hat tip reader Fred A)

‘Pre-crime’ Comes to the HR Dept. Datamation (hat tip reader John M).

Breakthrough in quantum computer race USNW Engineering (hat tip reader Crocodile Chuck)

Google’s Pound of Flesh Robert Cringley (hat tip reader John M)

For US Corporations the Whole of the Law Shall Be ‘Do What Thou Wilt’ Jesse (hat tip reader Glen)

Help!!! Lambert Strether

Satyam financials detail £1bn in dodgy transactions Channel Register (hat tip reader John M)

Congressional ‘net neutrality’ deal falls apart Financial Times

Democrats Find Many Big Donors Cutting Support New York Times

JPMorgan Suspending Foreclosures New York Times

Antidote du jour:

A measure passed by the House tonight, which would permit the US to impose tariffs on countries that keep their currencies artificially low, is at this juncture a mere statement of intent. It is nevertheless playing into a dynamic of the hardening of stances between the US and China.

Note that the bill has yet to pass the Senate, but given its wide approval margin, and more important, broad bipartisan support, a win there seems assured. But the bill does not require action, and so leaves any escalation in the hands of the executive branch. Given Obama’s tendency to talk tough and do little beyond elaborate symbolism, such as misbranded reform measures, I would not expect the Administration to suddenly change stripes and increase pressure on China in a meaningful fashion. Not surprisingly, China pointedly lowered the value of the renminbi today, clearly signaling it has no intention of cooperating.

Nevertheless, the move elicited predictable verbal fireworks from the Chinese officialdom. China denied that it undervalues the renminbi, which can hardly be accepted at face value. Not only is the renminbi undervalued 25% by some recent estimates, but the continued purchase of dollar assets is prima facie evidence of continued currency manipulation. Tim Duy has also pointed out that China’s purchases of the yen, which are clearly destructive to Japan, is tantamount to laundering dollar purchases (China buys yen, Japan has to buy more dollars to drive the yen back down). Indeed, Premier Wen Jinbao ‘fessed up that letting the renminbi rise would put a lot of domestic manufacturers out of business. So China clearly has motive for keeping the renminbi low, and it is by his admission to keep otherwise uncompetitive firms afloat.

China also charged the legislation would violate WTO rules, which is narrowly correct if the US does not first certify China as a currency manipulator. But if the US imposed tariffs withing the WTO framework, the impact would be limited due to the cumbersome nature of the countervailing duty process (companies have to prove they are being damaged by directly competing imports).

The measure is thus more important as a negotiating tactic than for any immediate impact. Congress has signaled loud and clear that it wants to see some movement from China. Given the wide margin of the vote, if China does not make some concessions and US unemployment and trade deficits remain high, Congress is likely to vote in legislation that has more real clout. The rhetoric was heated. Per the Financial Times:

“If China wants a strong trading relationship with the United States, it must play by the rules,” Nancy Pelosi, Democratic speaker of House, said ahead of the vote on Wednesday.

Some of the rhetoric was even stronger. “They cheat to steal our jobs,” said Mike Rogers, a Republican from Michigan, while Dana Rohrabacher, a Republican from California, attacked China’s “clique of gangsters” that was doing “great damage to the people of the United States of America”.

With the US having plenty of resources slack, this is one of the few times that orthodox economists would endorse trade restrictions. Normally, domestic considerations would be offset by the desire of US corporations to maintain access to China’s market, but the China has also recently become a less friendly venue for foreign players.

The problem, however, is China has taken to being non-negotiable, and is usually a very effective posture, but it runs the risk of driving other parties away from the bargaining table entirely. China has been reinforced in this behavior because its past shows of pique have led to quick climbdowns. It has occasionally used headfake concessions like its pretense that it would let the renminbi move to a more market based price, to keep its trade partners a bit off balance.

But China has made two very large errors. Despite playing a strong tactical game up to now, it has made a fundamental strategic mistake. It appears to have no plan to change from a mercantilist model. It somehow honestly seems to think that if it can avoid what happened to Japan , ie being forced to revalue its currency (per the 1985 Plaza accord), all will be well. It actually has been moving to a LOWER consumption share of GDP post crisis, the reverse of what you’d see if it were trying to rebalance the economy.

Everyone understands that for China move to a more consumption-driven economy is a very long term project. China could get away with a ton of foot dragging if it were taking legitimate steps in that direction, as it needs to. So far, however, it has demonstrated no commitment to that effort, so it is effectively exporting goods and related unemployment to other countries. In a period where everyone expects protracted low growth, when there is already a large overhang of unemployed workers, that will not wash. Other countries start retaliating on the trade front. And China, with a severely imbalanced economy, with 50% of GDP coming from exports and increasingly unproductive investment (it now takes $7 of investment to generate $1 of GDP growth, a stunningly bad ratio for a developing economy, and markedly lower than the tradeoff in the US), is much less solid that it looks.

China’s second error is a recent switch to disproportionate retaliation. This may simply be a variation in tactics, and it may revert to more measured responses. But if this becomes its new modus operandi, it is likely to backfire and result in isolation, as it has with Israel. The recent incident involving an arrest by Japan the captain of a trawler operating in disputed waters provides an example. From the Financial Times:

The immediate cause of alarm is Beijing’s rough-house tactics following the captain’s arrest in waters near the disputed Senkaku islands, known as Diaoyu islands in Chinese. Not only did Beijing insist on the captain’s immediate release, a demand to which Tokyo eventually capitulated. It also escalated the dispute. It arrested four Japanese nationals; blocked exports of rare earths used by Japanese electronics companies; cancelled diplomatic exchanges; and allowed anti-Japanese demonstrators to pour on to Chinese streets. (It even canned the tour of SMAP, a Japanese boy-band.) Even the release of the captain did not mollify Beijing, which demanded an apology and compensation.

The Japanese have a saying: teki no teki wa mikata, which means “enemy of enemy is friend.” As much as America has done a great deal to make itself unpopular around the world, China’s muscle flexing is making US look attractive by comparison, no mean feat. China is not yet secure enough in its footing to afford the consequences of uniting much of the world against it. But if it continues on a belligerent path, it may do precisely that.

Boy, if Fitch thinks servicer problems are limited to affidavits, it is gonna learn a lot more in the coming weeks and months. This report comes via BusinessWeek:

Fitch Ratings said Wednesday it’s asking mortgage servicers about their foreclosure practices in the wake of GMAC Mortgage LLC’s recent disclosure of procedural errors.

The agency believes that if more errors are found by other servicers, that could stall foreclosures in some states and increase losses related to residential mortgage-backed securities. That could prompt Fitch to downgrade ratings on servicers that are affected, the agency said.

“Any servicer with a significant portion of their portfolio in judicial foreclosure states will be either directly or indirectly impacted by the attention focused on this problem,” wrote Diane Pendley, managing director at Fitch.

The procedural errors involve affidavits verifying who owns the mortgage note. Fitch is reviewing each servicer’s internal process for executing foreclosure affidavits. If it finds the process is lacking, Fitch will consider lowering the servicer’s rating.

This looks reactive and appears to reflect an incomplete understanding of the problem. In judicial foreclosure states, certain affidavits were required as part of the documentation needed to proceed with a foreclosure. If the affidavits were improper, they are a fraud on the court.

In non-judicial states, the same problem arises when a foreclosure is challenged. A non-judicial process moves into the court system. Bankruptcy filings routinely lead to a motion for relief the bankruptcy stay (legalese for the servicer asking to grab the house now rather than let what happens to the homeowner borrowings be resolved by the judge). So you have similar issues in non-judicial states. not just as prevalent.

In addition, as we have indicated, the affidavit problem is only one of type of servicer/mortgage mill impropriety. There is increasing proof that foreclosure mills engaged in widespread document fabrication to show that trusts (the securitization entity) owned the note (the borrower IOU), when it fact it had not been properly conveyed to them, and retroactive fixes create problems under New York trust law and the provisions of the pooling and servicing agreement that governs the securitization.

But it isn’t clear what this means for bond ratings, since servicers are not stand alone entities with rated debt but live in larger entities. Servicing historically has been at best a low margin, often a breakeven business; of late, servicing has been a cash flow negative activity. Tom Adams comments:

Note that Fitch is talking about its “servicer ratings”, which are an operational assessment of the way servicers do their job, and have their own separate scale. In the past, the main purpose of the servicer ratings was to create an adjustment, up or down, based on the quality of the servicer’s operations [servicing entity], on new MBS credit enhancement requirements. Since very few MBS are being issued currently, I am not sure how Fitch uses the ratings now.

Of course this could be a preview (even if Fitch doesn’t realize it yet) – we may see the corporate bond ratings of the banks that own large servicing companies start to get downgraded as a result of these servicing problems.

See this video ofthe deposition of GMAC’s famed robo signer, Jeffrey Stephan, who estimates that he signs 10,000 documents a month. If nothing else, you need to watch from 5:00 to the end of the first segment.

Hat tip reader Barbara W, from 4closureFraud.org.

I wish the sound quality were better; you can also read excerpts of key sections, some of which is contained in these clips.

More shoes are dropping on the foreclosure improprieties front. Let’s not forget the throughline: the parties in the securitization pipeline were so keen to rip out fees and maximize profits that they allotted too little in the way of expense dollars to executing tasks required both by statue and contractual agreements. The result was that they cut corners to such a degree (explained longer form here) that the trusts (the securitization entity) appear not to have been properly conveyed the notes (the borrower IOUs) on a widespread, if not pervasive basis. In 45 states is necessary for the party foreclosing to have the note to be able to foreclose. I’ve had attorneys tell me that when they have uncovered serious document shortcoming, the trustee’s response to the judge has been, “You can’t expect us to do that. We aren’t paid enough.” Funny, they apparently didn’t raise this issue when they signed up for the job.

The failure to transfer ownership properly creates fundamental problems under securitization processes. Bottom line is we’ve spoken to a lot of people, there seems to be no simple or even not so simple fix. Put it another way: why would law firms and servicers be engaging in widespread document fabrication and other improprieties if there were a straightforward remedy?

The latest reports: first, the Florida Bar News reports that a sampling of foreclosures in Florida’s kangaroo foreclosure courts found 20% “or more” had serious shortcomings:

As Florida courts struggle to whittle down a backlog of property foreclosure cases, some judges and lawyers involved in the process say shoddy paperwork filed on behalf of lenders is handicapping the effort….

But the 12th Circuit compiled some numbers from three weeks of its “rocket docket” for foreclosures in Manatee and Sarasota counties and found that 20 percent or more of the cases set for summary judgment had some procedural or paperwork problems.

Yves here. Note this remark appears to address merely the documentation filed by the trustee/servicer. It appears NOT to address judge rubber stamping foreclosures when the borrower may have other legitimate issues. For instance, we gave several examples of cases where the borrower was in the HAMP mod process, but somehow had gotten erroneously kicked into the foreclosure process. and neither the mills nor the judge were willing to halt the process. In addition, the Legislature is pushing the courts to speed up their bogus procedures:

“What’s irritating to me is frankly that the impression is from the Legislature is that the courts are not processing these quickly. Well, the courts can only process them as people comply with the rules,” said 12th Circuit Chief Judge Lee Haworth.

Alan Grayson’s office provided a particularly troubling example, that of a counterfeited court summons. It’s bad enough that servicers and foreclosure mills are making up securitization-related paperwork out of whole cloth, but now court documents to seize someone’s home? This is lawlessness. (View on ScribD)

Separately, CNBC today got word to JP Morgan admitting to problems similar to GMAC with “robo signers” providing improper affidavits. Note that so far, JPM is asserting contra GMAC, which notably was silent on this point, that the underlying facts that the robo signers affirmed were correct, but it is nevertheless delaying foreclosures as a result of this problem. Hat tip 4closurefraud:

If you don’t see the screen image (WordPress can be funny about embeds), view the video here.

New study shows over one-fifth of the world’s plants are under threat of extinction PhysOrg

Google Blacklist – Words That Google Instant Doesn’t Like 2600

Brussels braces for huge anti-austerity protest BBC

WH messaging about its base Glenn Greenwald, Salon

Democrats to Employ Man Who Played Obama During 2008 Campaign Andy Borowitz (hat tip reader Scott)

How to Pay for Social Security Dale Coberly, Angry Bear

Advocacy Groups Stir Call for Probe Wall Street Journal

The Value of Money and Joining the Currency Wars Joe Costello

Currencies clash in new age of beggar-my-neighbour Martin Wolf, Financial Times

Posen pleads for new stimulus to save economy and democracy Independent

China’s quiet power grab Anne Applebaum, Washington Post (hat tip reader Scott)

A reciprocity requirement: The easy and legal way to stop currency manipulation Daniel Gros, VoxEU

Growth reducing structural change Dani Rodrik

Using multiple price indexes to measure changes in inequality is not a good idea Steve Waldman

For-profit school battlers dig in heels John Dizard, Financial Times

Meredith Whitney’s new target: The states Fortune versus States are not like banks Bond Girl (hat tip Richard Smith)

Bill to End Tax Provision on U.S. Jobs Is Blocked New York Times

Trucking Volume Collapses, Falls Most Month To Month Since March 2009 Clusterstock

Antidote du jour. NC has never featured an armadillo, and I thought it was tine to remedy that:

For those of you old enough to remember the Vietnam War, one of its aspects was an effort at what would now be called spin management. When Richard Nixon, who had promised in his 1968 Presidential campaign to exit the conflict but instead escalated it (the movie Patton had a bad effect on his decision process), finally conceded to the will of the American people, he had to come up with a way to present this reversal of course as a victory of sorts. Hence the dubious formulation, “peace with honor,” was born.

Team Obama is trying to present its shameful exodus from what it deems to be a hopeless losing cause, AIG, as a similar victory of sorts. The Journal tells us the US is going to “pare its stake” in the troubled insurer; the New York Times’ formula is “sever ties“; the Financial Times calls it an “exit plan“. But these sanitized phrases deliberately mask what the Administration is so keen to hide: that it has been badly overmastered, whether by incompetence or design, by the world’s biggest deadbeat. And the government’s eagerness to distance itself from a $182 billion sinkhole means it is yet again giving more unwarranted financial concessions.

Recall how we got here: AIG came in desperation to the Fed for a rescue when it somehow noticed it was about to burst aneurysms in its credit default swaps and securities lending operations, and a private sector rescue couldn’t come up with a big enough money transfusion. The Fed provided an $85 billion loan on the same terms as the failed private sector funding: effectively 11.5%, secured by all the subsidiaries of the company. The plan, which management agreed to, was that the divisions would be sold and the proceeds would repay the borrowings.

This would have been a good outcome: the high interest rate was a suitable reward for the risk taken, and the process sufficiently punitive so as to deter future bailouts. No tear should be shed at the prospect of dismembering a poorly run company. Andrew Ross Sorkin’s Too Big to Fail revealed that the company had remarkably poor financial controls; the fact that it also held the investments in many of its subs in physical certificates at head office is another red flag.

But the deal has been retraded a full four times, each time with the Uncle Sam putting up more dough and worsening its footing, through a combination of lowering its interest rate and taking a less senior position. A private sector creditor would do the reverse: more credit would be extended only on more, not less, stringent terms. But the government bought the AIG malarkey that it could not afford the interest rate it had agreed to. The only concession that should have been permitted was to allow interest payments to be deferred rather than lowered, and that should have been accompanied by far more oversight (board seats, more frequent operating reports, etc). And as we have chronicled at length, the government has tolerated the intransigence of the new CEO, Robert Benmosche, who has refused to execute the government program of sale of divisions until the financing is repaid, arguing that AIG is worth more intact. To him and the board members that back him, that is clearly the case.

Admittedly, AIG has hived off some operations. But no one has scrutinized why AIG is not able to dispose of more divisions. Some of the AIG subs have been reportedly been reinsuring each other and there may be other less than savory intra-corporate dealings that if unwound might make some of the divisions less attractive than outsiders believe them to be. So Benmoshe’s theatrics may serve as useful cover for some aggressive accounting.

The latest retrade, announced roughly two weeks ago, is that the government is going to convert its preferred shares to common, and seek to sell its stake over time. But why should the government swap out of preferred, which pays a dividend (well, is supposed to pay a dividend when and if earned) for common when the equity sales are not imminent? This is simply yet another sop to AIG. As reader RueTheDay noted:

Swapping preferred shares for common is LUNACY unless they plan on liquidating their entire holding all at once (which apparently they do not). The Treasury gives up their dividend and their place in line amongst creditors. By then trying to divest the common over a period of time, they expose themselves to market risk.

Here is a sketch of the current state of play, courtesy the Wall Street Journal:

The exit plan would involve the Treasury converting some $49 billion in AIG preferred shares it currently holds into AIG common shares that can be distributed or sold to private investors over time…

The conversion, which could take place at about $35 an AIG share, is likely to occur in the first half of 2011 and is expected to happen after AIG repays its secured debt to the New York Fed, the people added. The move would likely raise government ownership in AIG to more than 90% before it is reduced gradually.

The exact price at which the Treasury converts its preferred shares to common shares would determine how much of AIG the government would own as a result, a person familiar with the matter said.

The calculus in settling on a price involves weighing what the Treasury can reap for taxpayers against the desire to keep enough value for private investors so they will be incentivized to hold or buy AIG shares.

Yves here. Note that a recent example of the Treasury coming up with a way to balance the interest of banks versus other constituencies (in this case mortgage borrowers) in the HAMP resulted in a formula that explicitly gave banks license to game the program (they were encouraged to modify deeply underwater mortgages; the one with equity were evidently understood to be attractive foreclosure material). Do we have any reason to think Treasury will do better this time?

The New York Times adds some cautionary notes:

A rapid exit by the government could also lead to a credit downgrade, which would hurt the company’s ability to sell insurance…..

“This market can’t support” a flood of shares, said Christopher Whalen, managing director of Institutional Risk Analytics. “The reality is that the government has become a long-term stakeholder.”

He and others pointed out that while A.I.G. had made progress in its revamping, it had yet to pass certain milestones that would show it was ready to operate without government support. It is still working on two crucial transactions that must close before it can repay the Fed — roughly $46 billion, $25.7 billion of it in preferred stock that must be redeemed, and $19.7 billion of rescue loans.

Analysts said it was hard to see how the insurer would generate that much cash by the end of this year, which parties to the negotiations said was the Fed’s deadline.

Yves again. One has to wonder about the year end deadline. Does it relate to the Fed not wanting to issue another annual report on the Maiden Lane II and III vehicles, entities created by the Fed to fund lending against AIG mortgage and CDO exposures? The Fed had insisted these loans were money good; our analysis of Maiden Lane III suggested otherwise, and another detailed release might make it hard for the Fed to continue to take that position. Audit the Fed is around the corner, so the AIG bailout will be under renewed scrutiny.

Let’s not kid ourselves: all this fancy financial footwork is to divert public attention from the fact that AIG will deliver big losses to the taxpayer. The latest Congressional Oversight Panel report contained estimates of losses on the AIG financing, with estimates from separate government sources ranging form $36 to $50 billion. Do you see this acknowledged ANYWHERE in the New York Times, Bloomberg, or Wall Street Journal? (To its credit, the FT does pick this up). No, which means this propagandizing, sadly, is proving to be quite effective.

In The Three Burials of Melquiades Estrada, Tommy Lee Jones hauls a fragrant corpse across Texas and into Mexico to honor a commitment made to his dead ranch hand. True to Western hero form, Jones carries out his unpleasant duty manfully. The Obama Administration, by contrast, is ditching the dead body and hoping no one will notice.

As Satyajit Das remarked, our post global financial crisis malaise has some troubling elements in common with Japan’s post bubble era. One biggie is denial of the seriousness of the hangover, which per Das lasted for five years in Japan.

The bizarre aspect of the crisis response in the US was the speed and recklessness with which the Fed cut interest rates. Remember “75 is the new 25″? And the central bank dropped policy rates below 2%, which many regarded as a crucial level (as in below there, the Fed would have perilously little wriggle room. As super-low Fed funds rates failed to defibrilate the financial system, it then moved to implement its now famed alphabet soup of rescue facilities, so as to rescue firms formally beyond its discount window/Term Auction Facility reach by propping up prices of assets to which they were heavily exposed (letting them be pledged to the Fed for loans prevented selling as a way to achieve liquidity).

Initially, continued low rates seemed like an obvious idea if you thought on conventional lines: low rates mean low borrowing costs, surely that will spur economic activity. But banks have been making terms more stringent on consumer loans, and have actually increased interest rates despite lower funding costs. On the business side, credit to small businesses is reported by many to be tight, but the bigger impediment is that most business aren’t terribly keen to borrow given the not-so-hot economic outlook.

But low rates initially operated as a big subsidy to the banks, a way for them to rebuild their balance sheets on the sly. The low rates were accompanied by a steep yield curve, meaning a larger than normal gap between their funding costs (short term) and their lending returns (pegged off of longer dated reference rates, which are normally higher to being with, but in the early post crisis era, the gap was particularly large). This was one of the big drivers of supersized bank profits in 2009.

But the Fed has made it clear that it isn’t giving up on low rates any time soon. As a result, the yield curve has flattened, reducing this source of easy bank earnings. In addition, low rates wreak havoc with certain products like mutual funds, where the expenses associated with the product now exceed investment yields. Since the industry is committed to a $1 net asset value per share policy, that means many money market mutual funds lose money. It is also causing trouble with bread and butter investment products like annuities.

The Wall Street Journal gives an overview of some of the casualties. Note the problem starts in large measure from the fall in yields of longer-dated instruments:

Persistently low rates could force firms to rethink or even exit from businesses. Consider fixed-rate annuities and life-insurance products that offer a guaranteed minimum payout. If insurers, when selling products, didn’t match that liability with assets generating similar income, losses could ensue.

Firms usually hedge much of that risk. But they also face the prospect of declining business for some new products offering lower guaranteed payouts. Sales of fixed-rated, deferred annuities, for example, fell 45% in the second quarter of 2010 from the same period a year earlier, according to insurance-industry group Limra.

Insurers also can expect to generate lower income from their huge investment portfolios. Analysts at Keefe, Bruyette & Woods estimated that U.S. life insurers could see a 2% reduction in 2011 earnings and 4% in 2012 if yields stay at currently low levels.

Banks, too, are feeling the pinch. Many have already taken deposit rates close to zero and have converted high-yielding certificates of deposit to lower rates. That gives them less room to cut funding costs. The amount they can earn from lending or investing, though, is under continued pressure, shrinking banks’ net interest margins.

If rates stay at current levels, U.S. regional banks could see net interest margins decline from an average of about 3.54 percentage points in the third quarter to some 3.44 percentage points this time next year, according to Credit Suisse analyst Craig Siegenthaler. That compares with margins well above four percentage points before the crisis.

Brokers such as Charles Schwab and TD Ameritrade Holding; banks with big brokerage or asset-management operations, such as Bank of America and Morgan Stanley; and trust banks, such as Northern Trust and State Street, face threats, Sanford C. Bernstein analyst Brad Hintz notes. One is the greatly reduced returns firms can generate from cash in so-called sweep accounts that hold customer funds between trades, as well as money-market accounts. Another is the falloff in securities lending margins and activity.

The financial sector needs to shrink, so reducing some of these activities is not necessarily a bad thing. But super low rates and government efforts to drive credit to the housing market means this process is taking place with distorted market signals at work. I’d feel a lot better if we’d forced more clean-up of bank balance sheets, in particular write down and restructuring of loans, so that we would be on a path to getting the banks off the official dole.

An ongoing China v. Japan/US row is getting interesting, and probably not in a good way. Readers may recall that we took note of a ban on shipments of rare earths raw materials to Japan, which in many ways was also a shot across the US bow. Even though so-called rare earths are not that hard to find, they are nasty to mine, and it would take years to gear up production to replace Chinese output. Developed economies have allowed China to obtain a 93% share of this market, and many of these elements are important for production of advanced technology goods. The New York Times noted that China was trying to use this stranglehold to force its way into the production of higher-value-added end products:

But no ban has been imposed on the export to Japan of semi-processed alloys that combine rare earths with other materials, the officials said. China has been trying to expand its alloy industry so as to create higher-paying jobs in mining areas, instead of exporting raw materials for initial processing.

China had denied that a ban was underway (the New York Times had mentioned that in its initial report; they clearly didn’t buy it, and got confirmation from executives in a separate story).

The proximate cause was the detention of the captain of a fishing trawler in disputed waters; the Japanese agreed to release him, which if this was really the main bone of contention, things should be back to normal. But tensions appear to be rising rather than diffusing. As Bloomberg noted yesterday:

China and Japan continue to wrangle over islets in a gas-rich part of the East China Sea, three days after the release of a trawler captain who sparked the worst deterioration in their relations in five years.

Japan rejected China’s demand it apologize and pay compensation for the seizure of the trawler and its crew, with both nations claiming sovereignty over the uninhabited islands, known as Diaoyu in Chinese and Senkaku in Japanese. China and Japan have yet to implement an agreement signed in 2008 to jointly develop the natural gas fields.

This also occurs against a backdrop of China trying to forge stronger ties with traditional US allies in the region. For instance, even though Canberra had called China Australia’s biggest strategic threat last year, Australia participated in Chinese naval war games this week (hat tip reader Skippy).

During the eurozone crisis last May, a remarkable number of senior statesmen and respected policy makers weighted in the Financial Times, with the paper serving the odd role of a forum for posturing and floating trial balloons. The FT is a much less likely venue for that sort of thing in a Asian row, but a wee bit of that seems to be happening again. Yesterday, an FT comment from Jonathan Holslag, “China’s muscle-flexing is a sign of weakness,” noted:

Similar concerns exist about China’s economic nationalism, which feeds on a strong historical sense of vulnerability….excess capacity and reliance on foreign consumer markets impelled Beijing to strive to make its national champions truly global and to back them with an assertive trade policy.

While industrialised nations see this as unfair competition and try to straitjacket China into large regional organisations, developing countries are alarmed about Beijing’s attempts to buy and bully itself into their markets. They are determined to keep China’s champions at bay…. Central Asian countries have refused a free trade zone with China, while south-east Asian nations have demanded further concessions for a trade accord that came into force this year. China looks increasingly like a trapped giant.

In the past 30 years, the People’s Republic has mainly sought to regain its leading status in the international community by becoming a part of it. But, today, its economic model has become unsustainable: in spite of six years of bold declarations and experiments, it has got only more addicted to export-led manufacturing and investment in fixed assets. Unrest from Xinjiang to the factory halls of Shenzhen has cast a shadow over the harmonious society doctrine of Mr Wen and President Hu Jintao. Beleaguered by ambitious oligarchs on the right and a revival of communist patriotism on the left, the leadership is weakened. This reduces Mr Hu and Mr Wen’s scope for making compromises and raises the question of how the next generation of leaders will reinvent Chinese nationalism.

We have seen outbursts of assertiveness before, but this episode is the product of a bottleneck in China’s domestic transition, which, if not managed well, could lead to a return of destabilising patriotism. China flexes its muscle at a moment when other powers feel less confident about their future and are under pressure to stand strong. In such a climate, distrust could turn into a self-fulfilling prophesy, because it weakens the position of moderate leaders, stirs mutual fear of aggression and, above all, strengthens the belief that shifts in the balance of power inevitably lead to greater global rivalry.

Today, in an interview in the Financial Times, Japan’s new economics and fiscal policy minister, Banri Kaieda, said the ban was still on and Japan would look for other sources of materials:
China’s de facto ban on rare-earth exports to Japan imposed during the two countries’ diplomatic feud will propel Tokyo to seek new sources of the strategic minerals, according to Japan’s new economics and fiscal policy minister.

In an interview with the Financial Times, minister of state Banri Kaieda called on China to lift export restrictions “as soon as possible”.

Mr Kaieda added that Japan would try to develop substitutes for their use in high-tech products….

He said that Japan was willing to continue to be a major buyer of rare earths from China, which accounts for more than 90 per cent of global supply.

However, Mr Kaieda noted that Japan had been ill-prepared for what he called the “surprise attack” of Chinese export curbs.

“[It seems] there’s a need to put effort into developing substitute products,” that could play the same role as rare earths in high-tech products, he added.

Tokyo would also look to develop alternative sources of supply for rare earths, Mr Kaieda said. Such a policy could prove “effective” in helping reduce upward pressure on the exchange rate of the yen.

Yves here. The last remark is code for “we are prepared to throw a ton of money at this initiative.”

Even if China wins this round, this is an extraordinarily heavy-handed and short-sighted move. China is telling the world loud and clear that it is an unreliable partner. China is conducting this ban apparently without issuing formal regulations, which would subject it to WTO sanctions. But for it to think this action won’t lead to retaliation is naive, when political pressures abroad make China an easy target.

→ Washington’s Blog

Oil Spill Commission co-chair Bob Graham slammed the administration’s handling of the Gulf oil disaster, including its low-ball estimates of the size of the spill ( which was some 60 times too low):

It’s a little bit like Custer underestimating the number of Indians on the other side of the hill and paying a price for that ….

(Of course, since the Oil Spill Commission won’t have any subpoena power, that inquiry might be toothless.)

And the low-balling of oil spill impacts is continuing to this day.

For example, our tax dollars are being used to convince kids that Gulf seafood is safe, because oil “floats”, dispersants are harmless and wildlife is hearty:

A scientist with the National Oceanic and Atmospheric Administration partnered with BP to answer eighth graders’ questions about the Gulf of Mexico oil spill.

Gary Ott, science support coordinator with NOAA, demonstrated the basic science behind the oil spill and its cleanup for students using an aquarium filled with water as the Gulf of Mexico and cooking oil mixed with Hershey’s cocoa powder to represent BP’s spilled oil.

“Should you be afraid to eat shrimp?” Ott asked the library full of eighth graders. Some answered “Yes,” some said “No.”

But Ott assured them it was safe, and set out to explain why.

***

Other presentations at local schools are planned.

***

Using a pump at the bottom of the aquarium, Ott released the oil-cocoa mixture into the water, and students watched the oil globs rocket to the top and stay there in a slick.

“Oil floats. See, we’ve tested it,” Ott said.

***

A rubber ducky also went into the spill, representing oiled birds.

***

Of course, the oil doesn’t disappear when it’s dispersed, Ott acknowledged. It stays suspended in the water column for weeks where it can hurt some fish species. But it is broken down within weeks by hungry oil-eating microbes, he said. It’s a trade-off officials accept to keep huge slicks of oil from floating into wetlands and oiling birds, Ott said.

Ocean life in the real world, of course, is a tad more sensitive to pollution than a plastic rubber ducky.

And in the real world, as little as 2% of all oil which spills from deepwater wells ever makes it to the surface of the ocean (see this for detail), and the massive application of dispersants caused the remaining oil to sink under the surface. So the whole oil floats thing is ridiculous.

And scientists say that oil-eating microbes are not quickly breaking down the oil. Indeed, instead of oil-eating microbes breaking down the oil, they appear to have instead gorged themselves – according to the Los Angeles Times – on gases in the water.

And instead of just nourishing the good guys (oil-eating microbes), the oil and dispersants in the Gulf may be strengthening bacteria which are harmful to humans and seafood.

PhD toxicologist and oil spill expert Riki Ott has repeatedly raised this possibility. See this and this.

And as I have previously pointed out, scientists have found an oil-eating microbe in the Gulf which is in the same family as Vibrio and other nasty, disease-causing pathogens.

And as the New York Times noted in June:

Some bacteria in the Gulf of Mexico love eating oil as much as they like infecting humans.

***

Scientists have long known that the ultimate end of the crude oil spewing into the Gulf of Mexico from the damaged BP PLC well will rest in the hands of marine bacteria, single-cell organisms that have been purging the seas of oil from natural seeps for millenia, having only recently added human folly to their cleanup resume. Without these bacteria, whose numbers surge in response to hydrocarbons, enough oil would leak each year to coat the world’s oceans in a fine film, molecules deep.

Beneath this awareness, however, sit vast reserves of uncertainty. Microbiologists are unsure which bacteria, feeding off the oil, are already growing exponentially in the Gulf. They are curious how long the bacterial growth will last once the oil’s hard remnants drift down into ocean sediment. And no one seems certain how the surge in microbial life will alter the intricate, disentangling web of the Gulf’s already weakened ecology.

***

“The question is: Will there be an inadvertent enhancement of the growth of these potential human pathogens?” said Rita Colwell, former director of the National Science Foundation and an expert in marine microbial life. “It’s a question, and the answer is uncertain.”

So far, hard evidence is scant. Grimes recently examined an oiled water sample taken by the research ship Pelican. The oil, likely exposed to dispersant, was finely divided. Using gene-staining technology, Grimes discovered several microbes attached to the droplet. Now glowing blue, they had been gorging. At least one was a Vibrio.

“There’s no question bacteria, in general, increase following spills, and this includes Vibrios,” said Jim Oliver, a Vibrio specialist at the University of North Carolina, Charlotte. Whether the pathogenic Vibrios “significantly increase is unsure, I would say, but they are coastal bacteria … so [they] could well increase either as a direct result of oil degradation or as a side effect of the added nutrient levels.”

The ingredients are there for heightened concern, Oliver added. The carcasses of bacteria feeding off the oil will increase overall nutrient levels as sweltering summer temperatures hit their peak. While there are natural controls, like bacterial viruses and protozoa, that can check Vibrio growth, those can be overwhelmed, studies have shown. And because of the cleanup, more people could be coming into direct contact with the bacteria.

“I think that combination could lead to very serious public health concerns,” Oliver said.

The Times also notes that some species of Vibrio can contaminate seafood , especially oysters.

As Florida Oil Spill Law reports:

The National Science Foundation awarded a rapid response grant to research this very topic, From the NSF website on June 21, 2010:

How are the oysters faring with the oil spill? The National Science Foundation (NSF) has awarded a rapid response grant to scientists Crystal Johnson, Gary King and Ed Laws of Louisiana State University (LSU) to find out.

The researchers will look at how the abundance and virulence of naturally-occurring bacteria called Vibrio parahaemolyticus and Vibrio vulnificus, often found in oyster beds, may change in response to the spill.

The findings will provide insights into vibrios’ ability to “consume” oil, and will allow the biologists to uncover antibiotic compounds in certain species of phytoplankton that live in association with vibrios.

“Adaptation to the spilled oil may result in an increase in some types of vibrios,” says Johnson. “We believe that vibrios will change in response to the stress of direct exposure to oil and/or to indirect effects of interactions with other species affected by oil.”

Vibrios… may even help break down the components of the oil.

“Little is known about how microbes–in the water, along coasts, and associated with other species–are affected by the spill,” says Phillip Taylor, acting director of NSF’s Ocean Sciences Division.

“Through this NSF rapid response grant, these scientists will be able to track the oil’s effects on marine species living in the Gulf, and by extension, the possible threat to human health.” …

“Oil-induced changes in phytoplankton community composition and their associated bacterial communities are related to changes in vibrio abundance,” he says. Some species of phytoplankton in Louisiana and Mississippi coastal waters may excrete antibiotics that inhibit the growth of vibrios, according to Laws.

(the Florida Oil Spill Law article also documents the terrible disease that Vibrio can cause in humans.)

Indeed, there are many other reports of health problems among Gulf residents. See this, this and this.

Moreover, as the Tampa Tribune notes, the oil and dispersants are still there:

Most of the oil and dispersant are still below the surface and have the potential to cause long-term damage the eco-system, according to University of South Florida researcher John Paul who is included in a documentary debuting Tuesday night in the National Geographic Channel.

***

They discovered plumes of dispersed oil at the bottom of an undersea canyon about 40 miles off the Florida Panhandle.

It was found to be toxic to microscopic sea organisms, causing mutations to their DNA.

If this plankton at the base of the marine food chain is contaminated, it could affect the whole ecosystem of the Gulf.

***

“The problem with mutant DNA is that it can be passed on and we don’t how this will affect fish or other marine life,” he says, adding that the effects could last for decades.

In addition, more and more evidence points to the continued application of dispersant in the Gulf. See this, this, this and this.

The government and BP continue to act like General Custer … and the Gulf will pay a heavy price for their negligence.

Let’s be clear: there are plenty of bad guys, chumps, and people who should have known better in the subprime mess. High on the list for well deserved scorn are the ratings agencies, who still retain a central role in structured credit. Well, now, come to think of it, the mortgage securities business is now pretty much a subsidiary of the US government. Think the failure to reform ratings agencies and the failure of the private label mortgage securitization market to revive are unrelated events?

We’ve long critics of ratings agencies. But given what easy and obvious targets they are, one ought to be mindful of whether people who join in on the attacks on them might be engaging in more than a bit of artful misdirection.

There has been a fair bit of excited press coverage (see here and here) about a FCIC session last week. On deck was Keith Johnson, head of a firm called Clayton Holdings, which did something colloquially called underwriting in the subprime space. But they didn’t take risk, as that term implies; instead, they sampled the mortgages in pools due to be securitized and provided reports to their clients on what they found. In the case of subprime deals, the clients were investment banks putting the transactions together.

The juicy disclosure is that Johnson claims that half the mortgages his firm sampled in 2006 and 2007 didn’t meet the standards the banks had set. But revealingly, he shifts the focus away from his clients, the investment banks, and his relationship with them, to suggest the ratings agencies were at fault. Per the New York Times:

“We went to the ratings agencies and said, ‘Wouldn’t this information be great for you to have as you assign tranche levels of risk?’ ” Mr. Johnson testified last week. But none of the agencies took him up on his offer, he said, indicating that it was against their business interests to be too critical of Wall Street.

“If any one of them would have adopted it,” he testified, “they would have lost market share.”

Earth to base. Clayton already HAS a business relationship with the investment banks at this point. He implies now, in 2010, that he saw something amiss. So where does he go? Not to his clients, heavens no, if he clears his throat and asks why they are still buying crappy loans in the face of his reports, or maybe they ought to disclose them more clearly, he might jeopardize his meal ticket. Does he go to the SEC or the media to blow the whistle on subprime? Apparently not.

Instead, he cooked up an idea of how this little disparity might represent a new business opportunity and calls the ratings agencies. And one has to wonder how late in the game he made this move. Note he does not mention 2005, and by all accounts, the sharp fall in origination quality started in 2005. He didn’t call on Moodys till 2007 (suprime pretty much stopped cold in May 2007) and one wonders how late in 2006 he decided to cast about.

One also has to wonder why he hasn’t come forward on behalf of investors. The statute of limitations on securities underwritings is effectively three years. As noted, subprime was over as of May 2007. So Johnson testified after any investors might make use of this information (admittedly, as we discuss below, there are reasons why claiming the disclosure were inadequate probably isn’t a great line of attack).

Clayton was the largest provider of mortgage loan diligence in the market. The banks hired Clayton before they purchased or securitized subprime mortgage loans to confirm the quality and credit of the mortgage loans under consideration. In many ways, Clayton performed a role similar to that of a rating agency. Just about every subprime mortgage deal that was issued during the big bubble years had 10-20% of the loans reviewed for credit quality by an independent outside firm, and Clayton was the biggest player. Despite all of this diligence and review, just about every subprime mortgage deal issued during this period blew up. Seems like the diligence didn’t help all that much. This could due to a number of things, including the possibility that the underwriting was just fine and the loans blew up for other reasons – though that sure seems unlikely.

From what I can tell, no one heard about Clayton’s role in the crisis until January 2008, when the New York Attorney General’s office announced that Clayton had been granted immunity and would be providing information to the prosecutors on Wall Street’s bad practices in subprime land. Why on earth did Clayton need immunity? And from what?

Here we are in 2010 and still no news on how Andrew Cuomo has been using all of this valuable information from Clayton. Not to worry, however, because Clayton has still managed to make themselves useful: the Massachusetts AG recently announced a settlement with Morgan Stanley about its bad practices with former subprime lender New Century.

Clayton provided information about their former client, Morgan Stanley, which showed that Morgan Stanley knew, as a result of Clayton’s diligence, that New Century’s loans had all sorts of problems, including bad appraisals, predatory loans and a high concentration of stated income loans. But Morgan decided to buy the loans anyway and securitze them and sell them to Massachusetts pension funds.

Except that’s not the whole story. At first Morgan used this information to kick out the bad loans New Century tried to sell them, which would appear to be a sign that the process was working just fine. However, New Century was experiencing a similar loan rejection problem across Wall Street and was soon teetering on the brink of bankruptcy. Morgan, having extended New Century a hefty line of credit, agreed to buy more loans from New Century, at distressed prices, in an attempt to keep the lender afloat (For those who were watching, New Century’s bankruptcy in March 2007 marked the real trigger point for the financial crisis). Those desperation loans of New Century ended up in several Morgan Stanley MBS, which ended up in the Mass. pension funds. Since the whole New Century relationship looked quite ugly, it is no wonder that Morgan Stanley settled with the Attorney General.

Johnson has generously offered, presumably thanks to his grant of immunity, that both the rating agencies and the banks were on notice of the bad results of his former company’s diligence results. But it isn’t clear what this really means. The banks hired Clayton and others for their own diligence but they didn’t make any representations or warranties about the results of the diligence and that everything was fine with the loans, nor does Mr. Johnson appear to believe such a charge. The Times suggests that the banks did use the diligence results to kick back some loans and reduce the sales price for other loans, a savings the Times believes should have been passed along to the investors in the MBS backed by the weak loans. However, the value of MBS collateral was not set by the banks or based on the market price of the loans, but rather was determined by the rating agencies, the credit enhancement levels and the price investors were willing to pay for the bonds. The rating agency models all assumed that newly originated subprime loans would have a value equal to the loan balance, not some market value calculation.

The flood of articles about the Clayton results certainly must, we are told, have broad implications, about the failure of the rating agencies, the poor warehouse and mortgage lending practices of banks like Morgan Stanley, and the potential for future litigation against lenders and banks. It is of some historical interest to know that someone like Johnson was aware that thousands of mortgage loans were being originated without any regard to lending guidelines, though it certainly would have been nice if investors had been clued in back in 2005 and 2006 when they were considering buying the MBS, rather than in 2010, when their attorneys are trying to figure out what to do with the investor’s charred remnants. However, since the banks made no representations about the Clayton results, the rating agencies didn’t understand the significance of Clayton’s results (or didn’t want to pay as much as Clayton was charging), and most of the lenders who made the bad loans have long since left the planet, it is hard to know exactly what to do with these revelations.

Private water raiding threatens Angkor’s temples built on sand Guardian

India ‘faces pollination crisis’ BBC

Charges dismissed against Md. man who taped traffic stop Washington Post

Tensions Still Getting Worse, As Japan Demands Two Chinese Boats Leave Key Area Clusterstock. Hhm, this sound like posturing unless the Japanese actually do something (like a shot across the bow….) but this is more than most expected.

Regulators Call Health Claims in Pom Juice Ads Deceptive New York Times. I’m surprised the FTC has taken this long (and where is the FDA?). I’m not a lawyer, but I’ve had extensive dealings with FDA lawyers, and there seems to be a pretty simple rule: you can’t make health claims on without going through the clinical trial drill. Look at the back of any dietary supplement. They don’t make the sort of representations that POM does.

Rahm Emanuel Likely to Leave White House This Week ABC

The Left Right Paradigm is Over: Its You vs. Corporations Barry Ritholtz

Ross Douthat Claims That “Everybody Knows” Something That Is Not True Dean Baker

China’s muscle-flexing is a sign of weakness Jonathan Holslag, Financial Times

J.P. Morgan Targets WaMu Funds Wall Street Journal. This is probably as sus as it looks, but John Hempton was very much on the WaMu beat, and I think I’ll wait for him to weigh in. This deal looked like a steal for JPM, and now they are back at the trough?

Spanish spectres in the market FT Alphaville

The Van Rompuy talks force: Unambitious and Vague Eurointelligence

More Americans Expect Recovery Will Take Years WSJ Economics Blog

Where Are All the Prosecutions From the Crisis? New York Times

Morgan Stanley Said to Suspend Investment-Bank Hiring for 2010 Bloomberg

FDIC urges bank action on living wills Financial Times

Antidote du jour (hat tip reader Bob). Yes I know this has to be Photoshop, but the version I have locally is very high res, and I have to tell you it looks very real.

Well, at least you have to give the mandarins at the Bank of England points for honesty. They’ve actually admitted they don’t give a rat’s ass for the welfare of old people who had prudently hoped to live off income from their investments. Admittedly, the retirees might have been kidding themselves a wee bit, since the pre-bust interest rates had an modest inflation component built into their nominal yield, which served to compensate for gradual erosion of principal. But savers are now suffering because we’ve had not just a reduction in yields due to lower inflation but an even bigger fall due to central banks going into ZIRP-land, with the result that savers get paltry yields that are clearly in negative real interest rate territory.

This is the Bank of England’s version of the Charlie Munger “banks get theirs first, the rest of you suck it up and cope” message, courtesy the Telegraph:

Older households could afford to suffer because they had benefited from previous property price rises, Charles Bean, the deputy governor, suggested.

They should “not expect” to live off interest, he added, admitting that low returns were part of a strategy.

His remarks are likely to infuriate savers, who are among the biggest victims of the recession. About five million retired people are thought to rely on the interest earned by their nest-eggs. But almost all savings accounts now pay less than inflation.

The typical savings rate has fallen from more than 2.8 per cent before the financial crisis to 0.23 per cent last month.

Mr Bean said he “fully sympathised”. But he continued: “Savers shouldn’t necessarily expect to be able to live just off their income in times when interest rates are low. It may make sense for them to eat into their capital a bit.”

He added: “Very often older households have actually benefited from the fact that they’ve seen capital gains on their houses.”

Yves here. So how exactly do old people “benefit” from capital gains in their houses? This is the sort of “house as a financial asset” walking dead idea that needs a silver stake plunged in its heart. In the old days, housing was a vehicle for forced savings and shelter. You took a 20 to 30 year mortgage when you were young, which coincided nicely with a normal time in the workforce, and then you retired mortgage-free, paying only more modest real estate taxes and upkeep. More job mobility and overly cheap housing finance encouraged people to refi and move a lot more often than was good for anyone outside the banking and real estate industries.

So the Bank of England is basically saying old people need to monetize their houses, which is probably NOT going to be in the form of putting on a home equity line. It means selling their house and moving into a smaller house or a rental. Do you know how hard that is for old people?

Now this is clearly the way the world is going. There is no denying that many people are continuing to make unpleasant adjustments to the post financial crisis world. But what is offensive is the cavalierness of these remarks. The Bank also gives happy talk that savers can expect high rates again, which given the continued fragility of the banking system, I wouldn’t bet on any time soon.

Funny, I knew there was a reason I ran a video of now 114 year old Walter Breuning over the weekend. One of his bits of advice was to keep working as long as you can, you might need some extra money.