naked capitalism

‘Boredom can kill you’ ANI

Genes reveal ‘biological ageing’ BBC

Re-Engineering the Human Immune System h+ (hat tip reader David C)

Sahara Desert Greening Due to Climate Change? National Geographic (hat tip reader Diane R)

Spray-on liquid glass is about to revolutionize almost everything PhysOrg (hat tip reader Nick)

Sarah Palin caught cheating, proving to the world once again she’s a colossal IDIOT! Zeitgeist Watch (hat tip reader John L)

Unaccountable America Archein

Traders make $8bn bet against euro Financial Times

The Option of Last Resort: A Two-Currency EMU RGE Monitor

‘PIGS’ Crisis Is Opportunity for Euro to Stand Up Matthew Lynn, Bloomberg

Greek crisis intensifies as Joe Stiglitz calls for Europe to ‘teach the speculators a lesson’ Telegraph (hat tip Swedish Lex)

Mervyn King goes dog sledding but all avoid seal meat at G7 summit in Canada Guardian

Treasury is failing to force banks to lend, warn MPs Independent

The second lien sticking-point FT Alphaville (hat tip Richard Smith)

China says it shut down online academy for hackers LA Times (hat tip reader Sundog)

Dollars Flow Out as Data Flows In New York Times

In praise of mammoth deficits LA Times (hat tip reader Scott)

We’re Weimar James Howard Kunstler (hat tip reader Scott). Whether you agree or not, it’s a lively read

All roads lead to the renminbi Chevelle

Could we start industrial society from scratch today? Kurt Cobb (hat tip reader Robert M). From 2008, but the discussion is still pertinent

Name change: ‘Dynamite Prize in Economics’ Real World Economics. Vote for the economist most responsible for the crisis! (I did see this earlier, forgot to link, a nice reader reminded me, cannot find the message, so apologies for lack of h/t).

This Trend is Not Your Friend: Wall Street’s Killer Instinct Spells Death Knell for Jobs Pam Martens, CounterPunch (hat tip reader Stephen V)

Antidote du jour (hat tip reader Steve S):

Regulators have been making a concerted push for banks to hold more equity as a protection against loss and overly-optimistic valuation of trading assets. But the head of the Bank of International Settlements, Jamie Caruna, argued at a secret (not) central bankers’ conference in Sydney that banks also need to carry more in the way of liquid assets (note that this recommendation apparently came in the form of a paper, but we can find no such document at this hour at the BIS website).

Caruna recommended that banks hold enough to allow them to survive a month without access to funding. Note that idea only seems radical now, since banks have spent decades perfecting the art of running lean. The rule of thumb in banking is to lend out $9 of every $10 in deposits. In the 1960s, only $5 of loans versus $10 in deposit was considered prudent.

From Bloomberg:

Capital and liquidity buffers need to be built up in good times so that they can be drawn down in bad times,” Caruana said. “Banks should hold a sufficient stock of high-quality liquid assets to be able to survive a month-long loss of access to funding markets.”

The Basel Committee proposed in December that banks should keep assets that are simple to value and wouldn’t have to be sold at fire-sale discounts during times of stress.

Lenders should also increase the amount of equity and retained earnings they hold to help them cope with losses better, the Basel Committee said last year. Banks’ core capital should exclude stock with preferential dividend rights to reduce risks to the financial system, it said in a report.

“Capital requirements are the speed limits of banking,” Caruana said today. “Capital requirements should draw on deep pockets that can absorb losses. An idea worth exploring is whether those pockets might be usefully deepened by debt that is convertible to equity when times are bad.”

Simple and slow banking is, of course, less profitable in good times than the kind we’ve had over the last two decades. But banks were kept comfortably profitable and low risk via strict regulation for nearly five decades without having a major crisis (from the 1930s through the sovereign lending mess of the late 1970s). Although the financiers will fight it tooth and nail, simple, stupid banking looks a lot better than what we have right now.

While Eric Margolis’ entire comment in the Toronto Sun is a must-read, the following two quotes really hit the nail on the head:

More empires have fallen because of reckless finances than invasion…

If Obama really were serious about restoring America’s economic health, he would demand military spending be slashed, quickly end the Iraq and Afghan wars and break up the nation’s giant Frankenbanks.

Margolis is right.

As I have repeatedly shown, war is bad for the economy. According to a Nobel prize-winning economist, the head of JP Morgan and others, the Iraq war and the war on terror in general were huge factors in destroying our economy.

America is a dying empire, destroying the last of its resources to fight unnecessary wars. Instead of rebuilding our economy so that we can once again be a strong nation, we are wasting trillions fighting those unnecessary wars, thus guaranteeing that we do not have the economic resources to defend ourselves in the future from real threats.

Don’t believe me?

Well, our military and intelligence leaders say that the economic crisis is now the biggest threat to America’s national security.

And as leading economic historian Niall Ferguson recently wrote in Newsweek:

Call the United States what you like—superpower, hegemon, or empire—but its ability to manage its finances is closely tied to its ability to remain the predominant global military power…

This is how empires decline. It begins with a debt explosion. It ends with an inexorable reduction in the resources available for the Army, Navy, and Air Force…

If the United States doesn’t come up soon with a credible plan to restore the federal budget to balance over the next five to 10 years, the danger is very real that a debt crisis could lead to a major weakening of American power.
The precedents are certainly there. Habsburg Spain defaulted on all or part of its debt 14 times between 1557 and 1696 and also succumbed to inflation due to a surfeit of New World silver. Prerevolutionary France was spending 62 percent of royal revenue on debt service by 1788. The Ottoman Empire went the same way: interest payments and amortization rose from 15 percent of the budget in 1860 to 50 percent in 1875. And don’t forget the last great English-speaking empire. By the interwar years, interest payments were consuming 44 percent of the British budget, making it intensely difficult to rearm in the face of a new German threat.

Call it the fatal arithmetic of imperial decline. Without radical fiscal reform, it could apply to America next.

And William R. Hawkins (formerly an economics professor at Appalachian State University, the University of North Carolina-Asheville, and Radford University) fills in some details on the fall of the Hapsburg empire:

Spain was the first global Superpower…With Spain as its political base, and gold and silver flowing in from its American colonies, the Hapsburg dynasty became the dominant power in Europe. It controlled rich parts of Italy through Naples and Milan, and Central Europe from the Netherlands through the Holy Roman Empire to Austria. In the 16th century it added the far distant Philippine islands to its empire. The Hapsburgs held off the Ottoman Turks, whose resurgent wave of Islamic conquest in the 16th century swept across the Balkans and nearly captured Vienna.

The Hapsburgs went into decline in the 17th century, and while any such momentous event has many causes, for our purposes the focus will be on the economic collapse of Spain, which not only sapped the empire of strength but served to build up the power of its rivals.

The demands of empire required a strong and growing economy, but Spain did not keep up with the economic expansion that was taking place in other parts of Europe. Madrid’s financial base fell out from under its empire. Spain could continue to consume in the short term because of the flow of precious metals from American mines, but it could not produce the goods it needed at home, which in the long-run proved fatal to its standing as a Great Power and as an advanced society.

Spanish imports were double exports and the precious metals became scarce within weeks of the arrival of the American treasure fleets as the money flowed to Spain’s many creditors. What industry there was, along with banking and shipping, was in the hands of foreign owners. As a modern historian, Jaime Vicens Vives, has concluded, “This was one of the fundamental causes of the Spanish economy’s profound decline in the seventeenth century, maritime trade had fallen into the hands of foreigners.” This, plus the “opening of the internal market to foreign goods,” produced a “fatal result.” Spain’s exports were at the same time under heavy pressure by competitors in third country markets. A nation that cannot control its domestic market will seldom be able to sustain itself in foreign markets, which are inherently less accessible and more unstable.

Yet, Spanish leaders were deluded by a sense of false prosperity. This is testified by the statement of a prominent official, Alfonso Nunez de Castro in 1675: “Let London manufacture those fine fabrics of hers to her heart’s content; let Holland her chambrays; Florence her cloth; the Indies their beaver and vicuna; Milan her brocade, Italy and Flanders their linens…so long as our capital can enjoy them; the only thing it proves is that all nations train their journeymen for Madrid, and that Madrid is the queen of Parliaments, for all the world serves her and she serves nobody.” A few years later, the Madrid government was bankrupt. The Spanish nobleman had foolishly elevated consumption, a use for wealth, above production, the creation of wealth.

Historians have traced the flow of Spanish gold and silver across the markets of Europe. Those who “served” Spain by establishing industries to manufacture goods for the Spanish market gained the money. Spain’s rivals, France, Holland (which started a successful revolt in 1568) and England, prospered by their trade surpluses, and reinvested the money to expand their own capabilities. Another modern expert on Hapsburg history, Henry Kamen, has cited contemporary sources who referred to 17th century Spain as “the Indies for the foreigner.” The military empire of the Hapsburgs became the economic colony of other powers, or, to use a current phrase, Spain was the “engine of growth” for the rest of the continent.

Where there were jobs and prosperity, there was also rapid population growth, and rising tax revenue. Rival powers were able to field and finance military forces that could defeat the once superior Spanish forces both on land and at sea. The irony of this is that Spain was ruled by a warrior aristocracy tempered by centuries of constant warfare against Islamic hordes and Christian heretics. These nobles looked down on merchants and manufacturers and disparaged their mundane professions only to find that without a strong domestic business class they could not afford the fleets and armies that guarded the empire they had built.

Today, the American “empire” is also trying to consume more than it produces. The U.S. trade deficit is nearing Spain’s nadir of imports being double exports. Both government spending and private consumption are financed heavily by debt. Washington is printing money, the modern equivalent of digging gold out of the ground, rather than earning the means to pay its bills. And the political and military elites are apparently indifferent to the fate of domestic business and industry. Americans must learn … from the Spanish experience … and take corrective action while they still can.

As for the need to break up the “Frankenbanks”, see this.

By Edward Harrison of Credit Writedowns

In the lead-up to the credit crisis, I really didn’t write a considerable amount about second mortgages despite my focus on credit writedowns. At that time, I was more focused on writedowns from securitized mortgage paper (and later construction loans and commercial real estate because of the stress these loan types put on regional financials). However, second liens are a very big deal and I believe they will loom that much larger in 2010 because of the rise in strategic defaults in prime and Alt-A categories.

When the crisis first developed, in February of 2007, it was subprime where the worries were, with the lion’s share of writedowns coming from mark-to-market losses in the securitisation market.  However, subprime was a relatively small part of the overall market, making up 14% of loans outstanding at that time. Alt-A loans were 27% and prime loans were 57% respectively of loans outstanding according to a Banc of America Securities report.

As the 2004-2007 co-horts of Alt-A option ARM mortgages have started to reset and prime borrowers have come under stress, we have started to see defaults in markets which are an order of magnitude larger than subprime.

Diana Olick of CNBC says:

There are no specific numbers on how many option ARM loans there are. But analysts estimate that as many as 1.3 million borrowers took out $389 billion in option ARMs in 2004 and 2005 alone.

Many of those option ARM loans have already re-adjusted to higher payments, but more are on the way. Some 88 percent of Option ARMs originated between 2004 and 2007 are going to adjust higher between now and 2012. Those option ARM borrowers could see their housing bills go up as much as 63 percent, according to Fitch ratings.

The chosen solutions thus far has been to arrest the fall in house prices so that they are still at elevated levels. This is one reason the Fed is loath to raise interest rates; doing so would make interest payments unaffordable for many homebuyers and homeowners.

Nevertheless, the reset and strategic default issues are still with us and they bring second mortgages into view. I have been interested in the problem presented by second mortgages since I wrote a few posts on legal cases involving foreclosure, second mortgages and mortgage servicers.

What was clear then is that mortgage servicers were not incentivized to modify existing mortgages.  The incentive for servicers is to service an existing mortgage for as long as they can in order to collect the fees associated with that servicing. The big four commercial banks are by far the largest servicers of loans. Here is the breakdown from an October post linked just below.

• Bank of America: $2.1 trillion, up from $530 billion a year earlier (via its acquisition of Countrywide – this is WHY bank of America bought Countrywide)
• Wells Fargo: $1.8 trillion, up from $1.5 trillion a year earlier
• JPMorgan Chase: $1.5 trillion, up from $795 billion a year ago (thanks in large part to its acquisition of Washington Mutual)
• CitiMortgage (a division of Citigroup): $792 billion, down from $799 billion a year earlier. Citi is hurting i everywhere)
• ResCap: $391 billion, down from $449 billion in the first quarter of 2008.

See Why mortgages aren’t modified and what a ruling stopping foreclosures means.

But, as coincidence would have it, the big four commercial banks are at once the largest mortgage servicers and the largest second mortgage lenders. Here are the numbers from Amherst Securities’ Laurie Goodman via FT Alphaville.

The interesting bit is that, according to Reuters’ Felix Salmon, the lion’s share of writedowns on second liens to date come from that small sliver of ABS Issuers. The reason of course comes from the dichotomy between how loans and securities were treated before mark-to-market rules were liberalized last year.

You should have noticed that most of the assets written down in the past two years have been marked-to-market. Securities traded in the open market are marked to market. Loans held to maturity are not.  This is one reason that large international institutions which participate in the securitisation markets have taken the lion’s share of writedowns, despite the low percentage that marked-to-market assets represent on bank balance sheets.  But, this should end because of new guidelines in marked-to-market accounting.  However, the new guidelines do have two major implications.  First, there are still many distressed loans on the books of U.S. banks that if marked to market would reveal devastating losses.  Second, there will also now be many distressed securities on bank balance sheets that if marked-to-market would reveal yet more losses.  In essence, the new guidelines are helpful only to the degree that it prevents assets being marked down due to temporary impairment.  If much of the impairment is real, as I believe it is, we are storing up problems for later.

-The Fake Recovery, April 2009

So, when people default strategically, two things happen to the mortgage holder’s balance sheet. First, the losses become realized and must be accounted for. Second, the second mortgage gets vaporized.

I’m still trying to get to grips with the motivations of the too-big-to-fail banks given their outsized holdings of both second mortgages and service contracts and the lack of first mortgage holding. But, it seems that the interests of the servicer are to extend and pretend existing mortgages in order to get as much fee income as possible.  So the Home Affordable Modification Plan (HAMP) isn’t going to be the preferred approach here and that’s why it is largely a failure.

But what about the second mortgage holder? They clearly don’t want a modification either because they are subordinated to the primary mortgage and must take all of the initial hit in a modification. So the government has set up a second lien modification program.

The Second Lien Program announced today will work in tandem with first lien modifications offered under the Home Affordable Modification Program to deliver a comprehensive affordability solution for struggling borrowers. Second mortgages can create significant challenges in helping borrowers avoid foreclosure, even when a first lien is modified. Up to 50 percent of at-risk mortgages have second liens, and many properties in foreclosure have more than one lien. Under the Second Lien Program, when a Home Affordable Modification is initiated on a first lien, servicers participating in the Second Lien Program will automatically reduce payments on the associated second lien according to a pre-set protocol. Alternatively, servicers will have the option to extinguish the second lien in return for a lump sum payment under a pre-set formula determined by Treasury, allowing servicers to target principal extinguishment to the borrowers where extinguishment is most appropriate.

-Obama Administration Announces New Details on Making Home Affordable Program, U.S. Treasury Department, April 2009

Sounds pretty complicated if you asked me. As a large servicer who also has a lot of second liens, why would I agree to this if I could extend and pretend – especially since most modifications end up in foreclosure anyway? As I see it, the optimal response would be:

• extend the loan and get as many payments as you can from the homeowner
• meanwhile collect all the servicing fees in that time frame
• at some juncture, this pretense comes to a close. So, avoid a foreclosure by inducing a short sale in which you (secretly?) get some compensation (see my post “Short sale fraud”).

That way if you end up getting a foreclosure anyway, you can get the most money out of the situation. Again, this assumes you don’t have any residual exposure to the primary mortgage since you securitized that. What am I missing here?

Your thoughts on this subject are appreciated.  See also “This Crisis Won’t Stop Moving,” a recent article on second liens from the New York Times.

Galapagos sea lions head for warm Peru waters BBC (hat tip reader Steven L)

Pratap Chatterjee, Destabilizing Pakistan TomDispatch

Secret summit of top bankers News.com.au

Europe needs to show it has a crisis endgame Wolfgang Munchau Financial Times

Employers set to keep squeezing pay Independent

Irked, Wall St. Hedges Its Bet on Democrats New York Times. Some one needs to break these guys.

The SWIFT Battle Heats Up FireDogLake (hat tip reader Michael T)

Let’s Atomize Wall Street Martin Hutchinson, Prudent Bear

Super-wealthy investors move billions out of Greece Guardian

Flatlhead Matt Taibbi (hat tip reader John L). Old but fun.

‘Tidal wave’ of business failure feared as tax help scheme ends Independent

America Is Not Yet Lost Paul Krugman

Europeans want to tough it out Eurointelligence

My Sunday Media Nightmare Billy Blog (hat tip reader Joe B). Today’s must read.

Antidote du jour (hat tip reader DoctoRx):

We remarked last week that the FDIC had put forward a proposal for fixing the securitization market. To be a bit more precise, it was the FDIC’s plan, put forward for public comment, of the rules it wanted to have in place for banks to get “safe harbor”, meaning off balance sheet treatment, for their securitizations.

As anyone who had even slight contact with the business press no doubt knows, a whole raft of credit bubble era securitizations, particularly real estate and credit cards, have suffered losses far in excess of what banks and investors anticipated. The result, with real estate securitizations, is that almost all of the market ex government guaranteed paper is in a deep freeze. Worse, servicers, who were never set up to do loan mods (and by happenstance also make more by not doing mods) are operating to the disadvantage of investors and communities (as we have mentioned on previous posts, vulture investor Wilbur Ross, the antithesis of a bleeding heart, has demonstrated that deep principal reductions work and for viable borrowers produce better results for the investors than foreclosures). For credit card conduits, rather than let them flounder (banks desperately need to keep that pipeline open) banks have intervened to shore them up, raising serious questions about their off balance sheet treatment.

So right now, we have a securitization markets, ex the parts on government drip feed, or actively supported by the banks, that are in a wee bit of disarray. And the FDIC plan reveals an ugly little conundrum: what it takes to private real estate securitization safe for investors (in particular, twelve month seasoning of deals and a 5% retention, but there were other well though-out provisions as well) make it much less attractive to banks.

Now that might sound perfectly fine to most readers, but there was a reason loans started shifting off balance sheet in the 1980s: securitization was cheaper. If a bank held a loan, it had to put some equity up against it, and pay FDIC insurance on the portion funded by deposits. So banks had skinnier balance sheets all across the banking system and shifted loans to investors.

Now it may be that we have two unattractive choices: making the securitization market “less unsafe” (which seems to be the direction of the OCC ideas, which are getting vastly more MSM attention than the FDIC draft) or make it safe, which has the effect of making it much much smaller, and thus requiring banks to get bigger (in terms of their balance sheets). Bigger banks require a LOT more equity. Where will that come from?

So the inevitable result of more on balance sheet lending is less lending overall. Now many readers will regard this as a good solution, but they forget that this process of shrinking lending will be painful and is something policy markers are struggling mightily to avoid. This is the 21st century version of St. Augustine’s prayer, “Give me chastity and continence, but not jyet.”

One example of the discomfort that is resulting from this conundrum comes in tonight’s Financial Times. Citigroup is choking on some auto loans it would like to unload, but the securitization route isn’t open right now, and other possible buyers are not willing to bet on the market coming back to life (and note the implication: the pricing that Citi deems acceptable depends on the securitization market, neither Citi nor investors like the economics of owning and funding the loans):

The securitisation market’s failure to recover from its slump during the crisis is complicating efforts by Citigroup and other troubled financial groups such as AIG to sell unwanted assets and repair their balance sheets, bankers and executives say.

People close to the situation said that Citi had opened talks with private equity groups and hedge funds over the sale of $3bn-worth of car loans as part of its efforts to cleanse its balance sheet of billions of dollars in troubled assets….

However, some private equity groups and hedge funds that have looked at the assets said that the lack of a thriving market for securitised bonds, which are backed by cash flow from loans, made the assets less attractive. They added that the absence of a fully functioning securitisation market increased the uncertainty over how buyers could fund the loans once Citi’s credit facility expired.

“Private equity can’t make a bid on anything where the business model requires a bet that the external funding markets and securitisation comes back,” said the head of capital markets at a big private equity firm.

A second issue that is not getting the press it deserves is that banks are almost certain to take losses (and we don’t mean writedowns, as in recognizing impairments they arguably should have ‘fessed up to sooner, but hard dollar payments to third parties) on litigation and claims made under old mortgage securitizations.

The widespread perception is that the banks are off scott free on the bad loans they have sold to securitized vehicles. That isn’t exactly true. The banks made legal representations and warranties regarding the loans they sold. If the loans fell short of the contractually agreed upon standards, the seller has to make good in some form, say substitution of good collateral for the bad loan, or monetary damages. But the recoveries, by parties like Freddie, Fannie, AIG, MBIA, and Ambac, are going to come straight out of the bottom lines of banks. As Chris Whalen noted:

The wave of loan repurchase demands on securitization sponsors is the next area of fun in the zombie dance party, namely the part where different zombies start to eat one another. The GSE’s are going to tear 50-100bp easy out of the flesh of the banking industry in the form of loan returns on trillions of dollars in exposure, this as charge-offs on the several trillion in residential exposure covered by the GSEs heads north of 5%. The damage here is in the hundreds of billions and lands in particular on the larger zombie banks, especially Bank of America (BAC) and Wells Fargo (WFC).

To put the growing combat in the loan repurchase channel into perspective, keen analysts will already know that a new item has appeared in the disclosure for non-interest income by many larger banks that have been active in the securitization markets. In the case of WFC in Q4 2009, gross income of $1.2 billion in mortgage loan originations was net of $316 million in loss reserves for loan repurchases. Imagine if we add a zero to the loss allocation, then another, and you get to the worst-case exposure on OBS loan repurchases.

MBIA’s latest financial statements (see the disclosure starting p. 53) illustrates how ugly this can get.

It appears that MBIA has requested and received almost 27,000 loan files, mainly from Countrywide relating to pools of second mortgages that MBIA had guaranteed. This is a small sample of the total (over 400,000) and represented 25% of the loans classified seriously delinquent at the time (I understand mid-2007) . Of the 27,000, 24,000 were fraudulent/non-conforming (FICO scores below what was repp’ed and warrantied, homes not primary residences). Those who have been watching the case believe the same percentage would apply to all of the remaining “seriously delinquent” loans, and perhaps even more of the rest of the loans, since those were the earliest vintages and those from later in the cycle were even more suspect. But their access to more files was blocked so they filed the lawsuits, etc. MBIA has already recorded $1.2 billion as “receivable” from this action, and that is based ONLY on those 27,000 loans.

As one reader noted:

The magnitude of the absolute liability of the mortgage originators to the bond insurers and securitization trusts themselves – on second mortgages alone – is, categorically and empirically, well into the tens of billions of dollars. The percentage of abjectly fraudulent second-mortgage loans made by Countrywide, ResCap, IndyMac, JPM, WFC is staggering. When the house of cards begins to come down, it will spread far and wide – to not only the bond insurers and mortgage insurers, but to the trusts themselves. The GSEs are just starting this process on their firsts, but it’s the private sector entities who are moving aggressively in court, but have been (temporarily) stymied by the aforementioned defendants who have thrown up all sorts of legal bs just to prevent even showing the original loan files to the very institutions that insured them on the basis of the originators’ reps and warranties!

Some of this is on MBIA’s website, but I haven’t seen this really written about anywhere, despite (because of?) the impact it would have on the banks’ balance sheets.

This could become very interesting, and not in a good way, either.

The article tonight at Bloomberg, “No Job Growth for Small Business Spurs Recovery Doubt,” is a bit surprising, because so many of the people quoted in the article seem….surprised. It appears to have suddenly dawned on some economists and commentators that small concerns aren’t adding jobs, and that might have broader ramifications.

What is peculiar instead is the LACK of interest in the small business sector. In the last expansion, the overwhelming majority of hiring took place in small businesses. By contrast, big companies in the US shed jobs.

So why so little focus on small businesses? It’s drunk under the street light behavior (you do know that joke, , cop sees drunk on ground under street light, cop asks drunk what he is doing, drunk says he is looking for he keys. Cop ascertains drunk probably lost keys somewhere else, asks drunk why he is looking for keys here. Drunk says, “Because the light is better.”) It’s easy to get data about big businesses, so that’s what most analysts focus on:

Because few economic reports capture small-business statistics, some economists say investors are being misled about the strength of recovery from the longest, deepest recession since the Great Depression.

Recent numbers suggest “the official data are too heavily weighted towards bigger companies, which are doing better than credit-constrained smaller firms,” said Ian Shepherdson, chief U.S. economist at High Frequency Economics Ltd. in Valhalla, New York. “The latter employ half the workforce.”

The data-gathering problem affects other areas of investigation. One of my colleagues, Amar Bhide, wrote a path-breaking book on entrepreneurship. Why was his book novel? Because all the previous academic work on entrepreneurs looked only at venture capital funded companies because it was easy to study them. But less than 1% of startups winds up getting venture funding. So Bhide did fieldwork on the unwashed, unstudied 99% and wrote up what he found.

It does not take special powers of observation to divine that all is not well in small business land. First, as we have noted on this blog repeatedly, credit cards are an important source of funding to small businesses, particularly for seasonal businesses and ones that buy inventory in lumpy quantities to obtain discounts, as well as to buffer short term cash flow shortfalls (the classic problem of a customer paying late). Two of the biggest players that focused on the small business market, Advanta and American Express, have exited that business, and it is hardly a secret that other credit card issuers are getting tougher on terms.

The anecdotal evidence is also strong that many small businesses are suffering. How many retail stores and restaurants do you know of that have shuttered? And there were no doubt some small businesses that in turn sell to small businesses like these.

The Bloomberg story provides further detail:

Improvement in the unemployment rate, which fell to 9.7 in January from 10 percent in December, may stall later this year if these firms aren’t hiring, and growth likely won’t meet the median 2.7 percent annual rate forecast for 2010 by 67 economists in a Jan. 14 Bloomberg News survey….

The National Federation of Independent Business’s index of small-business optimism has been near historic lows for 15 consecutive months, declining to 88 in December from 88.3 in November, the federation reported Jan. 12. During the four prior recessions, it dipped below 90 only once.

“It has been a very difficult year, and 2009 did not end on an uplifting note,” William Dunkelberg, chief economist for the federation in Philadelphia, said in the report. “Optimism has clearly stalled, in spite of the improvements in the economy.”

Twenty-two percent of the group’s members reduced employment in December, while 10 percent added workers. The federation will release its January data tomorrow.

Investors shouldn’t assume there’s value in small caps during this recovery, according to Robert Olstein, who manages the $14 million Purchase, New York-based Olstein Strategic Opportunities Fund, which focuses on small businesses.

“Smaller startups are having a really hard time,” Olstein said in an interview. “…

Lack of access to credit is also affecting small businesses disproportionately. The Federal Reserve reported Feb. 1 that banks were continuing to tighten standards for loans to small firms, while standards for large companies were unchanged….

PayNet Inc.’s Small Business Loan Index, which tracks loans of $1 million or less, was 8.6 percent lower in December than a year ago.

“In the first half of 2009, the average monthly decrease was about 20 to 25 percent, so it’s clearly a step in the right direction,” said William Phelan, president of the Skokie, Illinois-based company, which offers credit reports for banks that lend to smaller firms. Still, “demand for expansion loans for small businesses is 35 percent below its peak in 2006. That’s another indication of how far we have to go to climb out of this recession.”

“Things don’t seem to be getting any worse, but they aren’t getting any better,” the NFIB’s Wade said. Small businesses “are in a kind of survival mode. We just haven’t seen anything indicating a change.”

Boy, is this a down-market move for former Merrill CEO John Thain, both in terms of size of balance sheet and credit focus of the organization. CIT, which focuses on small and medium-sized business lending, had a roughly $70 billion balance sheet as of end of September, versus nearly $670 billion for Merrill as of year end 2008.

That $35,000 commode was more costly than Thain or his decorator could ever have imagined….

From the Wall Street Journal:

CIT is trying to mount a comeback of its own, having emerged from bankruptcy protection in December after eliminating more than $10 billion of debt.

It is one of several financial firms that have struggled to find a CEO amid the credit crisis, curbs on executive pay and the specter of government scrutiny. Now, more 16 months after the collapse of Lehman Brothers Holdings Inc., other executives prominent during the crisis are starting to surface. Thomas Russo, former general counsel at Lehman, recently became general counsel at American International Group Inc.

CIT recently approached Mr. Thain, whom Bank of America ousted shortly after its purchase of Merrill closed in January 2009. Since then, few public companies had been willing to take a risk on the executive, according to people familiar with the matter. Some CIT directors and stakeholders also raised concerns.

By all accounts, Thain was a capable executive before his career went off the rails at Merrill, and CIT is a more important organization than its size might suggest (it is a bulwark of lending to smaller enterprises). So let’s hope Thain can turn his career and the company around.

Two readers, Don B and Marshall Auerback, pointed to a Ambrose Evans-Pritchard story at the Telegraph which argues the the sovereign debt perturbations have the potential to have ramifications as serious as the subprime/Alt-A crisis. Now Evans-Pritchard has a tendency to the apocalyptic, but he also made some astute calls in 2007 and 2008 (as in not buying the commodities bubble and related resurgence of inflation theme, and seeing deflation as the real underlying risk).

And here he connects some important dots. It isn’t just that bond yields on Greece have spiked up; the other countries seen as being big external debt risks are facing bond rollovers soon:
The world risks a replay of the Lehman collapse if this runs unchecked, this time involving sovereign dominoes.

Barclays Capital says the net external liabilities of Greece are 87pc of GDP, or €208bn (£182bn). Spain is worse at 91pc (€950bn), and Portugal worse yet at 108pc (€177bn); Ireland is 68pc (€123bn), Italy is 23pc, (€347bn). Add East Europe’s bubble and foreign debts top €2 trillion.

The scale matches America’s sub-prime/Alt-A adventure and assorted CDOs and SIVS of the Greenspan fling. The parallels are closer than Europe cares to admit. Just as Benelux funds and German Landesbanken bought subprime debt for high yield with AAA gloss, they bought Spanish Cedulas because these too had a safe gloss – even though Spain’s property boom broke world records. They thought EMU had eliminated risk: it merely switched exchange risk into credit risk.

A fat chunk of Club Med debt has to be rolled over soon. Capital Economics said the share of state debt maturing this year is even higher in Spain (17pc) than in Greece (12pc), though Spain’s Achilles’ Heel is mortgage debt.

The risk is the EMU version of Mexico’s Tequila crisis or Asia’s crisis in 1998.

Both Evans-Pritchard and Simon Johnson regarded the G-7 response to the pressures building as insufficient. First Johnson:

The entirely pointless G7 meeting this weekend only served to underline the fact that Europe is again entering a serious economic crisis….

The Europeans with deep-pockets are doing nothing – except insist that all countries under pressure cut their budgets quickly and in ways that are probably politically infeasible. This kind of precipitate fiscal austerity contributed directly to the onset of the Great Depression in the 1930s.

The International Monetary Fund was created after World War II specifically to prevent such a situation from recurring…

Dominique Strauss-Khan, the Managing Director of the IMF, said Thursday on French radio that the Fund stands ready to help Greece. But he knows this is wishful thinking.

“Going to the IMF” brings with it a great deal of stigma. European governments are unwilling to take such a step as it could well be their last.

The IMF is supposed to provide only “balance of payments” lending. That doesn’t fit well when a country is in a currency union such as the euro, which floats freely and does not have a current account issue, and the main problem is just the budget.

Greece and the other weak eurozone countries need euro loans, not any other currency. If the IMF lent euros, that would be distinctly awkward – as this is what the European Central Bank (ECB) is supposed to control.

Sending Greece to the IMF would result in some international “burden sharing,” as it would be IMF resources – from all its member countries around the world – on the line, rather than just European Union funds. But is the US really willing to burden share through the IMF? After all, Europe has long refused to confront the trouble in its weaker countries, now known as PIIGS (Portugal, Ireland, Italy, Greece, and Spain)? How would the Chinese react if such a proposition came to the IMF?

Would the Europeans really want the IMF and its somewhat cumbersome rules to get involved – this would be a huge loss of prestige. It could also lead to some perverse outcomes – you never know what the IMF and the US Treasury (and Larry Summers) will come up with in terms of needed policies (ask Korea about 1997-98; not a good experience). The European Union (EU) has handled IMF recent engagement well in eastern Europe (from the EU perspective), but that was seen as the EU’s backyard. If the eurozone is in trouble, everyone will be paying much more attention – no more sweetheart deals.
The IMF gave eastern Europe amazingly good deals over the past 2 years (by IMF standards). Would this fly with financial markets in the sense of restoring confidence in the PIIGS and their medium-term fiscal futures?

Does the IMF really have enough resources to backstop all the PIIGS? …

The IMF could play a constructive “technical assistance role” alongside the European Commission, but everyone would want to keep this pretty low profile….

The IMF cannot help in any meaningful way. And the stronger EU countries are not willing to help – in part because they want to be tough, but also because they do not have effective mechanisms for providing assistance-with-strings. Unconditional bailouts are simple – just send a check. Structuring a rescue package that will garner support among the German electorate – whose current and future taxes will be on the line – is considerably more complicated.

The financial markets know all this and last week sharpened their swords. As we move into this week, expect more selling pressure across a wide range of European assets.

And Evans-Pritchard:

The EU’s refusal to offer Greece anything beyond stern words and a one-month deadline for harsher austerity – while admirable in one sense – is to misjudge how fast confidence is ebbing. Greece’s drama has already metastasised into a wider systemic crisis.

We do have a factor here that could get the reluctant Europeans, meaning the Germans in particular, to act, namely, that Eurobanks are still wobbly and are not doubt exposed directly and indirectly to a European sovereign debt crisis. There is no way to avoid rescue operations of some sort, it’s merely a matter of picking which poison. Do they want to face the ugly bailout of countries they see as profligate, or wait till it morphs into a crisis and have to put their banks on emergency life support? The problem is the latter is politically more palatable, even though ultimately more destructive, since a lot of collateral damage will occur in the wave that hits the banks.

Sure, American politicians have been bought and paid for by the Wall Street giants. See this, this and this.

And everyone knows that the White House and Congress – while talking about cracking down on Wall Street with strict regulation – have actually watered down some of the most important protections that were in place.

For example, Senator Cantwell says that the new derivatives legislation is weaker than the old regulation. And leading credit default swap expert Satyajit Das says that the new credit default swap regulations not only won’t help stabilize the economy, they might actually help to destabilize it.

But the U.S. is not being sold out in a vacuum.

On March 1, 1999, countries accounting for more than 90 per cent of the global financial services market signed onto the World Trade Organization’s Financial Services Agreement (FSA). By signing the FSA, they committed to deregulate their financial markets.

For example, by signing the FSA, the U.S. agreed not to break up too big to fails. The U.S. also promised to repeal Glass-Steagall, and did so 8 months after signing the FSA.

Indeed, in signing the FSA and other WTO agreements, the U.S. has legally bound itself as follows:

• No new regulation: The United States agreed to a “standstill provision” that requires that we not create new regulations (or reverse liberalization) for the list of financial services bound to comply with WTO rules. Given that the United States has made broad WTO financial services commitments – and thus is forbidden by this provision from imposing new regulations in these many areas – this provision seriously limits the policy [options] available to address the current crisis.

• Removal of regulation: The United States even agreed to try to even eliminate domestic financial service regulatory policies that meet GATS [i.e. General Agreement on Trade in Services] rules, but that may still “adversely affect the ability of financial service suppliers of any other (WTO) Member to operate, compete, or enter” the market.

• No bans on new financial service “products”: The United States is also bound to ensure that foreign financial service suppliers are permitted “to offer in its territory any new financial service,” a direct conflict with the various proposals to limit various risky investment instruments, such as certain types of derivatives.

• Certain forms of regulation banned outright: The United States agreed that it would not set limits on the size, corporate form or other characteristics of foreign firms in the broad array of financial services it signed up to WTO strictures …

• Treating foreign and domestic firms alike is not sufficient: The GATS market-access limits on U.S. domestic regulation apply in absolute terms; that is to say, even if a policy applies to domestic and foreign firms alike, if it goes beyond what WTO rules permit, it is forbidden. And, forms of regulation not outright banned by the market-access requirements must not inadvertently “modify the conditions of competition in favor of services or service suppliers” of the United States, even if they apply identically to foreign and domestic firms.

In other words, the problem isn’t just that Congress and the White House have sold out to the Wall Street giants.

The problem is also that the U.S. has signed WTO agreements that have given the keys to the too big to fails, and have neutered their regulators. Even if some politicians tried to stand up to Wall Street – or even if we “throw out all of the bums” currently in political roles – the U.S. would still be locked into the WTO’s scheme for helping the financial giants to grow ever bigger and to take ever-bigger and ever-riskier gambles.

Indeed, the financial giants are pushing hard for further deregulation, demanding that the WTO’s “Doha round” of agreements be signed.

On the other hand, if the American people stood up for our sovereignty and demanded that the financial giants be reined in, it would be easy to fix the WTO agreements which the U.S. has already signed. Public Citizen notes, “as a legal matter, these problems are easy to remedy …”

Will the American people stand up and demand that the WTO deregulatory scheme be rolled back?

Or will we continue to let the financial giants destroy our country through buying and selling politicians (with the help of the Supreme Court) and forcing us into more and more draconian WTO treaties which destroy our sovereignty altogether?

Many people assume that they just have to hang in there until things improve. But the powers-that-be are grabbing more and more power and – unless we stand up to them – they will take it all.

As highly-regarded economist (Michael Hudson, Distinguished Research Professor at the University of Missouri, Kansas City, who has advised the U.S., Canadian, Mexican and Latvian governments as well as the United Nations Institute for Training and Research, and who is a former Wall Street economist at Chase Manhattan Bank who helped establish the world’s first sovereign debt fund) said:

“You have to realize that what they’re trying to do is to roll back the Enlightenment, roll back the moral philosophy and social values of classical political economy and its culmination in Progressive Era legislation, as well as the New Deal institutions. They’re not trying to make the economy more equal, and they’re not trying to share power. Their greed is (as Aristotle noted) infinite. So what you find to be a violation of traditional values is a re-assertion of pre-industrial, feudal values. The economy is being set back on the road to debt peonage. The Road to Serfdom is not government sponsorship of economic progress and rising living standards, it’s the dismantling of government, the dissolution of regulatory agencies, to create a new feudal-type elite.”

And Foreign Policy magazine ran an article entitled “The Next Big Thing: Neomedievalism“, arguing that the power of nations is declining, and being replaced by corporations, wealthy individuals, the sovereign wealth funds of monarchs, and city-regions.

We either stand up, or we slip back into a darker age.