Author Archives: Yves Smith

Class Traitors: How Ideological Brainwashing Gets Rich and Ordinary Americans to Undermine Their Economic Interest

Linda Beale, of ataxingmatter, has written forcefully and persuasively about some of the propagandizing-accepted-as-gospel that the well-heeled use to advocate policies that advance their economic interests. For instance, as most Naked Capitalism readers appreciate, but a remarkably large swathe of the US population does not, tax cuts for big corporations are simply a transfer to the rich. From a post last year:

I’ve argued frequently in the past that there is no there there–i.e., that lowering corporate tax rates will do nothing to create jobs. Instead, I’ve said, it will simply deliver an even higher profit margin to be skimmed off by the highest paid executives and, possibly, shareholders. The higher profit margins are unlikely even to be used to increase workers’ shares of the corporate revenues through higher wages, a place where they could most help the economy other than new jobs created. Thus, the drive for “revenue neutral” corporate tax reform (cut corporate taxes, cut expenditures elsewhere to make up for the decreased corporate tax revenues) is just another example of corporatism as an engine of the modern form of US class warfare

Beale takes up a different theme today: how the rich and poor act against their economic interest. For many in middle and lower income strata in red states, hostility to the government is an article of faith even though those states (and many of those same govement-hating citizens) are significant beneficiaries of Federal programs.

But less well recognized are the ways that the wealthy are undermining themselves. They’ve taken the “increase our distance from everyone else” experiment well beyond its point of maximum advantage, not just to the society around them but also in terms of the costs to the class warriors.

As we’ve pointed out, highly unequal societies have lower lifespans, even among the rich; the shallower social networks of stratified societies and the high cost of losing one’s perch, in terms of loss of friends and status, creates an ongoing level of stress that has a longevity cost. Beale points out something we’ve mentioned occasionally in the past, that creating an underclass with inadequate access to medical services is a great breeding ground for public health problems. The fact that many low income Americans can’t afford to take sick days and health plans generally have high deductibles, which discourage individuals from getting treated until they are sure they are really sick, isn’t a great program design if you want to reduce the spread of infectious diseases.

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Gail Tverberg: Eight Pieces of Our Oil Price Predicament

Yves here. As oil prices have come into focus as a result of a recent Saudi decision to facilitate a reset at a lower price per barrel, they’ve come into focus yet again as a critical nexus of economic and political power, and that’s before you get to the complicating overlay of climate change considerations.

This article by Gail Tverberg takes a more sophisticated, multi-persepctive approach than the overwhelming majority of articles on this topic. One of her big messages is that there is no way the world economy is getting divorced from oil any time soon.

Even so, I have some minor points of contention. For instance, she correctly points out that oil producers, even the Saudis, need oil prices to be at a moderately high prices to sustain national budgets. But Riyadh has a very low production break even point, a large cash horde, and plenty of borrowing capacity. The desert kingdom could afford a price war, say to hurt geopolitical enemies or to forestall investment in and development of alternative energy sources. Low oil prices make other energy sources look unattractive, and volatile prices also deter investment, making it well-nigh impossible to forecast cost advantages (if any) and end user takeup.

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Wolf Richter: Leading Indicator Amazon Gets Re-Crushed

Yves here. As Matt Stoller wrote recently, Amazon’s business strategy is all about becoming a globally-dominant trading company. It might have helped if Amazon and its investors had studied the closest historical analogue to what Amazon is seeking to become: Japanese trading companies. In their heyday, Japanese trading companies, such as Mitsubishi International Corporation, which intermediated trade for the Mitsubishi zaibatsu, and its post-World War II less-tightly-integrated incarnation, a keiretsu, had an almost impossible-looking financial statements: staggeringly large revenues, extremely thin profits (those went to the industrial companies) and enormous balance sheets with breathtaking leverage.

The Amazon 2.0 version has a lot of improved features, the biggest being impressive cash flow, since it manages to get income before it has to pay for goods. However, Amazon, like its Japanese forebearers, is interested in dominance above all. For the Japanese trading companies, that made sense because they were the sales arms for the companies in their group, so the objective wasn’t for them to prosper but to merely get by. But for Amazon, plowing its vast cash flow into growth looks less and less sensible as losses gap up. It’s one thing to incur large costs to obtain a monopoly or oligopoly position, since high margins are expected to come later. Amazon has gotten away with no profits because, in reality, cash flow generation is in many ways a better measure of the true productivity of a business. But in Amazon’s case, its hugely positive cash flow is entirely dependent on its collection v. when it pays suppliers. If suppliers, which Amazon is also squeezing on cost, start to push back this hugely successful machine will look a lot less pretty. And this ins’t a theoretical concern; Justin Fox at the Harvard Business Review points out that Amazon of late hasn’t been able to stretch payables as much at it once could. Amazon is moving on so many fronts where establishing a dominant position is far from assured, which could call its entire model into question.

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Pro Big Corporate IRS: Agency Guts Whistleblower Program, Leaves Billions on the Table

It’s widely known among tax professionals that the US does little in the way of tax enforcement, and the little that it does do is directed against individuals and small businesses.

What is not so widely known is how deep the institutional bias is in the IRS in favor of letting big corporate tax cheats get away with it.

Conventional wisdom is similar to the rationalization of weak enforcement at the SEC: that the agency is afraid that if they go after big companies, they’ll have the penalties and fines challenged in court, and they’ll often lose by virtue of being outgunned by better lawyer (yes, Virginia, even if you have a solid case, that doesn’t mean you’ll win at trial). And top tax litigators are among the most highly paid legal talent. I’m not up on current rates, but in the mid 1980s, Sumitomo Bank fought the IRS on a $100 million assessment and won. Their attorney was a solo practitioner who charged $1000 an hour.

It turns out that the picture is vastly worse than that.

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Richard Alford: AIG Redux – How the Fed Usurped Congress

Yves here. Richard Alford, a former New York Fed economist, provides his assessment of the AIG bailout in light of some of the revelations in the AIG bailout trial. While many of his arguments have merit, I want to quibble with a couple of them.

The first is the size of the actual amount taken by AIG and the reason for the drawdowns. At the time AIG hit the wall, the amount it needed was first estimated at $50 billion to cover its credit default swaps portfolio and $20 billion for its securities lending. The Maiden Lane III vehicle that the Fed created to take the CDOs has a $62.9 billion face value, so we can use that as a rough and ready value, and the securities lending bailout costs rose to roughly $50 billion. But consider: those two together get you to only a bit over $110 billion versus the peak lending amount reported as just shy of $185 billion. And some of that ~$110 billion includes laundering a bank bailout through AIG, by not obtaining haircuts on the CDS on the Maiden Lane CDOs. So where did that say $80 billion go? It might be commercial paper or medium term notes during the very worst of the crisis, although with the Fed supporting AIG, you’d think investors would be see its paper as fine. We’re conferring with some close AIG watchers and may write up a discussion of what that AIG black hole consisted of.

Second is that at the end, Alford adopts a “what matters is looking forward,” as in preventing future crises. Yes, but we are great believers in post-mortems, particularly in light of the George Santayana saying, “Those who do not remember the past are condemned to repeat it.”

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Uber Economics: There is No Such Thing as Bad Publicity

Yves here. This post on Uber raises a sobering point about activism and human cognition. How do you opposed a cause you regard as dubious without unwittingly legitimating it? For instance, remember when one of the many justifications offered for the Iraq War was that Saddam Hussein was in cahoots with Osama bin Laden? Even though that idea was patently false, efforts to debunk it actually reinforced the connection between Hussein and Bin Laden simply by featuring their names in close proximity.

If readers, particularly activists, have ideas for how to steer clear of effectively promoting ideas and causes you are challenging, please let us know in comments.

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The Financialization of Life

Yves here. One of the efforts the Naked Capitalism community has been engaged in is trying to understand and map our emerging political and economic order. Over the last four decades, massive changes have taken place in social values, in job security, in the importance of communities relative to other networks, like professional associations, and in the role of the state. Economists, social scientists, and laypeople have used various frameworks for describing this period. Understanding the driving process is important not merely for the purposes of description, but also for analysis, since a major question remains open: is this a last gasp of large-scale industrial capitalism, or is this the starting phase of a new economic order? We’ve tended to see this period as a self-limiting finance-led counter-revolution against the New Deal, but that may prove to be too optimistic a reading.

This Real News Network interview with Costas Lapavitsas, a professor in economics at the University of London School of Oriental and African Studies, takes a different perspective. Lapavitsas contends that financialization itself constitutes a new form of capitalism, which is supported by neoliberal ideology.

Independent of whether you fully agree with Lapavitsas’ framing, this talk gives a good overview of the major economic and political changes since 1970. His summary would be useful for those who could use a historical perspective on these shifts, or want a high-level understanding of the restructuring of modern economies without having to get too deep into the weeds. But even though this interview is designed to go down easily, it offers a lot of grist for thought.

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Ilargi: 40% of Eurozone Banks Are In Bad Shape

Yves here. While investors remain fixed on how much more the Fed and the ECB will pump into financial assets via QE, Eurozone banks lumber on in their walking wounded state. Deflationary pressures and lousy growth grind down weak and even once-good borrowers. And it’s not as if the banks who lent to them in the first place were good shape themselves.

As we wrote at the onset of the Eurozone bank stress tests, they were designed to be even more cosmetic than the US bank stress tests. Just a month ago, we posted an analysis that showed that many countries in Europe have banking systems weaker than those in Latin America.

Even with the efforts to use the stress tests as a confidence-building exercise, the result of the current exam of Eurozone banks is expected to be less than impressive.

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Matt Stoller: Why Is Alan Greenspan’s Lawyer, Scott Alvarez, Still Controlling the Federal Reserve? (AIG Bailout Trial)

Yves here. This important post explains why Scott Alvarez, the general counsel of the Federal Reserve Board of Governors, needs to be fired. His responses to the plaintiffs’ questions at the AIG bailout trial weren’t simply evasive; they reveal a deep, almost visceral, dedication to defending the very policies that nearly destroyed the world economy as well as a salvage operation that favored financial firms over the real economy. We have embedded the transcripts from the first three days of the AIG bailout trial, which cover Alvarez’s performance on the stand, at the end of this post.

Alvarez was brought to the Fed by Alan Greenspan. As a staff lawyer, he helped implement bank deregulation policies such as ending supervision of primary dealers in 1992, refusing to regulate derivatives in 1996 (I recall gasping out loud when I first read about the Fed’s hands off policy), and implementing the rules that shot holes through Glass Stegall before it was formally repealed in 1999. Among those measures was giving a commercial bank, Credit Suisse, waivers to take a 44% stake one of the biggest investment banks, First Boston, in 1988 and assume control in 1990.

Alvarez also has a poor record as far as representing broad public interest in his tenure as General Counsel, which started in 2004. The Fed did an even worse job than the bank-cronyistic Office of the Comptroller of the Currency in enforcing Home Ownership and Equity Protection Act, a law that put restrictions on high-cost mortgage lenders. The Fed was also one of the two major moving forces behind the disastrous Independent Foreclosure Review, an exercise that promised borrowers who were foreclosed on in 2009 and 2010. The result instead was a fee orgy by the supposedly independent consultants, capricious and inadequate payments to former homeowners, and virtually no disclosure of what was unearthed during the reviews.

Yellen has said she wants to make financial stability as important a priority of the Fed as monetary policy. That means, among other things, being willing to regulate banks. Scott Alvarez is too deeply invested in an out-of-date world view to carry that vision forward. If Yellen intends to live up to her word, Alvarez has to go.

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Forward Guidance: Human Plans and Divine Laughter

ves here. VoxEU has come to serve as a wonky alternative to the Financial Times comments section, which is Brit-speak for op-eds. While most FT comments are at least interesting and timely, now and again the pink paper serves as a venue where real policy players put a stake in the ground, sometimes in exclusive interviews but also in opinion pieces.

This article by David Miles of the Bank of England is clearly intended to reach a wider audience than the normal VoxEU piece. In it, he calmly and methodically tries to tell finance people that what they want from central bank forward guidance is tantamount to having their cake and eating it. Admittedly, the unreasonable expectations for what forward guidance can accomplish is partly central bankers’ own creation. In keeping, this piece suggests that a retreat from efforts at precision in forward guidance would probably be a plus.

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Low Oil Prices Hurting U.S. Shale Operations

Yves here. In yesterday’s Water Cooler, Lambert posted a link from Bloomberg that indicated that oil at $80 a barrel would pop the fracking bubble, an outcome we’d discussed previously. Some readers in comments expressed doubts.

In fact, it was already happening as oil prices were falling from over $100 a barrel through the nineties. Seasoned energy hands had warned that shale operations could be shut down rapidly, and that has started to take place. However, the author of this article argues that the shutdowns are likely to be delayed and that most US shale operations have low break-even costs, insulating them from the impact of the oil price drop. However, he misses that another driver of the shale boom has been access to super-cheap credit and an overly-bullish mentality that has not factored in the short production lives of shale wells. The junk bond market has been much less accommodating of late, and if that skittishness continues, the prognosis isn’t quite as sanguine for the industry as Cunningham suggests.

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Why is the Boston Globe Covering Up for Gubernatorial Candidate Charlie Baker? (Updated)

Boston’s paper of record is effectively covering up for Massachusetts gubernatorial candidate Charlie Baker by failing to cover a growing pay to play scandal in New Jersey, with Baker as one of its central figures. David Sirota has been doing impressive sleuthing, and his latest report, which we’ll cover shortly, reveals that Chris Christie is persistine in his effort to hide information that presumably implicates Baker.

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