AP IMPACT: Ordinary folks losing faith in stocks

By BERNARD CONDON — AP Business Writer

NEW YORK — Andrew Neitlich is the last person you'd expect to be rattled by the stock market.
He once worked as a financial analyst picking stocks for a mutual fund. He has huddled with dozens of CEOs in his current career as an executive coach. During the dot-com crash 12 years ago, he kept his wits and did not sell.

But he's selling now.
"You have to trust your government. You have to trust other governments. You have to trust Wall Street," says Neitlich, 47. "And I don't trust any of these."
Defying decades of investment history, ordinary Americans are selling stocks for a fifth year in a row. The selling has not let up despite unprecedented measures by the Federal Reserve to persuade people to buy and the come-hither allure of a levitating market. Stock prices have doubled from March 2009, their low point during the Great Recession.
It's the first time ordinary folks have sold during a sustained bull market since relevant records were first kept during World War II, an examination by The Associated Press has found. The AP analyzed money flowing into and out of stock funds of all kinds, including relatively new exchange-traded funds, which investors like because of their low fees.
"People don't trust the market anymore," says financial historian Charles Geisst of Manhattan College. He says a "crisis of confidence" similar to one after the Crash of 1929 will keep people away from stocks for a generation or more.
The implications for the economy and living standards are unclear but potentially big. If the pullback continues, some experts say, it could lead to lower spending by companies, slower U.S. economic growth and perhaps lower gains for those who remain in the market.
Since they started selling in April 2007, eight months before the start of the Great Recession, individual investors have pulled at least $380 billion from U.S. stock funds, a category that includes both mutual funds and exchange-traded funds, according to estimates by the AP. That is the equivalent of all the money they put into the market in the previous five years.
Instead of stocks, they're putting money into bonds because those are widely perceived as safer investments. Individuals have put more than $1 trillion into bond mutual funds alone since April 2007, according to the Investment Company Institute, a trade group representing investment funds.
Selling stocks during either a downturn or a recovery is unusual. Americans almost always buy more than they sell during both periods.
Since World War II, nine recessions besides the Great Recession have been followed by recoveries lasting at least three years. According to data from the Investment Company Institute, individual investors sold during and after only one of those previous downturns - the one from November 1973 through March 1975. And back then a scary stock drop around the start of the recovery's third year, 1977, gave people ample reason to get out of the market.
The unusual pullback this time has spread to other big investors - public and private pension funds, investment brokerages and state and local governments. These groups have sold a total of $861 billion more than they have bought since April 2007, according to the Federal Reserve.
Even foreigners, big purchasers in recent years, are selling now - $16 billion in the 12 months through September.
As these groups have sold, much of the stock buying has fallen to companies. They've bought $656 billion more than they have sold since April 2007. Companies are mostly buying back their own stock.
On Wall Street, the investor revolt has largely been dismissed as temporary. But doubts are creeping in.
A Citigroup research report sent to customers concludes that the "cult of equities" that fueled buying in the past has little chance of coming back soon. Investor blogs speculate about the "death of equities," a line from a famous BusinessWeek cover story in 1979, another time many people had seemingly given up on stocks. Financial analysts lament how the retreat by Main Street has left daily stock trading at low levels.
The investor retreat may have already hurt the fragile economic recovery.
The number of shares traded each day has fallen 40 percent from before the recession to a 12-year low, according to the New York Stock Exchange. That's cut into earnings of investment banks and online brokers, which earn fees helping others trade stocks. Initial public offerings, another source of Wall Street profits, are happening at one-third the rate before the recession.
And old assumptions about stocks are being tested. One investing gospel is that because stocks generally rise in price, companies don't need to raise their quarterly cash dividends much to attract buyers. But companies are increasing them lately.
Dividends in the S&P 500 rose 11 percent in the 12 months through September, and the number of companies choosing to raise them is the highest in at least 20 years, according to FactSet, a financial data provider. Stocks now throw off more cash in dividends than U.S. government bonds do in interest.
Many on Wall Street think this is an unnatural state that cannot last. After all, people tend to buy stocks because they expect them to rise in price, not because of the dividend. But for much of the history of U.S. stock trading, stocks were considered too risky to be regarded as little more than vehicles for generating dividends. In every year from 1871 through 1958, stocks yielded more in dividends than U.S. bonds did in interest, according to data from Yale economist Robert Shiller - exactly what is happening now.
So maybe that's normal, and the past five decades were the aberration.
People who think the market will snap back to normal are underestimating how much the Great Recession scared investors, says Ulrike Malmendier, an economist who has studied the effect of the Great Depression on attitudes toward stocks.
She says people are ignoring something called the "experience effect," or the tendency to place great weight on what you most recently went through in deciding how much financial risk to take, even if it runs counter to logic. Extrapolating from her research on "Depression Babies," the title of a 2010 paper she co-wrote, she says many young investors won't fully embrace stocks again for another two decades.
"The Great Recession will have a lasting impact beyond what a standard economic model would predict," says Malmendier, who teaches at the University of California, Berkeley.
She could be wrong, of course. But it's a measure of the psychological blow from the Great Recession that, more than three years since it ended, big institutions, not just amateur investors, are still trimming stocks.
Public pension funds have cut stocks from 71 percent of their holdings before the recession to 66 percent last year, breaking at least 40 years of generally rising stock allocations, according to "State and Local Pensions: What Now?," a book by economist Alicia Munnell. They're shifting money into bonds.
Private pension funds, like those run by big companies, have cut stocks more: from 70 percent of holdings to just under 50 percent, back to the 1995 level.
"People aren't looking to swing for the fences anymore," says Gary Goldstein, an executive recruiter on Wall Street, referring to the bankers and traders he helps get jobs. "They're getting less greedy."
The lack of greed is remarkable given how much official U.S. policy is designed to stoke it.
When Federal Reserve Chairman Ben Bernanke launched the first of three bond-buying programs four years ago, he said one aim was to drive Treasury yields so low that frustrated investors would feel they had no choice but to take a risk on stocks. Their buying would push stock prices up, and everyone would be wealthier and spend more. That would help revive the economy.
Sure enough, yields on Treasurys and many other bonds have recently hit record lows, in many cases below the inflation rate. And stock prices have risen. Yet Americans are pulling out of stocks, so deep is their mistrust of them, and perhaps of the Fed itself.
"Fed policy is trying to suck people into risky assets when they shouldn't be there," says Michael Harrington, 58, a former investment fund manager who says he is largely out of stocks. "When this policy fails, as it will, baby boomers will pay the cost in their 401(k)s."
Ordinary Americans are souring on stocks even though stock prices appear attractive relative to earnings. But history shows they can get more attractive yet.
Stocks in the S&P 500 are trading at 14 times what companies earned per share in the past 12 months. Since 1990, they have rarely traded below that level - that is, cheaper, according to S&P Dow Jones Indices. But that period is unusual. Looking back seven decades to the start of World War II, there were long stretches during which stocks traded below that.
To estimate how much investors have sold so far, the AP considered both money flowing out of mutual funds, which are nearly all held by individual investors, and money flowing into low-fee exchange-traded funds, or ETFs, which bundle securities together to mimic the performance of a market index. ETFs have attracted money from hedge funds and other institutional investors as well as from individuals.
At the request of the AP, Strategic Insight, a consulting firm, used data from investment firms overseeing ETFs to estimate how much individuals have invested in them. Based on its calculations, individuals accounted for 40 percent to 50 percent of money going to U.S. stock ETFs in recent years.
If you assume 50 percent, individual investors have put $194 billion into U.S. stock ETFs since April 2007. But they've also pulled out much more from mutual funds - $580 billion. The difference is $386 billion, the amount individuals have pulled out of stock funds in all.
If you include the sale of stocks by individuals from brokerage accounts, which is not included in the fund data, the outflow could be much higher. Data from the Federal Reserve, which includes selling from brokerage accounts, suggests individual investors have sold $700 billion or more in the past 5 1/2 years. But the Fed figure may overstate the amount sold because it doesn't fully count certain stock transactions.
The good news is that a chastened stock market doesn't necessarily mean a flat stock market.
Bill Gross, the co-head of bond investment firm Pimco, has probably done more than anyone to popularize the notion that stocks will prove disappointing in the coming years. But he says what is dying is not stocks, but the "cult" of stocks. In a recent letter to investors, he suggested stocks might return 4 percent or so each year, about half the long-term level but still ahead of inflation.
And if America's obsession with stocks is over, some excesses associated with it might fade, too.
Maybe more graduates from top colleges will look to other industries besides Wall Street for careers. Of every 100 members of the Harvard undergraduate Class of 2008 who got jobs after graduation, 28 went into financial services, such as helping run mutual funds or hedge funds, according to a March study by two professors at the university's business school. The average for classes four decades ago was six out of 100.
Of course, those counting the small investor out could be wrong.
Three years after that BusinessWeek story on the "death of equities" ran, in 1982, one of the greatest multi-year stock climbs in history began as the little guys shed their fear and started buying. And so they will surely do again, the bulls argue, and stock prices will really rocket.
Neitlich, the executive coach, has his doubts.
Instead of using extra cash to buy stocks, he is buying houses near his home in Sarasota, Fla., and renting them. He says he prefers real estate because it's local and is something he can "control." He says stocks make up 12 percent his $800,000 investment portfolio, down from nearly 100 percent a few years ago.
After the dot-com crash, it seemed as if "things would turn around. Now, I don't know," Neitlich says. "The risks are bigger than before."

Read more here: http://www.adn.com/2012/12/27/2735566/ap-impact-ordinary-folks-losing.html#storylink=cpy

US heading over fiscal cliff, says Senate leader Harry Reid

Almost £370bn of tax rises and spending cuts will to come into force on 1 January if a deal is not agreed

Senate Majority Leader Harry Reid has warned that the United States looks to be headed over the “fiscal cliff” of tax hikes and spending cuts that will start next week if squabbling politicians do not reach a deal.

Reid, the top Democrat in Congress, criticized Republicans for refusing to go along with any tax increases as part of a budget remedy as he sketched out a pessimistic outlook.

"It looks like that is where we're headed," Reid said of the likelihood of the US economy going over the "fiscal cliff" - with tax increases on most working Americans and automatic spending cuts kicking in next month.

Reid made his comments in a Senate floor speech at the opening of a post-Christmas session, adding that time was running out ahead of a December 31 deadline to act to avert the "fiscal cliff."

Reid urged House of Representatives Speaker John Boehner, the top Republican in Congress, to bring his chamber back into session and to avoid the biggest impact of the "fiscal cliff" by passing a Democratic-backed bill extending low income tax rates for all Americans except those with net household incomes above $250,000 a year.

House Republicans are expected to hold a telephone conference call on the fiscal cliff on Thursday afternoon, a House Republican aide said, adding that a schedule for returning to Washington would be discussed.

Should Congress fail to act by December 31, tax rates for all Americans would snap sharply higher, back to pre-2001 levels, and two days later, $109 billion in automatic spending cuts would start to take effect. Together, the higher taxes and lower spending would suck about $600 billion (£370bn) out of the US economy, potentially causing a new recession in 2013.

On Wednesday, it was Boehner who urged the Democratic-controlled Senate to act first to avoid the fiscal cliff, offering to at least consider anything that the Senate produced.

Reid returned the volley on Thursday, saying that the Senate had already acted, and the Democrats' solution needs the consent of both Boehner and Senate Republican Leader Mitch McConnell.

Reid said Boehner "has just a few days left to change his mind" on the Senate bill. "I don't know time-wise how it can happen now."

AP

 

David Cameron's moves could make EU fall apart, says Herman Van Rompuy

President of European council says plan to repatriate British powers could damage the single market

Herman Van Rompuy, president of the European council. Photograph: KeystoneUSA-Zuma/Rex Features

David Cameron's quest to find a new deal for Britain in Europe by clawing back powers from Brussels could cause the European Union to fall apart quickly and inflict immense damage on the single market, Herman Van Rompuy, the president of the European council, has warned.
Van Rompuy, the top official in the EU, also voiced strong doubts about reopening EU treaties to retool Europe after years of debt crisis, further complicating Cameron's strategy, which hinges on renegotiating the Lisbon treaty in order to secure concessions for Britain.
In his first remarks on the vexed issue of Britain's future in the EU, Van Rompuy told the Guardian that a British exit would cause immense damage to Europe, hurting both Britain and the 26 other countries.
"If every member state were able to cherry-pick those parts of existing policies that they most like, and opt out of those that they least like, the union in general, and the single market in particular, would soon unravel," he said.
"All member states can, and do, have particular requests and needs that are always taken into consideration as part of our deliberations. I do not expect any member state to seek to undermine the fundamentals of our co-operative system in Europe."
Adding to the growing chorus of concern across Europe about the direction Cameron is taking in Europe, Wolfgang Schäuble, the influential German finance minister, told the Guardian that Britain would be shooting itself in the foot if a Cameron government second term resulted in the UK terminating more than 40 years of European membership.
"Without the EU as an amplifier, Britain's influence in the world would be lessened. No European country alone can make its voice heard in today's globalised world," said Schäuble, one of Europe's most powerful politicians. "Europe needs an ongoing critical debate about the best way forward. The British voice is sorely needed in this competition of ideas."
As the EU's first council president chairing the summits that have virtually become a monthly fixture through three years of the currency crisis, Van Rompuy has become the union's chief fixer, mediating between national leaders. The Flemish Christian Democrat expressed strong support for keeping Britain in the EU, while indirectly suggesting that Cameron's gameplan would fail. Schäuble, too, listed several reasons why Britain gained from EU membership, by implication highlighting the losses the UK would suffer were it to depart.
"The political stability and economic prosperity European integration has secured have benefited the UK as much as they have the continent. As an EU member, Britain has enjoyed unrestricted access to the world's largest single market," he said. "The EU has benefited tremendously from British membership. The UK is one of Europe's strongest, most innovative economies. London is the financial capital of Europe."
Van Rompuy, speaking to the Guardian as part of a three-day series on the future of Britain in Europe ahead of the 40th anniversary, on Tuesday, of it joining the EEC, said a British departure would "see a friend walk off into the desert". Given its history as the EU's pre-eminent trading nation, he said, Britain had far more to lose than to gain from cutting the EU cord.
"Britain's contribution is greater, I think, than it sometimes realises itself. It has been crucial in building the EU's centrepiece, the single European market, now the largest market in the world, and the common rules for the common market that are necessary for it to function.
"British expertise in the fields of foreign policy, finance and trade shape the EU's policies in these fields. It has led the way on climate change and development aid. It has offered us the English language, now in practice the lingua franca of Europe."
Senior British officials who have spent decades working in Brussels as well as in Whitehall and Downing Street are also voicing strong dismay over the direction of British travel in the EU.
Robert Cooper, a leading UK diplomat and until recently one of the EU's most senior foreign affairs officials, warned that any British attempt to disentangle itself from the EU through "repatriating" powers from Brussels would generate great rancour and recrimination. Few policymakers in the EU would be willing to do Cameron any favours, resulting in an enfeebled, lonelier Britain.
"The UK has been very good for Europe. Many would regret deeply the UK leaving," he said. "Britain would be more isolated and weaker. It would be completely crazy. The separation would not be amicable. It would be an extremely messy divorce and the bigger partners will win. The disposition for being friendly to the UK would be about zero. It's pretty much at about zero already."
The disputes about recovering national sovereignty, currently raging on the right of UK politics, are completely misplaced, he argued.
"I don't understand why the British would be more sovereign outside Europe. It wouldn't be. If you leave, you become less sovereign. Sovereignty is a seat at the table, having a voice on the future."
With Cameron poised to deliver his keynote speech on Britain in Europe within weeks, a statement being billed as the most important and fateful of his premiership, it is clear that his attempt to redefine the UK-EU relationship depends on renegotiating the Lisbon treaty, a reopening made necessary to facilitate greater integration in the eurozone in response to the flaws exposed by the currency crisis of the past three years.
Reopening the treaty, however, is a political minefield. Other EU capitals, not least Berlin, have, for the moment in any case, gone cold on the idea.
"It's a very open question as to whether this will come," said a diplomat in Brussels, adding that Cameron could find himself in the lonely position of being the sole national leader urging a renegotiation.
Van Rompuy highlighted the problems, signalling that he would seek to avoid unpicking the treaty.
"The treaties allow a considerable degree of flexibility and much can be done without needing to amend them," he said. "It is perfectly possible to write all kinds of provisions into the treaties, but amending them is a lengthy and cumbersome procedure needing the unanimous agreement of every single member government and ratification."

The fiscal cliff tax timebomb: How American families would be $400 worse off a MONTH from December 31 if no deal is reached

Hard working American families could be $4,603 a year in total worse off on their paycheck if the U.S. falls off the fiscal cliff

The President has returned to the Capitol from his Christmas vacation in Hawaii to deal with the looming fiscal cliff which will be triggered on Monday when the U.S. debt ceiling is hit

Treasury Secretary Timothy Geithner however has told Congress that the president's administration would take 'extraordinary measures' to avoid the tax increases

The inability to make a decision has been likened to a group of kindergarten children playing a dare game of 'who goes first'

With time running out for lawmakers in Washington D.C. to reach a deal on the looming fiscal cliff, every hard working American is staring down the barrel of a combined $536 billion tax hike.
Monday is the deadline for a resolution between the White House and the House of Representatives and if that is not reached then middle income American families will be hit hardest - losing upwards of $4,603 a year for a couple whose household earns $100,000.
That would leave married Americans almost $400 a month worse off and with high gas prices and a fragile economy only starting to show green shoots of recovery, it could be catastrophic not just for the U.S. but for the wider global economic health.
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The fiscal cliff tax burden for married people is shown here in this graph

This chart shows a snapshot of how single people in different income groups will be affected by the U.S. stepping off the fiscal cliff

Indeed, no American would escape the terrifying prospect of large tax rises, should the George W. Bush era tax cuts be allowed to expire.
A single American earning $50,000 would lose $1,128 off their yearly salary, as their effective tax rate rises from 18 percent to 21 percent.

And a married American Middle Class family on $50,000 would find themselves and their household down $2,008 or $167 dollars a month.
Economist, Robert Salvino has said that he does not expect those on Capitol Hill to meet the midnight December 31st deadline and said, deal or no deal - the payroll tax cut is certain to change.

President Obama returned to Washington under pressure to forge a year-end deal with Republicans to avoid the tax hikes and spending cuts of the fiscal cliff

He justified this by saying that the tax break was part of the stimulus plan for the recession and that immediate danger has passed.
'If the payroll tax cut expires then, it doesn't matter what tax bracket you are in, everyone will be hurt' he said.
The average household income across the country is $43,000 per year and with the additional two percent tax on payroll will cost the average household around $800 a year from their paychecks.
Frighteningly, if lawmakers do not act fast, farm and dairy subsidies could expire too, which could lead to a ruinous rise in food prices for average income families.

The move comes as President Obama and the GOP are locked in negotiations over how to avoid the fiscal cliff. Obama is pictured (second right) with Geithner (far left), House Speaker John Boehner (second left) and Senate Majority Leader Harry Reid (right)

'The extent that the cuts could effects education is through various federal programs that provide grant money for schools to do certain things like providing free or reduced lunch or providing laptop for students,' said Salvino.
The outlook on the 'fiscal cliff' coming up at year-end is uncertain. Democratic President Barack Obama has said he hopes for a last-minute deal to avert it. That would need to get done soon, with Congress just now coming back from its holiday break.

'We are heading over the Fiscal Cliff because of a Dictatorship': Senate Leader Harry Reid Voices His Fears Today

Speaking on the Senate floor today, Democrat Harry Reid said that the U.S. appears to be heading over the 'fiscal cliff' and accused the House of Representatives of being a 'dictatorship'.

Taking to the floor to declare his frustration with the other chamber, Reid said that getting the 60 plus Senate votes any new legislation needs seemed to be doomed unless the Republicans gave it strong backing.

'It looks like that's where we're headed,' said Senate Leader Mr. Reid about the fiscal cliff.

He said the the House-Speaker John Boehner could easily end the impasse and stop the massive $536 billion tax hike by adopting the legislation the Senate has already passed to preserve the Bush tax-cuts for incomes under $250,000.

However, Reid said that Boehner will not do that because he is more concerned with his own power and re-election as Speaker which comes up for renewal on January 3rd.

'The American people I don't think understand the House of Representatives is operating without the House of Representatives,' Reid said. 'It's being operated by a dictatorship of the speaker, not allowing the vast majority of the House of Representatives to get what they want.'

'If the 250 were brought up, it would pass overwhelmingly,' said Reid, referring to the Senate approved $250,000 plan.

'What goes on in this country shouldn't be decided by 'the majority,' it should be decided by the whole House of Representatives,' Reid said.

Boehner's office was unimpressed with Reid's declarations.

'Senator Reid should talk less and legislate more,' said Boehner spokesman Michael Steel. 'The House has already passed legislation to avoid the entire fiscal cliff. Senate Democrats have not.'

Weeks of inconclusive political drama over the 'cliff' have focused largely on individual income tax rates and spending on federal programs such Medicare and Social Security, but many tax issues are also involved, including the estate tax.
At the moment, under laws signed a decade ago by Bush, the estate tax is applied to inherited assets at a rate of 35 percent after a $5 million exemption.
That means a deceased person can pass on an inheritance of up to $5 million before any tax applies. Inherited wealth passed to a spouse or a federally recognized charity is generally not taxed.

President Barack Obama walks down the the lower steps instead of the usual longer stairway from Air Force One upon his arrival at Andrews Air Force Base this morning

Obama wants to raise the rate to 45 percent after a $3.5 million exemption. Republicans have called for complete repeal of the estate tax, which they call the 'death tax,' though Boehner earlier this month called for freezing the estate tax at its present level.
It was difficult to determine what the Republicans want after last week's events in the House.
If Congress and Obama do not act by Dec. 31, numerous Bush-era tax laws will expire, including the one on estate taxes. That would mean the estate tax rate will shoot up next year to the pre-Bush levels of 55 percent after a $1 million exemption.
It would also mean that for the first time in years, a portion of that estate tax would go to the states, through the return of the credit system.
Under that old law, estates paying the tax could get a credit against their federal tax bill for state estate tax payments of up to 16 percent of the estate's value.
If the fiscal cliff were allowed to take hold unaltered by Washington, 30 states would again automatically begin getting their share of federal estate taxes. The state laws are generally written so the state estate tax amounts are calculated under a formula based on the amount of the federal credit.
This would help states that have struggled with lower tax revenues since the 2007-2009 financial crisis and resulting recession, according to research by the Pew Center on the States, though painful federal spending cut backs would also hurt the states.

President Barack Obama waves as he steps off the Marine One helicopter and walks on the South Lawn at the White House in Washington as the fiscal cliff looms

In fact it is thought that millions of middle-class Americans would face higher taxes immediately if Congress fails to reach an agreement to avoid the fiscal cliff.
The alternative minimum tax which was enacted years ago and was meant to hit what were then higher income Americans is due to expire, affecting those making as little as $45,000.
'It'll come as a surprise for many people,' said Marshall Mennenga, an enrolled agent with Mennenga Tax and Financial Service.
'There's going to be a lot of people very upset if they don't pass the 'patch' and get this thing corrected.'
The alternative minimum tax of AMT, went into effect in 1968 to deduct tax from wealthy Americans who were deducting so much that they weren't paying any viable income tax.

Peering over the Fiscal Cliff: What happens if no deal if reached by December 31st?

On January 1st the tax cuts instituted by George W. Bush expire and huge spending cuts will have to occur.
In total $607 billion of cuts and tax rises are planned, these include:

• Reductions in the defense budget
• The end of the two-percent payroll tax cut
• Changes to Medicare allowances - which provide provisions for the elderly
• Family income credits for lower income families will be reduced
• The 'alternative minimum tax' for many employees will return
• Two million people will see the end of their long-term federal unemployment benefits - which are around $300 a week.

If this happens most observers say that a five percent cut in the country's output will happen in one swoop.
Unemployment, which has been falling could rise as businessess have to cut back in hiring because of the new costs.
The head of The Federal Reserve, Ben Bernanke has said that falling off the fiscal cliff could send the economy 'toppling back into recession'.
The Congressional Budget Office has said that U.S. unemployment could rise above nine percent in a year if the impasse is not resolved.
And as is often the case, any difficulties experienced in the world's largest economy will affect the health of the global financial situation.

However, the tax was not linked to inflation which means it is catching more people each year.
And with the so called 'patch' or Congress' short-term solution to the fiscal cliff, those on $45,000 to $74,450 could fall into paying the tax.
Without any deal, the net expands to a low of $33,750 for individuals and $45,000 for married couples.
While the U.S. stares over the 'fiscal cliff' and $536 billion in tax increases for all Americans, President Obama and the House of Representatives have been accused of acting like kindergarten students engaged in a dangerous dare of 'who goes first'.
President Obama returned to Washington D.C. after cutting short his Christmas vacation and the Senate is going back into session, but the Republican ruled House is still out on recess as the deadline of January 1st looms that could damage a still fragile recovery.
Treasury Secretary Timothy Geithner informed Congress on Wednesday that the government was on track to hit its borrowing limit on Monday and that he would take 'extraordinary measures as authorized by law' to postpone a government default.

President Barack Obama waves as he boards Air Force One to return to Washington to deal with the looming fiscal cliff that the U.S. is staring over

Still, he added, uncertainty over the outcome of negotiations over taxes and spending made it difficult to determine how much time those measures would buy.
In recent days, Obama's aides have been consulting with Senate Democratic Leader Harry Reid's office, but Republicans have not been part of the discussions, suggesting much still needs to be done if a deal, even a small one, were to be struck and passed through Congress by Monday.
At stake are current tax rates that expire on Dec. 31 and revert to the higher rates in place during the administration of President Bill Clinton.
All in all, that means $536 billion in tax increases that would touching nearly all Americans. Moreover, the military and other federal departments would have to cut $110 billion in spending.
But while economists have warned about the economic impact of tax hikes and spending cuts of that magnitude, both sides appear to be proceeding as if they have more than just four days left.
Indeed, Congress could still act in January in time to retroactively counter the effect on most taxpayers and government agencies, but chances for a large deficit reduction package would likely be put off.
House Republican leaders on Wednesday said they remain ready to negotiate, but urged the Senate to consider or amend a House-passed bill that extends all existing tax rates. In a statement, the leaders said the House would consider whatever the Senate passed.
'But the Senate first must act,' they said.
Aides said any decision to bring House members back to Washington would be driven by what the Senate does.
Reid's office responded shortly after, insisting that the House act on Senate legislation passed in July that would raise tax rates only on incomes above $200,000 for individuals and $250,000 for couples.
Meanwhile, Obama has been pushing for a variant of that Senate bill that would include an extension of jobless aid and some surgical spending reductions to prevent the steeper and broader spending cuts from kicking in.
For the Senate to act, it would require a commitment from Senate Republican Leader Mitch McConnell not to demand a 60-vote margin to consider the legislation on the Senate floor.
McConnell's office says it's too early to make such an assessment because Obama's plan is unclear on whether extended benefits for the unemployed would be paid for with cuts in other programs or on how it would deal with an expiring estate tax, among other issues.

President Barack Obama greets base visitors and personnel before boarding Air Force One to return to Washington on December 26th from Hawaii

What's more, House Speaker John Boehner would have to let the bill get to the House floor for a vote. Given the calendar, chances of accomplishing that by Dec. 31 were becoming a long shot.
Amid the standoff, Geithner advised Congress on Wednesday that the administration will begin taking action to prevent the government from hitting its borrowing limit. In a letter to congressional leaders, Geithner said accounting measures could save approximately $200 billion.
That could keep the government from reaching the debt limit for about two months. But if Congress and the White House don't agree on how to avoid the "fiscal cliff," he said, the amount of time before the government hits its borrowing limit is more uncertain.
'If left unresolved, the expiring tax provisions and automatic spending cuts, as well as the attendant delays in filing of tax returns, would have the effect of adding some additional time to the duration of the extraordinary measures,' he wrote.
Whenever the debt ceiling hits, however, it is likely to set up yet another deadline for one more budget fight between the White House and congressional Republicans.
Initially, clearing the way for a higher debt ceiling was supposed to be part of a large deal aimed at reducing deficits by more than $2 trillion over 10 years with a mix of tax increases and spending cuts, including reductions in health programs like Medicare.
But chances for that bargain fizzled last week when conservatives sank Boehner's legislation to only let tax increases affect taxpayers with earnings of $1 million or more.
Obama and his aides have said they would refuse to let Republicans leverage spending cuts in return for raising the debt ceiling.
But Republicans say the threat of voting against an increase in the limit is one of the best ways to win deficit reduction measures.
Treasury Secretary Timothy Geithner said in a letter Wednesday to congressional leaders that the department will take several accounting measures to save approximately $200 billion.

U.S. Treasury Secretary Timothy Geithner is going to unveil 'extraordinary measures' in efforts to avoid the nation triggering the debt ceiling

The government borrows about $100 billion a month, so that typically would keep the government from reaching the limit for about two months.
The move comes as President Barack Obama and the GOP congressional leadership are locked in negotiations over how to avoid a series of tax increases and spending cuts, known as the 'fiscal cliff,' that are scheduled to take effect next week.
Congressional officials said Wednesday they knew of no significant strides toward a compromise over a long Christmas weekend, and no negotiations have been set.
After conferring on a conference call, the House Republican leadership said they remain ready for talks, but gave no hint they intend to call lawmakers back into session unless the Senate first passes legislation.
'The lines of communication remain open, and we will continue to work with our colleagues to avert the largest tax hike in American history, and to address the underlying problem, which is spending,' the leadership said in a statement.
Obama has sought to include an increase in the borrowing limit in the talks. But Speaker John Boehner and other Republican leaders have demanded concessions in return. The negotiations hit a stalemate last week and Obama and lawmakers are returning to Washington this week to resume talks.
Geithner says it is harder to predict how long the delay will last because ongoing negotiations over tax and budget policies make it hard to forecast what tax revenue and government spending will be next year.
The borrowing limit is the amount of debt the government can pile up. The government accumulates debt two ways: It borrows money from investors by issuing Treasury bonds, and it borrows from itself, mostly from Social Security revenue.

Warning: The phrase 'fiscal cliff' is attributed to Ben Bernanke (pictured), chairman of the Federal Reserve, America's central bank, who has warned about 'a massive fiscal cliff of large spending cuts and tax increases'

Another potential showdown is pending. A renewed clash over spending could come in late March; spending authority for much of the government expires on March 27.
In 2011, Congress raised the limit to nearly $16.4 trillion from $14.3 trillion. Three decades ago, the national debt was $908 billion. But Washington spent more than it took in, and the debt rose steadily — surpassing $1 trillion in 1982, then $5 trillion in 1996.
It reached $10 trillion in 2008 as the financial crisis and recession dried up tax revenue and as the government spent more on unemployment benefits and other programs.
In August 2011, the rating agency Standard & Poor's stunned the world by stripping the U.S. government of its prized AAA bond rating because it feared that America's dysfunctional political system couldn't deliver credible plans to reduce the federal government's debt. S&P decried American 'political brinksmanship' and concluded that 'the differences between political parties have proven to be extraordinarily difficult to bridge.'
A year and a half later, the two political parties are still as deadlocked as ever.
Despite S&P's warnings and the political stalemate, investors still want U.S. Treasurys. Given economic turmoil in Europe and uncertainty elsewhere, U.S. government debt and U.S. dollars look like the safest bet around.
That is why the interest rate, or yield, on 10-year Treasury notes has fallen from 2.58 Aug. 5, 2011 to 1.75 percent Wednesday.

VIDEO: Obama's last public statement on the fiscal cliff:  

Play Video

Investors yank $150 billion from stocks for 3rd year

The U.S. stock market has been on a bull run since early 2009. At the same time, individual investors have been pulling billions of dollars out of stocks each year.
As the S&P 500  rallied about 13% during the first eleven months of 2012, individual investors yanked about $152 billion from the U.S. stock market, according to data from EPFR Global, a Boston-based firm that tracks fund flows for both mutual funds and exchange traded funds.
That marks the third year in a row that investors have withdrawn more than $150 billion from U.S. stock mutual funds and ETFs.
While individual investors have been shunning the market, institutional investors, such as hedge funds and pension funds, have been significantly adding to their stock positions. They've poured more than $80 billion into stocks so far this year.
"Retail investors and institutional investors have acted in complete opposition since the March 2009 lows," noted Simon Ringrose, managing director at EPFR Global.
Quiz: Are you a markets whiz?
In November alone, individual investors pulled nearly $19 billion out of the market, the most since August 2011, when the debt ceiling debacle and the Standard and Poor's credit rating downgrade took center stage. November's big bleed was a result of more political wrangling in Washington -- this time over the fiscal cliff.
The mass exodus from stocks isn't exactly new. While individual investors have been taking money out of the stock markets since 2005, the outflows accelerated considerably beginning in 2010.
Experts have largely pinned the reason for the stock dump on the Baby Boomer generation.
They represent the largest group among retail investors, and after having their portfolios rocked by the dot-com crash and the financial crisis, they've shifted out of stocks and into bonds much earlier than usual as they head into retirement.
And any money do they do have in the market is consistently going into bond funds, said Ringrose.


Since the beginning of this year, individual investors have plowed more than $90 billion into U.S. bond funds, the most since the record $117 billion in 2009, according to EPFR.
A lack of confidence among investors across age groups has also been a factor, in the wake of high-frequency trading, and incidents like the May 2010 flash crash , Nasdaq's bungled Facebook IPO (FB) and the Knight trading glitch (KCG).

Pensioners are about to be robbed yet again

The Chancellor is poised to alter the way inflation is calculated and interest paid, says Philip Johnston. 

 

Photo: GETTY

 

 

The post-Christmas sales are in full swing and prices are tumbling, but who among us can answer this question with any certainty: what is the current rate of inflation? The official figure for November, published by the Office for National Statistics, stood at 2.7 per cent, unchanged on the previous month; yet does anyone recognise that from the real world?

We are talking here about the Consumer Price Index (CPI), adopted as the Government’s official inflation target by Gordon Brown in his pre-Budget statement of 2003, in one of those notoriously garbled announcements that few noticed at the time, but whose impact became apparent in subsequent days.

The CPI superseded the Retail Price Index (RPI). The RPI at least had the virtue of familiarity, having been with us through thick and thin since the late 1940s, and it is still used in some instances, of which more later. Both measure how fast the prices of goods and services increase and rely on a regularly revised basket of items that we are most likely to purchase.

Crucially, however, the CPI excludes housing costs, council tax and home insurance, which make up about 20 per cent of the average household’s spending. And why this omission? Because the methodology was devised by EU statisticians about 20 years ago – and since home ownership varies so much across Europe, they couldn’t agree a formula to cover them all.

In other words, far from being a technical change intended more accurately to reflect the lives we lead and the goods we buy, the CPI rapidly came to bear little resemblance to the experience most people have of inflation. In any case, this varies depending on where you live, who you are and what you buy: the cost of living is different for the elderly, for country dwellers (high fuel bills) and for the better-off (rising school fees).

But the CPI had a magical quality that made it irresistible for governments: invariably it was lower than the RPI. So if index-linked benefits, grants and other payments could be based on the new measure, lots of money could be saved.
For a few years at least, the RPI remained the preferred inflation measure for the indexation of pensions, but that ended for many in 2011 when the Government said these could be based on the CPI as well. Private schemes which specified RPI in their rules retained this measure, while schemes whose rules referred only to the statutory requirements moved to CPI automatically, as did all public sector pensions. This decision was taken principally to reduce the liabilities on pension schemes, which are under massive pressure because people are living much longer than actuaries had assumed just a few years ago. Needless to say, it was bad news for pensioners.
According to the Office for Budget Responsibility, the CPI over the coming decades will be about 1.4 percentage points lower than the RPI. This might not sound a great deal; but the incremental effect will amount to a difference of many thousands of pounds in the pension someone will receive during their retirement. In total, the Department for Work and Pensions estimates that inflation switching could cost private pensioners more than £73 billion.
Still, there was one saving grace: government bonds remained linked to the RPI, and since pension funds invested heavily in those, savers were at least getting some benefit of the higher inflation measure.
You can just guess what’s coming next, can’t you? Next month, a report from the Office for National Statistics (ONS) is to be published on the future of the RPI. The ONS has carried out a brief and not very well publicised consultation on a number of options, including whether and how to bring it more into line with the CPI. Doing so would save George Osborne £3 billion a year in interest – and hammer yet another nail into the coffin of private pensions, especially those still linked to the RPI. It would also cut the returns on the £18 billion worth of inflation-linked policies which have been sold by National Savings and Investments.
This really makes sense, doesn’t it? We are living longer; we are massively in debt as a nation; we cannot afford to care for our elderly: what better time than now to mess up our pensions even more? After decades of debt-fuelled consumer bingeing, we need to encourage young people to save; and to that end the Government has introduced a system of automatic pension enrolment. But you can opt out – and if you can’t trust the government to stick to the deal that you started with, why would you want to join up?
Millions of investors have taken decisions about their futures based on the continuation of the RPI. Pensions, by their very nature, are all about long-term planning; so the integrity of government indexation is crucial. If the goal posts can simply be moved around the pitch at the whim of a chancellor, it is hardly surprising that confidence in a system which just 15 years ago was lauded as the envy of the world is now shot to pieces.
The savers of Britain are justifiably fed up with the larcenous manipulation of the value of their nest eggs. It is rumoured that next month’s report will recommend revaluing RPI downwards by anything up to one per cent. But the final decision will rest with George Osborne, and he must make sure it doesn’t happen. Enough is enough.
* Read more on rising pension ages and how retirement income has been hit

Monetary Malpractice: Deceptions, Distortions and Delusions

Source: Gordon T. Long

The Hippocratic Oath is an oath taken by physicians swearing to practice medicine ethically, honestly and above all, to do no harm to the patient. Unelected central bankers do not take such an oath. They do however swear allegiance to the Constitution.

On February 6, 2006, Ben Bernanke took an oath to the Constitution at his swearing-in ceremony as Chairman of the Board of Governors of the Federal Reserve System. The significance of this is that as a federal officer, despite being the front man for a privately owned, quasi government bank, he can be prosecuted for any violations of the Constitution that he swore to uphold.
Bernanke is likely never to be charged with a crime against the constitution, but he is certainly guilty of malpractice. As a result of  his untested and uncharted monetary policies, he has created broad based Moral Hazard and Unintended Consequences that have inflicted immeasurable and potentially fatal harm to the America he swore allegiance to.
DECEPTIONS, DISTORTIONS & DELUSIONS
By the Deceptive means of Misinformation and Manipulation of economic data the Federal Reserve has set the stage for broad based moral hazard. Through Distortions caused by Malpractice and Malfeasance, a raft of Unintended Consequences have now changed the economic and financial fabric of America likely forever. The Federal Reserve policies of Quantitative Easing and Negative real interest rates, across the entire yield curve, have been allowed to go on so long that Mispricing and Malinvestment has reached the level that markets are effectively Delusional. Markets have become Dysfunctional concerning the pricing of risk and risk adjusted valuations. Fund Managers can no longer use even the Fed's own Valuation Model which is openly acknowledged to be broken.
MONETARY MALPRACTICE

• Low interest rates and massive transfers of capital from Fed to banks has allowed banks to become hedge funds, making most of their money through proprietary trading and the creation of ever-more exotic instruments (moral hazard). This has lead to a merger of the banks, government and military/industrial complex into one entity (unintended consequence) that is not focused on expanding its power rather than serving its original constituents.

• Low interest rates and easy money have lead to massive concentrations of wealth as bankers and corporate CEOs take ever-greater risks, keeping the profits and handing the losses off to taxpayers (moral hazard). Wealth disparities have exploded (unintended consequences), creating in effect an aristocracy – and a disaffected majority. Political instability has risen (unintended consequence), leading the government to build a police state apparatus. The coming confrontation will look like Greece, with the addition of advanced technology on all sides (very unintended consequence).

"An environment where financial crises are seen to be a regular part of the landscape is one where people might actually take more precautions. People would maintain a margin of safety in all their decisions, investment and otherwise, regulations would be well thought out and diligently enforced, and the unscrupulous and the incompetent would quickly fail and disappear from the scene. Modern day attempts to abolish failure only serve to ensure it, as moral hazard - the likelihood that people's behavior changes in response to artificial supports or guarantees - surges. Attempts to prevent or wish away future crises only make them more likely. Only by allowing, even welcoming, episodic failure do we have a chance of reducing the likelihood and magnitude of future financial crises."

On The Morality Of The Fed 12/21/12 The Baupost Group

 

MORAL HAZARD
In economic theory, a moral hazard is a situation where a party will have a tendency to take risks because the costs that could incur will not be felt by the party taking the risk

• A moral hazard may occur where the actions of one party may change to the detriment of another after a transaction has taken place.

Example: persons with insurance against automobile theft may be less cautious about locking their car, because the negative consequences of vehicle theft are now (partially) the responsibility of the insurance company.

• A party makes a decision about how much risk to take, while another party bears the costs if things go badly, and the party isolated from risk behaves differently from how it would if it were fully exposed to the risk.

Example: the Euro debt crisis, in which the troika of relief funds (aka the ECB, the IMF, and the EC) for heavily indebted nations like Greece are waiting as long as possible to act. The risks of a money run, and the consequential market crash in Europe is by far not as detrimental to these institutions as to the indebted nations themselves.

• An individual or institution does not take the full consequences and responsibilities of its actions, and therefore has a tendency to act less carefully than it otherwise would, leaving another party to hold some responsibility for the consequences of those actions.

• One party in a transaction has more information than another.

 In particular, moral hazard may occur if a party that is insulated from risk has more information about its actions and intentions than the party paying for the negative consequences of the risk. More broadly, moral hazard occurs when the party with more information about its actions or intentions has a tendency or incentive to behave inappropriately from the perspective of the party with less information.

•   One party, called an agent, acts on behalf of another party, called the principal.

The agent usually has more information about his or her actions or intentions than the principal does, because the principal usually cannot completely monitor the agent. The agent may have an incentive to act inappropriately (from the viewpoint of the principal) if the interests of the agent and the principal are not aligned.
Read More...

Crisis Event Unleashed Soon

Generation Y Wakes Up From The American Dream, Faces An American Nightmare

Source: Zero Hedge

Three and a half years after the worst recession since the Great Depression, the earnings and employment gap between those in the under-35 population and their parents and grandparents threatens to unravel the American dream of each generation doing better than the last. We have noted a number of times that these divides are growing and warned of the social tension this could create and, as Bloomberg notes, it does not appear to be getting any better, Generation Y professionals entering the workforce are finding careers that once were gateways to high pay and upwardly mobile lives turning into detours and dead ends. "This generation will be permanently depressed and will be on a lower path of income for probably all of their life - and at least the next 10 years," as middle-income jobs are disappearing. A 2009 law school graduate sums it up rather succinctly: "I had a lot of faith in the system, the mythology that if you work really hard you can achieve anything, and the stock market always goes up. It was pretty naïve on my part."
Via Bloomberg:

Generation Y professionals entering the workforce are finding careers that once were gateways to high pay and upwardly mobile lives turning into detours and dead ends. Average incomes for individuals ages 25 to 34 have fallen 8 percent, double the adult population’s total drop, since the recession began in December 2007. Their unemployment rate remains stuck one-half to 1 percentage point above the national figure.
Three and a half years after the worst recession since the Great Depression, the earnings and employment gap between those in the under-35 population and their parents and grandparents threatens to unravel the American dream of each generation doing better than the last. The nation’s younger workers have benefited least from an economic recovery that has been the most uneven in recent history.

which is leading to an increasingly disenfranchised generation:

“This generation will be permanently depressed and will be on a lower path of income for probably all of their life -- and at least the next 10 years,” says Rutgers professor Cliff Zukin, a senior research fellow at the university’s John J. Heldrich Center for Workforce Development. Professionals who start out in jobs other than their first choice tend to stay on the alternative path, earning less than they would have otherwise while becoming less likely to start over again later in preferred fields, Zukin says.
...
Only one-fifth of those who graduated college since 2006 expect greater success than their parents, a Rutgers survey found earlier this year. Little more than half were working full time. Just one in five said their job put them on a career path.

As the dream fades:

“I had a lot of faith in the system, the mythology that if you work really hard you can achieve anything, and the stock market always goes up,” says 2009 law school graduate Elizabeth Hallock, 33. “It was pretty naïve on my part.”

And fingers are pointed:

Hallock is the named plaintiff in one of 14 lawsuits against some of the nation’s best-known law schools, including her alma mater, the University of San Francisco School of Law. The civil complaints, filed in 2011 and 2012, accuse the institutions of overstating graduates’ job-placement results and incomes.
Young Americans are struggling to reconcile their lack of economic rewards with their relatively privileged upbringings by Baby Boomer parents and the material success of their older peers, Generation X, born in the late 1960s and 1970s...

But whose fault is it?

“It’s a generation that had really high expectations, in some part driven by the way they were raised by their boomer parents,” she says. “Yet in the past five years they have had reality slammed in their face by the employment situation.”

As...

The same housing crash that hammered young architects and loan officers also slammed lawyers. Law schools are turning out about 45,000 degree holders a year for about 25,000 full-time positions available to them, according to the National Association for Law Placement Inc. in Washington. The class of 2011 had the lowest placement with law firms, 49.5 percent, in 36 years.
“It is not the perfect path to wealth and success that people may have envisioned,” says Robin Sparkman, editor in chief of The American Lawyer magazine in New York.

Which is leading to lawsuits - by the new lawyers against their schools...

“It’s hard to look at the information the schools were putting out and say it’s not misleading,” says Derek Tokaz, research director of the nonprofit Law School Transparency initiative. It published research showing that the chance of recent graduates getting permanent full-time work in law was far lower than the 80-95 percent total employment rates the schools typically boasted.

But for some - a new different life is peeking through...

“As it is, all of my possessions still fit in the back of my truck,” she says. “I can pack it in a couple hours, pick up the trailer and horses and move anywhere the gas tank will take me at the drop of a hat. What can the system take away from you when you have that kind of freedom?”

Abolish the Federal Reserve Act (ch. 6, 38 Stat. 251, enacted December 23, 1913, 12 U.S.C. ch.3)

"I am a most unhappy man. I have unwittingly ruined my country. A great industrial nation is controlled by its system of credit. Our system of credit is concentrated. The growth of the nation, therefore, and all our activities are in the hands of a few men. We have come to be one of the worst ruled, one of the most completely controlled and dominated Governments in the civilized world no longer a Government by free opinion, no longer a Government by conviction and the vote of the majority, but a Government by the opinion and duress of a small group of dominant men." -Woodrow Wilson, after signing the Federal Reserve into existence

Abolish the Federal Reserve Act Petition on Whitehouse.gov

We have all read about the "Deport Piers Morgan" petition for trying to get our 2nd amendment taken away when he is not even a U.S. citizen.

This is what the petition says:

 British Citizen and CNN television host Piers Morgan is engaged in a hostile attack against the U.S. Constitution by targeting the Second Amendment. We demand that Mr. Morgan be deported immediately for his effort to undermine the Bill of Rights and for exploiting his position as a national network television host to stage attacks against the rights of American citizens.

I did not want to sign up on a government site for petitions, but I went ahead and did so today to sign the Morgan petition.   Which has over 80000 signatures now.

I was number 81486 on that petition.

There is an abolish the Federal Reserve Act petition on the site that was just put up.   I signed that one and was number 287.   Obviously there needs to be thousands who sign the petition.

This is what the petition says:  (I believe better words could have been used, but the point is to abolish the Federal Reserve Act)

"I am a most unhappy man. I have unwittingly ruined my country. A great industrial nation is controlled by its system of credit. Our system of credit is concentrated. The growth of the nation, therefore, and all our activities are in the hands of a few men. We have come to be one of the worst ruled, one of the most completely controlled and dominated Governments in the civilized world no longer a Government by free opinion, no longer a Government by conviction and the vote of the majority, but a Government by the opinion and duress of a small group of dominant men." -Woodrow Wilson, after signing the Federal Reserve into existence
Now this one I believe is very important.  It is up to all of us to stand up and try and get that done, just as Ron Paul has been trying for decades.

Collectively we should sign this petition and try and get it everywhere on social media sites, just as the Morgan one has been, to have people aware of it.

By taking a stance and signing it, all of us who are the 99% can begin being the power and force who are stronger than the 1%.

This petition deserves our attention and signing for our liberty and freedom from debt. 

We have to stand up and have the courage to put our name to what we stand for!

Peter Schiff: We Can't Solve Our Problems Without Going Over A Cliff - CNBC 12/26/2012

Watch this link   http://shar.es/hDvkB  via @sharethis

On The Morality Of The Fed

Via The Baupost Group:

"Finally, we must question the morality of Fed programs that trick people (as if they were Pavlov's dogs) into behaviors that are adverse to their own long-term best interest. What kind of government entity cajoles savers to spend, when years of under-saving and over-spending have left the consumer in terrible shape? What kind of entity tricks its citizens into paying higher and higher prices to buy stocks? What kind of entity drives the return on retiree's savings to zero for seven years (2008-2015 and counting) in order to rescue poorly managed banks? Not the kind that should play this large a role in the economy."

...

"An environment where financial crises are seen to be a regular part of the landscape is one where people might actually take more precautions. People would maintain a margin of safety in all their decisions, investment and otherwise, regulations would be well thought out and diligently enforced, and the unscrupulous and the incompetent would quickly fail and disappear from the scene. Modern day attempts to abolish failure only serve to ensure it, as moral hazard - the likelihood that people's behavior changes in response to artificial supports or guarantees - surges. Attempts to prevent or wish away future crises only make them more likely. Only by allowing, even welcoming, episodic failure do we have a chance of reducing the likelihood and magnitude of future financial crises."

1000x Systemic Leverage: $600 Trillion In Gross Derivatives "Backed" By $600 Billion In Collateral

There is much debate whether when it comes to the total notional size of outstanding derivatives, it is the gross notional that matters (roughly $600 trillion), or the amount which takes out biletaral netting and other offsetting positions (much lower). We explained previously how gross is irrelevant... until it is, i.e. until there is a breach in the counterparty chain and suddenly all net becomes gross (as in the case of the Lehman bankruptcy), such as during a financial crisis, i.e., the only time when gross derivative exposure becomes material (er, by definition). But a bigger question is what is the actual collateral backing this gargantuan market which is about 10 times greater than the world's combined GDP, because as the "derivative" name implies all this exposure is backed on some dedicated, real assets, somewhere. Luckily, the IMF recently released a discussion note titled "Shadow Banking: Economics and Policy" where quietly hidden in one of the appendices it answers precisely this critical question. The bottom line: $600 trillion in gross notional derivatives backed by a tiny $600 billion in real assets: a whopping 0.1% margin requirement! Surely nothing can possibly go wrong with this amount of unprecedented 1000x systemic leverage.
From the IMF:

Over-the-counter (OTC) derivatives markets straddle regulated systemically important financial institutions and the shadow banking world. Recent regulatory efforts focus on moving OTC derivatives contracts to central counterparties (CCPs). A CCP will be collecting collateral and netting bilateral positions. While CCPs do not have explicit taxpayer backing, they may be supported in times of stress. For example, the U.S. Dodd-Frank Act allows the Federal Reserve to lend to key financial market infrastructures during times of crises. Incentives to move OTC contracts could come from increasing bank capital charges on OTC positions that are not moved to CCP (BCBS, 2012).

The notional value of OTC contracts is about $600 trillion, but while much cited, that number overstates the still very sizable risks. A better estimate may be based on adding “in-the-money” (or gross positive value) and “out-of-the money” (or gross negative value) derivative positions (to obtain total exposures), further reduced by the “netting” of related positions. Once these are taken into account, the resulting exposures are currently about $3 trillion, down from $5 trillion (see table below; see also BIS, 2012, and Singh, 2010).

Another important metric is the under-collateralization of the OTC market. The Bank for International Settlements estimates that the volume of collateral supporting the OTC market is about $1.8 trillion, thus roughly only half of exposures. Assuming a collateral reuse rate between 2.5-3.0, the dedicated collateral is some $600 - $700 billion. Some counterparties (e.g., sovereigns, quasi-sovereigns, large pension funds and insurers, and AAA corporations) are often not required to post collateral. The remaining exposures will have to be collateralized when moved to CCP to avoid creating puts to the safety net. As such, there is likely to an increased demand for collateral worldwide.

And there it is: a world in which increasingly more sovereigns are insolvent, it is precisely these sovereigns (and other "AAA-rated" institutions) who are assumed to be so safe, they don't have to post any collateral to the virtually unlimited derivatives they are allowed to create out of thin air.
Is it any wonder why, then, in a world in which even the IMF says there is an increased demand for collateral, that banks are making a total mockery out of such preemptive attempts to safeguard the system, such as the Basel III proposal, whose deleveraging policies have been delayed from 2013 to 2014, and which will be delayed again and again, until, hopefully, everyone forgets all about them, and no financial crises ever again occur.
Because if and when they do, the entire world, which has now become one defacto AIG Financial Products subsidiary, and is spewing derivatives left and right, may have to scramble just a bit to procure some of this $599 trillion in actual collateral, once collateral chains start breaking, once "AAA-rated" counterparties (such as AIG had been days before its bailout) start falling, and once the question arises: just what is the true value of hard assets in a world in which the only value created by financial innovation is layering of derivatives upon derivatives, serving merely to prod banker bonuses to all time highs.

Why do smart people still choose Keynes over Hayek?

Looking back over the last few years you have to ask how intelligent people, examining the evidence, can still choose Keynes over Hayek

On October 17^th a group of concerned economists wrote to the Times. The current economic woes, they wrote, were down to insufficient spending/increased saving. “[W]hen a man economizes in consumption”, they argued, “and lets the fruit of his economy pile up in bank balances or even in the purchase of existing securities, the released real resources do not find a new home waiting for them.” Crucially, “In present conditions their entry into investment is blocked by lack of confidence.” The government should step in and spend to make up the shortfall they said.
On October 19^th another group of economists replied with their own letter to the Times. They believed that the cause of the economic problems was monetary mismanagement which had created “a deficiency of investment-a depression of the industries making for capital extension, &c., rather than of the industries making directly for consumption.” They argued for the necessity of increased saving to readjust this and explicitly rejected any role for government spending, writing that “many of the troubles of the world at the present time are due to imprudent borrowing and spending on the part of the public authorities.”
But this was October 1932 and the letters were written by John Maynard Keynes and Friedrich von Hayek. It says much about the essentially static nature of economic knowledge that an 80 year old debate remains so compelling today that it continues to inspire radio shows, debates, books, and even rap-offs.
Keynes’s economics, in a nutshell, argues that of the two components of ‘effective demand’, consumption and investment, investment is prone to volatile swings. As Keynes put it, investment spending was reduced when their expected payoff, the Marginal Productivity of Capital, dipped below the cost of financing them, the interest rate.
Why might this happen? “Animal spirits” was Keynes’ answer; “Don’t ask me guv” in other words. Whatever it was that tipped investors from optimism into effective demand-sapping pessimism is exogenous to the model; it cannot be accounted for by it.
Either way, the policy prescriptions of the Keynesian model are obvious. Financing costs must be held down with low interest rates and the Marginal Productivity of Capital must be underwritten by a government guarantee to purchase, with deficit spending if need be, whatever output industry might produce. Low interest rates and deficit spending. That is the Keynesian prescription for prosperity.
Hayek’s theory is very different. For Hayek, when low interest rates cause an expansion of credit, this credit flows into some parts of the economy before others. This blows up bubbles in the affected part of the economy, be it in housing, internet stocks, or tulips.
At some point, Hayek argues, the inflationary effect of this credit expansion overwhelms any wealth effect and interest rates begin to rise. With no further credit available to purchase the bubble assets the prices of these assets and their attendant industries collapse. This is the bust.
A major difference between Hayek’s theory and Keynes’s is that for Hayek the bust as well as the boom is endogenous to the model, it is explained by it. The bust isn’t caused by “animal spirits” switching inexplicably out of the clear blue sky, but by the predictable outcome of actions undertaken in the boom.
As Hayek’s model is radically different from Keynes’s, radically different prescriptions follow from it. Viewing the cycle as a whole Hayek believed that preventing a future bust was as important as fighting the current one and he proposed measures to limit the ability of banks to swell credit, his favoured solution being competing currency issue by banks.
More immediately, Hayek argued that as the bubble assets and attendant industries had been pumped up by unsustainable injections of inflationary credit, they could only be liquidated; any attempt to preserve their value would only prolong the bust or, as bad, set another cycle in motion. Sound money and non-intervention was the prescription of Hayek and his fellow Austrian Schoolers.
Looking back over the last few years you have to ask how intelligent people, examining the evidence, can still choose Keynes over Hayek. In both Britain and America we had monetary policy makers working to keep financing costs down with low interest rates. We had governments running budget deficits and applying fiscal stimulus to economies which were already growing. We followed the Keynesian prescription for prosperity and we still ended up with a bust – a bust which Hayekians, with their superior model, saw coming.
The answer lies in the prescriptions. Keynes, with his cheap credit and shower of borrowed money, is a pleasant prospect. Indeed, Paul Krugman, one of the most uncompromising modern Keynesians, believes that “Ending the depression should be incredibly easy”, all we need is cheaper credit and more borrowing. Just, in fact, what we had going into the crisis.
Hayek, on the other hand, offers a more painful prospect. As his mentor Ludwig von Mises put it:      
“There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved”
Which of these vistas would you prefer to gaze upon?
But these theories should be judged not on how warm and fuzzy they make us feel but on how accurate they are. On that score Hayek wins hands down yet some still cling doggedly to Keynes. It’s for the same reason the aunt who gives you chocolates is preferred to the aunt who makes you do your homework. 

The Unholy Alliance of John Maynard Keynes

Perhaps the greatest modern champion of central economic planning was the 20th century English economist John Maynard Keynes. Keynes, who was a political socialist and for a time a central banker, advocated the idea that the government should play a large, active role in the economy. Among the consequences of Keynes’ economic theories, whether intended or unintended, is the fact that Western economies today are characterized by large, central governments, central banks and massive debts.

Leviathan the sea-monster, with Behemoth the land-monster and Ziz the air-monster.

According to Dr. Andrew Gelman, Professor of Statistics and Political Science at Columbia University, “the law of unintended consequences is what happens when a simple system tries to regulate a complex system. The political system is simple. It operates with limited information (rational ignorance), short time horizons, low feedback, and poor and misaligned incentives. Society, in contrast, is a complex, evolving, high-feedback, incentive-driven system. When a simple system tries to regulate a complex system you often get unintended consequences.” Professor Gelman’s statement seems equally apropos to central banking.
Government policies based on Keynesian theories and the institution of central banking form a nexus of central economic planning. Control of the central planning process is a winner-take-all proposition for businesses. In the U.S., the result is an unholy alliance of the U.S. federal government, the Federal Reserve (along with the largest U.S. banks) and the largest U.S. corporations. The logical chain beginning with Keynes’ fundamental idea that government, supported by a central bank, should play a large and active role in the economy sets the stage for a centrally planned economy and ultimately produces a corporate state.
The U.S. economy is locked in a downward spiral of economic decline. By growing in size, and by engaging in ever larger economic interventions, the U.S. federal government became itself a material cause of the recession that began in 2007. By attempting to grow the economy through monetary expansion, i.e., consumer spending fueled by debt, the Federal Reserve destroyed savings and fueled a series of disastrous economic bubbles, culminating in the housing bubble. At the same time, the largest U.S. banks engaged in reckless lending and high-stakes gambling on hundreds of trillions in over the counter (OTC) derivatives. OTC derivatives, which amount to risky, largely un-backed wagers, were the root cause of the “too big to fail” doctrine that has virtually bankrupted Western governments since 2008. By seeking ever greater influence over Washington D.C. and by seeking to generate higher profits by cutting production in the U.S., the largest U.S. corporations undermined the U.S. market and economy. The U.S. federal government did virtually nothing to prevent the destructive developments because of the influence of the largest U.S. corporations.
Following Keynesian economic theories, the policy response of the U.S. federal government to the recession that began in 2007 and of the financial crisis that began in 2008 was to expand the government further and at a more rapid pace. In other words, some of the root causes of the economic imbalances that lead to the recession and financial crisis (the relative size of the government and the resulting economic distortions) were compounded. As a consequence, the so-called “double dip recession” in the U.S. that began in the second half of 2011 will be longer and ultimately more severe than the economic downturn of 2007-2009.

The Baltic Dry Index (BDI) indicates international shipping returning to crisis levels. Since the U.S. is the world’s largest economy and has a large trade deficit, the BDI suggests that the U.S. is in a recession.

Keynes and Leviathan: The Size of the State

Originally a sea monster referred to in the Bible and, in demonology, one of the seven princes of Hell, as well as its gatekeeper, the name Leviathan was adopted by the English philosopher Thomas Hobbes to refer to an artificial political order, i.e., to the institution of the state. Hobbes was concerned with the distinction between individual rights and the powers of sovereign governments and he elaborated the idea of the social contract. When a government taxes its citizens, it implicitly asserts the right of the government over the property rights of individuals and presupposes that the government can make better use of economic resources than households, individual entrepreneurs, businesses and private investors.
In theory, the government’s use of economic resources accomplishes goals that privately owned businesses cannot, such as national defense or emergency response services, i.e., things that, by their nature, are not economically productive or profitable but still necessary for society. In contrast, embarking upon idealistic projects such as “creating jobs” or “expanding home ownership” encroaches on the productive elements of the economy. However, governments are inefficient compared to privately owned businesses due to the absence of competition. Further, the record of history suggests an inability on the part of central planners to make superior economic decisions.

Leviathan or The Matter, Forme and Power of a Common Wealth Ecclesiasticall and Civil by Thomas Hobbes (1588–1679)

Government encroachment on the private sector, like a self fulfilling prophecy, often magnifies the reasons why government intervention was originally believed to be necessary. For example, when the U.S. federal government became involved in education through federally guaranteed student loans, the result was that the cost of a college education rose towards the limit of what students could borrow and repay during their careers simply because the loans were guaranteed by the government. The guarantees produced more and riskier loans, larger loans and higher education costs.
When the U.S. federal government promoted home ownership for minorities and the poor, mortgage loan guarantees resulted in higher home prices and contributed to the sub-prime lending debacle where banks originated loans to unqualified borrowers in order to sell them to government sponsored entities (GSEs), i.e., to Fannie Mae and Freddie Mac, and to investors as collateralized debt obligations (CDOs) and other mortgage backed securities (MBS).
Banks were certainly to blame for knowingly making bad loans, which is fraud, but the conditions that made the problem possible existed substantially because of government intervention in the housing market, i.e., opening the door to fraud was an unintended consequence of policies intended to increase lending to unqualified, low income borrowers. Of course, the U.S. federal government did not compel lenders to commit fraud, thus accountability for the U.S. mortgage disaster is shared by the federal government, which interfered with the free market, pursued misguided policies and failed in terms of regulatory oversight and law enforcement, and by banks, which engaged in widespread mortgage related fraud.
Governments redistribute wealth and manipulate economic activity through taxes, subsidies, guarantees, regulations and so forth, but they do not produce new wealth. Government spending may be for good purposes, or at least stem from good intentions, but it unavoidably favors businesses with close ties to the government over those that are taxed but that do not benefit. Despite the theoretically higher moral purposes of lofty government undertakings, government programs that overlap the private sector divert economic resources to businesses that have the favor of politicians minus the cost of government, thus producing economic distortions and a net loss of wealth for society.
The Rahn curve is an economic theory proposing that there is an optimal level of government spending, 15% to 25% of gross domestic product (GDP), to maximize economic growth.

As the government grows larger, economic growth is curtailed and, eventually, the economy contracts, crushed under the burden of government.

As the government grows in size relative to the economy, not only is economic growth compromised, but the potential for, and the cost of, government waste, fraud and abuse increases.

How the Government Destroys Jobs

While politicians extol the theoretical benefits of ever more government control of the economy, e.g., through increased regulation, from the standpoint of individual entrepreneurs, businesses and private investors, the government is a nuisance, an impediment to wealth creation, and the source of countless costs and risks. The larger the government becomes relative to the size of the economy, the more it tends to discourage economic activity. Although roughly 70% of U.S. jobs are created by small businesses, ranging from family owned businesses to high technology startups, the burden of government falls disproportionately on them because they have fewer resources with which to administer and to demonstrate compliance with government regulations.

Picture from the Franklin D. Roosevelt Library, courtesy of the National Archives and Records Administration.

When large companies are audited or investigated by any of several government agencies, their accounting, legal and compliance departments are well equipped to deal with such matters. However, when a small company faces the same hurdles or seeks government permits, licenses or certifications, its operations are directly impacted and the associated accounting, legal and regulatory compliance costs can cause the business to lose money or to fail. In the event of an audit or investigation, small business owners in the U.S. generally seek to comply immediately and often pay fines or penalties without contest in order to end the government’s interference. While large companies can afford to dispute the government, small businesses face the equivalent of extortion.
As a practical matter, small businesses in the U.S. are permitted to operate at the sole discretion of government bureaucrats that can effectively shut down small businesses without any evidence of wrongdoing. Setting aside the fact that small business owners live in constant and well justified fear of their own government, the result is a stifling of economic activity and a net loss of jobs. For example, traditional small businesses in the U.S., i.e., sole proprietorships, increasingly avoid hiring employees.

Free market competition and the inherent uncertainty of economic conditions provide ample risk for startup businesses. A disproportionately large government relative to the size of the economy damages economic activity and discourages investment in new businesses. The aggregate overhead of government regulations and regulatory compliance, along with taxes and potential penalties, e.g., the 2010 Patient Protection and Affordable Care Act (“Obamacare”), increases business costs, amplifies business risks and further increases the burden of regulatory compliance. The result of systematically increasing the costs and risks of doing business—in lock step with the size of government—is to reduce the rate of business formation and to encourage investors to look elsewhere to find returns.

If the U.S. government, currently almost 45% of GDP, desired to create jobs, the correct policy would be to greatly reduce the countless regulations, taxes and fees that encumber small businesses. The path to job creation is for the government to reduce job destruction. Since no political will to reduce the size of the government exists, however, continued shrinking real GDP and permanent workforce reduction can be expected.

Keynes and Ziz: Money Out of Thin Air

Ziz, the beast of the air, is a giant griffin-like bird in Jewish mythology large enough to blot out the sun with its wingspan. Central banks, such as the Federal Reserve, are examples of central economic planning, i.e., they control the money supply and exercise centralized control over the value and cost of money through interest rates, bank reserve ratios, monetary inflation and by other means. In contrast to the government’s central planning for the putative public good, the Federal Reserve engages in central planning for the benefit of banks. Like the U.S. federal government, the Federal Reserve, through monetary mechanisms, distorts spending and investment patterns, redistributes wealth and preempts the financial and economic decisions of households, individual entrepreneurs, businesses and private investors.
When a central bank increases the money supply beyond the level necessary to support a sustainable economy or population growth, it destroys the value of savings and wages by diluting the value of money and causing prices to rise. Wall Street embraces the Federal Reserve because easy monetary policies provide an inexpensive way to finance operations and to expand, but there is a cost. Inflationary monetary policies favor speculators over savers and debt over genuine capital formation.

The Bank of England, established 1694 (also known as The Old Lady of Threadneedle Street)

Banks do not create wealth. The structure of the financial system, where debt-based money is created ex nihilo, virtually guarantees banks a piece of the action whenever wealth is created. When debt service (principal and interest payments) is attached to the income streams of consumers and businesses, excess production is diverted from capital formation into the coffers of banks. The Federal Reserve, therefore, is at the core of a system where, over time, wealth accrues to banks while capital formation is reduced, ironically increasing the need to borrow. The majority of entrepreneurs and businesses have little choice but to borrow and, even if they are successful, the economy as a whole may still suffer due to increased debt levels relative to GDP.
Keynesians embrace the Federal Reserve’s un-backed, fiat money because it permits the government to borrow and spend freely based on the theory that stimulating the economy through deficit spending produces economic growth at a faster pace than debt accumulates. However, as a function of debt service, the number of dollars that must be borrowed and spent to generate each new dollar of GDP becomes larger as the total amount of debt grows.

The result is debt saturation where further debt funded increases in GDP are impossible and where, therefore, existing government debt cannot be retired, i.e., the result of Keynes’ theory, taken to an extreme, is government insolvency and sovereign default. Default, of course, can take the form of monetary inflation in order to debase the currency and reduce the real value of debt, e.g., the Federal Reserve’s monetary easing and continued accommodative monetary policy.

Keynes and Behemoth: The Corporatocracy

Behemoth is a mythological beast of the land mentioned in the Book of Job (40:15-24) that has come to describe any extremely large or powerful entity. The U.S. economy is anything but a free market today. In fact, the U.S. government increasingly resembles an oligarchy in which the oligarchs are large corporations, i.e., a “corporatocracy”. Thus, the illegitimate offspring of the grand government envisaged by Keynes and the institution of central banking is a corporate state.
Without a large government, businesses have little incentive to influence it, but with the government (local, state and federal) representing nearly half of the U.S. economy, influencing the government is a mission-critical objective for every company. The size of government implied by Keynesian economics provides motive and opportunity but only the largest corporations have the means to succeed.

Obama		Romney
Citigroup Inc	$736,771	Citigroup Inc	$57,050
Columbia University	$547,852	Bain & Co	$52,500
General Electric	$529,855	Bain Capital	$74,500
Goldman Sachs	$1,013,091	Goldman Sachs	$367,200
Google Inc	$814,540	Bank of America	$126,500
Harvard University	$878,164	Barclays	$157,750
IBM Corp	$532,372	Blackstone Group	$59,800
JPMorgan Chase & Co	$808,799	JPMorgan Chase & Co	$112,250
Latham & Watkins	$503,295	Credit Suisse Group	$203,750
Microsoft Corp	$852,167	EMC Corp	$117,300
Morgan Stanley	$512,232	Morgan Stanley	$199,800
National Amusements Inc	$563,798	HIG Capital	$186,500
Sidley Austin LLP	$600,298	Kirkland & Ellis	$132,100
Skadden, Arps et al	$543,539	Marriott International	$79,837
Stanford University	$595,716	PriceWaterhouseCoopers	$118,250
Time Warner	$624,618	Sullivan & Cromwell	$79,250
UBS AG	$532,674	UBS AG	$73,750
University of California	$1,648,685	The Villages	$97,500
US Government	$513,308	Vivint Inc	$80,750
WilmerHale LLP	$550,668	Wells Fargo	$61,500
Total Primary Dealers:	$3,603,567	Total Primary Dealers:	$810,050
Political campaign contributions indicating U.S. Federal Reserve Primary Dealers (Source: opensecrets.org)

The goals of businesses seeking to influence the government include winning government business, mandating consumption of products and services (from child car seats to health insurance), avoiding taxes, guaranteeing profits, creating regulatory loopholes, protecting markets, eliminating competition, socializing losses and so forth.
The influence of Wall Street over Washington D.C. through political campaign contributions, corporate lobbyists and revolving doors (where the same individuals alternate between closely linked private sector jobs and government posts) is almost absolute. Lobbyists are intimately involved in writing legislation that is often rubberstamped by the U.S. Congress, i.e., passed without reading or meaningful debate. The largest corporations support political candidates through campaign contributions and by funding political action committees that, among other things, use corporate public relations tools for political purposes, i.e., propaganda. Key government posts are consistently held by individuals with clear conflicts of interest and the existence of such conflicts is routinely ignored.
The current reality of the United States is that the largest corporations have hijacked the Keynesian central planning powers of the federal government and have used these powers to encourage ever larger and more direct interventions in the economy for their own benefit, as well as laws and regulations that serve as a barrier to free market competition. U.S. regulators, such as the Securities and Exchange Commission (SEC), Commodities and Futures Trading Commission (CFTC) and the Food and Drug Administration (FDA) appear to have been captured by the industries they are intended to regulate. Government regulators selectively enforce regulations, often against small businesses and growing companies, such as organic dairy farmers, protecting the interests of the largest corporations from small businesses, free market competition and consumer choice.

The largest U.S. corporations (including oil companies like ExxonMobil and Chevron; drug companies like Johnson & Johnson, Pfizer and GlaxoSmithKline; agribusiness companies like Archer Daniels Midland, which are heavily subsidized by the U.S. federal government; agricultural biotechnology companies like Monsanto; military contractors like Lockheed Martin, Northrop Grumman, Boeing, Raytheon and General Dynamics; and banks like Bank of America, J. P. Morgan Chase, Citigroup, Wells Fargo, Goldman Sachs and Morgan Stanley) have not only been the beneficiaries of government expansion, deficit spending and central economic planning, but, considering political campaign funding practices, have become the de facto oligarchs of America.

Leviathan, Ziz, Behemoth and Keynes

The decline of the U.S. economy is the logical outcome of Keynesian economics, which enshrines central economic planning and embraces central banking. The unholy alliance of Leviathan, Ziz and Behemoth (the federal government, the Federal Reserve and Wall Street) has all but eliminated capitalism and has transformed the United States from a burgeoning free market economy into a failing corporate state.
The U.S. federal government, the Federal Reserve and Wall Street each played a role in the progression from central economic planning and central banking to a corporate state. Politicians used Keynesian economics to justify big government, a welfare state and budget deficits. The Federal Reserve sought to grow the economy through monetary expansion, focusing on consumption but ignoring debt levels and inadvertently encouraging financial speculation. At the same time, Wall Street sought higher profits both by eliminating production (and jobs) in the U.S. and by sparing no expense to influence the government. The resulting corporate state undermined capitalism and the free market in the United States and produced a downward spiral of economic decline from which there is no escape without fundamental reforms.