Wednesday, January 12, 2011

Could the U.S. central bank go broke?

(Reuters) - The U.S. Federal Reserve's journey to the outer limits of monetary policy is raising concerns about how hard it will be to withdraw trillions of dollars in stimulus from the banking system when the time is right.

While that day seems distant now, some economists and market analysts have even begun pondering the unthinkable: could the vaunted Fed, the world's most powerful central bank, become insolvent?

Almost by definition, the answer is no.

As the monetary authority, the central bank is the master of the printing press. It can literally conjure up money at will, and arguably did exactly that when it bought about $2 trillion of mortgage-backed securities and U.S. Treasuries to push down borrowing costs and boost the economy.

The Fed's unorthodox steps helped it generate record profits in 2010, allowing it to send $78.4 billion to the U.S. Treasury Department. But its swollen balance sheet leaves the central bank unusually exposed to possible credit losses that could create a major headache at a time of increasing political encroachment on the Fed's independence.

Asked about the issue of potential losses during congressional testimony on Friday, Fed Chairman Ben Bernanke suggested the risks were minimal. If liabilities on the Fed's balance sheet were to exceed its assets, it would only be so because of rising interest rates in the context of a thriving economy, he suggested.

"Under a scenario in which short-term interest rates rise very significantly, it's possible that there might come a period where we don't remit anything to the Treasury for a couple of years. That would be I think a worst-case scenario," Bernanke said. Customarily, the Fed submits surplus profits from its operations back to the Treasury's coffers.

But the Fed's newfangled policy steps and the potential for credit losses raises, for some experts, the prospect that the Treasury may actually be forced to "recapitalize" the Fed -- economist-speak for what others might call a bail-out.

That would be a strange role reversal given the Fed's efforts to ease monetary policy by buying the Treasury's debt, and it could raise a political firestorm from lawmakers who believed all along the Fed was putting taxpayer money at risk.


Varadarajan Chari, an economics professor at the University of Minnesota and a consultant to the Minneapolis Fed, says that at some point during its exit from easy monetary policies, the Fed actually may go broke -- at least on paper.

"The most obvious exit strategy is, when inflation starts to pick up, to stop and reverse asset purchases," he said. "That's likely to include requiring the Fed in an accounting sense to see a significant accounting loss."

The Fed now holds just over $1 trillion in Treasuries, Chari noted, and if inflation rose by a couple of percentage points, it would dent the value of those holdings by about 10 percent, leaving the Fed with a $100 billion loss.

"I'm sure it will have some negative political fallout," Chari said. "But not economic consequences. Their ability to print money means it (insolvency) doesn't mean anything."

Many economists argue that the potential cost to the taxpayer from the Fed's policies is far smaller than the threat of a prolonged period of economic stagnation that would result from a less proactive approach.

Ohio Judge Follows JPMorgan Chase’s Advice, Ends up in Foreclosure

I have to tell you… I’ve been waiting for this to happen.

Ohio Judge Peter Sikora was looking to take advantage of the lowest mortgage interest rates in decades and refinance his eight-bedroom, lakefront Cleveland home, so he contacted his bank, JPMorgan Chase. With property values in decline in Cleveland, Chase said no to refinancing but told the judge to apply for a loan modification instead. The judge followed JPMorgan Chase’s advice to the letter and as a result has fallen a year behind on his nearly $1 million mortgage… hasn’t paid his property taxes… and now has ended up in foreclosure.

So, all I can think of to say is… don’t you just hate these irresponsible sub-prime borrowers who should never have been allowed to buy their homes in the first place and now think they’re entitled to loan modifications? I know I sure do. Maybe if the judge had called a scammer and paid an up front fee… he would have gotten his loan modified… no, wait… that’s not right… maybe if he had called a lawyer he would have… wait, no… he is a lawyer, right. Well, maybe if he… oh wait, I know… MAYBE IF HE HAD NOT BELIEVED THE LIES TOLD BY JPMORGAN CHASE… yeah, that’s sure as shootin’ where he went wrong.

According to a story in the Cleveland Plain Dealer, that I’m betting mysteriously isn’t going to get a lot of national attention…

“The bank advised me that the only way they would consider a loan modification would be if I fell behind on my payments,” said Sikora, 59, a judge since 1989. “I took their advice and put the money aside.”

'Our savings have vanished – we've lost everything'

Angry investors take to streets as Dhaka's stock exchange crashes. Andrew Buncombe reports

Police in Bangladesh used tear gas and water canons to disperse angry protests by crowds of small investors after a dramatic free-fall plunge on the country's stock market caused the authorities to suspend trading.

Hundreds of outraged investors took to the streets outside the stock exchange in the Motijheel neighbourhood of the nation's capital after the worst plunge in the country's history saw the Dhaka Stock Exchange (DSE) fall by 660 points, or 9.25 per cent, in less than an hour.

Chanting slogans that accused brokers and traders of manipulating stock prices and of the government of failing to properly regulate the situation, the small-scale investors smashed up cars, burned tyres and ran loose until police stepped in to break them up. There were other protests in smaller cities and towns. Four journalists were reportedly beaten by police.

Last night, with trading due to restart later today in both Dhaka and the country's second city, Chittagong, Bangladesh's prime minister, Sheikh Hasina, met with senior financial officials including the governor of the central bank, and ordered them to take steps to try and ease the crisis. The Securities and Exchange Commission (SEC), after an emergency meeting with the central bank, said trading – which was halted yesterday after just an hour – could resume.

But the crisis that began on Sunday, when the DSE's bench mark Dhaka Stock Exchange general index (DGEN) fell by almost 8 per cent, has long been smouldering. Last month there were similar demonstrations to those yesterday when the market fell by around 7 per cent, triggering panic among investors. Since early December, the index – which had climbed by more than 80 per cent in 2010 – has fallen by 27 per cent.

The problem, say experts, is that the booming stock market had in recent years become deeply overvalued, something that had been ignored as investors enjoyed massive gains. Amid demands that it act to address the situation, the authorities had recently taken a series of steps to limit the percentage of deposits that banks can invest in the market and cool the situation. As a result, many larger, institutional investors decided to withdraw from the market, a move that set off the hysteria.

"This was coming – it was only a matter of when it would take place," said Mustafizur Rahman of the Centre for Policy Dialogue, a Dhaka-based think-tank. "The market had been heating up for quite a time, particularly over the last year. There was too much money chasing too few shares... This is a correction."

Observers say that many of those taking to the streets yesterday were among more than 3 million new, small-sized investors who had been attracted to the stock market in the last few years. Keen to cash in on the heated-up market, they had placed their money in shares rather than putting it in traditional bank deposits or savings accounts.

Many of these so-called retail investors may have had little investment expertise or knowledge about the companies in which they were putting their money. "They thought this would be a way for them to raise some capital from the markets," said Professor Arindam Banik of Delhi's International Management Institute.

But when the markets started to collapse, countless numbers of smaller investors were left ruing their decision to invest in stocks. "I poured all my money into the Dhaka stock exchange," investor Humayum Kabir, who had lost 60 per cent of his family's 2.5m taka (£22,000) in savings, told the Agence France-Presse. "The finance minister lured us into the stock market, he told us it was safe, but now we have lost everything. They artificially jacked up the prices of junk shares and now our savings have vanished."

The instability is the last thing needed by Bangladesh and Mrs Hasina's Awami League-led government. Even though the country's economy is growing by around 6 per cent, inflation is booming, especially the price of food and basic essentials. The country is also still recovering from political turmoil; last month Bangladesh came to a halt after the main opposition party, the Bangladesh National Party, headed by former prime minister Khaleda Zia, called a national strike. The dispute was essentially triggered by a decision to evict her from a grace-and-favour house in the centre of Dhaka but the incident took on national ramifications when the country's businesses and offices were forced to close.

The DSE, which was first incorporated in 1954 when the country was still part of Pakistan, is tiny compared to other regional or global markets. But the stock market is made up almost entirely of local investors with just 1 per cent of domestic shares being held by foreigners. The impact of a further collapse could have terrible consequences for a country of 160 million people already struggling with huge social, economic and environmental problems.

Last night, as they prepared for trading to restart, officials in Bangladesh were hoping that investors would not panic further and trigger a further collapse similar to that in 1996 when almost 80 per cent was wiped from share prices. Yeasin Ali, deputy head of the SEC, told reporters in Dhaka: "We are calling for people to be calm – if the market crashes again it could cause a crisis in the broader economy."

* Laos, one of the last remaining communist states in the world, will today open its first stock exchange in an attempt to boost its economy. In recent years, the country has struggled to attract the increased inward investment enjoyed by its more economically liberal neighbours.

The Lao Securities Exchange, based in the capital Vientiane, will initially offer shares in just two companies, Electricité du Laos Generation Company (EDL), the country's major energy enterprise, and the Banque Pour Le Commerce Exterieur Lao. There are expected to be restrictions on foreign investment.

Innocents Betrayed - The History of Gun Control PT 1

Mazel Tov: American Jews Arm Themselves

Algorithms Take Control of Wall Street

Wall Street Algorithms Are in Control

Today Wall Street is ruled by thousands of little algorithms, and they've created a new market—volatile, unpredictable, and impossible for humans to comprehend.
Photo: Mauricio Alejo

Last spring, Dow Jones launched a new service called Lexicon, which sends real-time financial news to professional investors. This in itself is not surprising. The company behind The Wall Street Journal and Dow Jones Newswires made its name by publishing the kind of news that moves the stock market. But many of the professional investors subscribing to Lexicon aren’t human—they’re algorithms, the lines of code that govern an increasing amount of global trading activity—and they don’t read news the way humans do. They don’t need their information delivered in the form of a story or even in sentences. They just want data—the hard, actionable information that those words represent.

Lexicon packages the news in a way that its robo-clients can understand. It scans every Dow Jones story in real time, looking for textual clues that might indicate how investors should feel about a stock. It then sends that information in machine-readable form to its algorithmic subscribers, which can parse it further, using the resulting data to inform their own investing decisions. Lexicon has helped automate the process of reading the news, drawing insight from it, and using that information to buy or sell a stock. The machines aren’t there just to crunch numbers anymore; they’re now making the decisions.


An app that jams with you.

A good session player is hard to find, but ujam is always ready to rock. The Web app doubles as a studio band and a recording studio. It analyzes a melody and then produces sophisticated harmonies, bass lines, drum tracks, horn parts, and more.

Before ujam’s AI can lay down accompaniment, it must figure out which notes the user is singing or playing. Once it recognizes them, the algorithm searches for chords to match the tune, using a mix of statistical techniques and hardwired musical rules. The stats are part of the software’s AI and can generate myriad chord progressions. The rules-based module then uses its knowledge of Western musical tropes to narrow the chord options to a single selection.

The service is still in alpha, but it has attracted 2,500 testers who want to use the AI to explore their musical creativity—and they have the recordings to prove it. As ujam gathers more data on users’ preferences and musical tastes, programmers feed this info back into the system, improving its on-the-fly performance. In this respect at least, ujam is like a human: It gets better with practice.
—Jon Stokes

That increasingly describes the entire financial system. Over the past decade, algorithmic trading has overtaken the industry. From the single desk of a startup hedge fund to the gilded halls of Goldman Sachs, computer code is now responsible for most of the activity on Wall Street. (By some estimates, computer-aided high-frequency trading now accounts for about 70 percent of total trade volume.) Increasingly, the market’s ups and downs are determined not by traders competing to see who has the best information or sharpest business mind but by algorithms feverishly scanning for faint signals of potential profit.

Algorithms have become so ingrained in our financial system that the markets could not operate without them. At the most basic level, computers help prospective buyers and sellers of stocks find one another—without the bother of screaming middlemen or their commissions. High-frequency traders, sometimes called flash traders, buy and sell thousands of shares every second, executing deals so quickly, and on such a massive scale, that they can win or lose a fortune if the price of a stock fluctuates by even a few cents. Other algorithms are slower but more sophisticated, analyzing earning statements, stock performance, and newsfeeds to find attractive investments that others may have missed. The result is a system that is more efficient, faster, and smarter than any human.

It is also harder to understand, predict, and regulate. Algorithms, like most human traders, tend to follow a fairly simple set of rules. But they also respond instantly to ever-shifting market conditions, taking into account thousands or millions of data points every second. And each trade produces new data points, creating a kind of conversation in which machines respond in rapid-fire succession to one another’s actions. At its best, this system represents an efficient and intelligent capital allocation machine, a market ruled by precision and mathematics rather than emotion and fallible judgment.

But at its worst, it is an inscrutable and uncontrollable feedback loop. Individually, these algorithms may be easy to control but when they interact they can create unexpected behaviors—a conversation that can overwhelm the system it was built to navigate. On May 6, 2010, the Dow Jones Industrial Average inexplicably experienced a series of drops that came to be known as the flash crash, at one point shedding some 573 points in five minutes. Less than five months later, Progress Energy, a North Carolina utility, watched helplessly as its share price fell 90 percent. Also in late September, Apple shares dropped nearly 4 percent in just 30 seconds, before recovering a few minutes later.

These sudden drops are now routine, and it’s often impossible to determine what caused them. But most observers pin the blame on the legions of powerful, superfast trading algorithms—simple instructions that interact to create a market that is incomprehensible to the human mind and impossible to predict.

For better or worse, the computers are now in control.

Ironically enough, the notion of using algorithms as trading tools was born as a way of empowering traders. Before the age of electronic trading, large institutional investors used their size and connections to wrangle better terms from the human middlemen that executed buy and sell orders. “We were not getting the same access to capital,” says Harold Bradley, former head of American Century Ventures, a division of a midsize Kansas City investment firm. “So I had to change the rules.”

Bradley was among the first traders to explore the power of algorithms in the late ’90s, creating approaches to investing that favored brains over access. It took him nearly three years to build his stock-scoring program. First he created a neural network, painstakingly training it to emulate his thinking—to recognize the combination of factors that his instincts and experience told him were indicative of a significant move in a stock’s price.

But Bradley didn’t just want to build a machine that would think the same way he did. He wanted his algorithmically derived system to look at stocks in a fundamentally different—and smarter—way than humans ever could. So in 2000, Bradley assembled a team of engineers to determine which characteristics were most predictive of a stock’s performance. They identified a number of variables—traditional measurements like earnings growth as well as more technical factors. Altogether, Bradley came up with seven key factors, including the judgment of his neural network, that he thought might be useful in predicting a portfolio’s performance.

He then tried to determine the proper weighting of each characteristic, using a publicly available program from UC Berkeley called the differential evolution optimizer. Bradley started with random weightings—perhaps earnings growth would be given twice the weight of revenue growth, for example. Then the program looked at the best-performing stocks at a given point in time. It then picked 10 of those stocks at random and looked at historical data to see how well the weights predicted their actual performance. Next the computer would go back and do the same thing all over again—with a slightly different starting date or a different starting group of stocks. For each weighting, the test would be run thousands of times to get a thorough sense of how those stocks performed. Then the weighting would be changed and the whole process would run all over again. Eventually, Bradley’s team collected performance data for thousands of weightings.

Once this process was complete, Bradley collected the 10 best-performing weightings and ran them once again through the differential evolution optimizer. The optimizer then mated those weightings—combining them to create 100 or so offspring weightings. Those weightings were tested, and the 10 best were mated again to produce another 100 third-generation offspring. (The program also introduced occasional mutations and randomness, on the off chance that one of them might produce an accidental genius.) After dozens of generations, Bradley’s team discovered ideal weightings. (In 2007, Bradley left to manage the Kauffman Foundation’s $1.8 billion investment fund and says he can no longer discuss his program’s performance.)

Bradley’s effort was just the beginning. Before long, investors and portfolio managers began to tap the world’s premier math, science, and engineering schools for talent. These academics brought to trading desks sophisticated knowledge of AI methods from computer science and statistics.

And they started applying those methods to every aspect of the financial industry. Some built algorithms to perform the familiar function of discovering, buying, and selling individual stocks (a practice known as proprietary, or “prop,” trading). Others devised algorithms to help brokers execute large trades—massive buy or sell orders that take a while to go through and that become vulnerable to price manipulation if other traders sniff them out before they’re completed. These algorithms break up and optimize those orders to conceal them from the rest of the market. (This, confusingly enough, is known as algorithmic trading.) Still others are used to crack those codes, to discover the massive orders that other quants are trying to conceal. (This is called predatory trading.)

« Dylan Ratigan: Capitalism is broken »

We'll start with this clip from Oct. 2008, right in the heart of the crisis, which I just found this morning.

What we have in this country is subsidized corporate communism...


RATIGAN: "We have a broken system right now."

JOE SCARBOROUGH: "It's a money party."

RATIGAN: "It's more than that. We allowed excess risk-taking. We allowed total detachment of checks and balances of capitalism. Capitalism is broken."

SCARBOROUGH: "Capitalism as practiced in republican Washington over the past eight years--"

RATIGAN: "Busted. Terrible."

SCARBOROUGH: "--is not capitalism."


Next a clip from last year...

Video - Ratigan on corporate communism...

"$24 Trillion Of National Capital Is Being Sucked Into A Failed Banking System"


First 30 seconds are health care, then it's banking and the bailouts.

  • "The beneficiaries of an ongoing $24 trillion taxpayer-funded bailout...$24 trillion dollars."
  • "That is national capital that is being sucked into a broken banking system at the expense of the rest of our country. They continue to use "Too Big To Fail" as blackmail to the taxpayer in order to get us to provide capital to them."
  • "It is a system that takes resources from the citizenry and redistributes it to a tiny elite."
  • "A handful of weak, un-competitive, outdated companies and industries are purchasing control of the American political system in order to stay in business using their cronyism.
  • "It is coming at the direct expense of the rest of us in this nation. And it's a total betrayal of everything that represents America."


Read Dylan's Accompanying editorial...

The Cost Of Corporate Communism

Lately I have been using the phrase "Corporate Communism" on my television show. I think it is an especially fitting term when discussing the current landscape in both our banking and health care systems.

As Americans, I believe we reject communism because it historically has allowed a tiny group of people to consolidate complete control over national resources (including people), in the process stifling competition, freedom and choice. It leaves its citizens stagnating under the perpetual broken systems with no natural motivation to innovate, improve services or reduce costs.

Lack of choice, lazy, unresponsive customer service, a culture of exploitation and a small powerbase formed by cronyism and nepotism are the hallmarks of a communist system that steals from its citizenry and a major reason why America spent half a century fighting a Cold War with the U.S.S.R.

And yet today we find ourselves as a country in two distinctly different categories: those who are forced to compete tooth and nail each day to provide value to society in return for income for ourselves and our families and those who would instead use our lawmaking apparatus to help themselves to our tax money and/or to protect themselves from true competition.

If you allow weak, outdated players to take control of the government and change the rules so they are protected from the natural competition and reward systems that have created so many innovations in our country, you not only steal from the citizens on behalf of the least worthy but you also doom them by trapping the capital that would be used to generate new innovation and, most tangibly in our current situation, jobs.

We are losing the opportunity cost of all the great ideas that should be coming from the proper deployment of that 23.7 trillion in capital. Everything from innovation in medical delivery systems to accessible space travel, free energy to the driverless car; all of these things may never come to bear because those powerful individuals who have failed, been passed over by technological advancements, innovation and flat-out smarts, have commandeered our government to unfairly sustain their wealth and power.

Unfortunately, they use our wealth and laws not only to benefit their outdated, failed companies, but also spend a small pittance of their ill-gotten gains lobbying and favor-trading with politicians so the government will continue to protect them from competition and their well-deserved failure.

The massive spike in unemployment, the utter destruction of retirement wealth, the collapse in the value of our homes, the worst recession since the Great Depression have all resulted directly from the abdication of proper government.

Even with all that -- the only changes that have been made, have been made to prop up and hide the massive flaws on behalf of those who perpetuated them. Still utterly nothing has been done to disclose the flaws in this system, improve it or rebuild it. Only true rules-based capitalism ensures constant adaptation and implementation of the latest and best practices for a given business, as those businesses that don't adapt fail, and those who deploy the latest innovations to their customers benefit, prosper.

The concept of communism is rightly reviled in this country for the simple reason that it is blind to human nature, allowing a small group of individuals near-total control, while sticking everyone else with the same crappy systems -- and the bill. America spent countless lives and half a century fighting against this system of government. So why are we standing for it now?

« Willem Buiter Warns Sovereign Default Fears Will Spread To U.S. & Japan: "There Is No Place For Anyone To Hide" »

Buiter is chief economist for Citigroup and a former UK Central Banker, who is keen on picking fights with Bernanke and the U.S. Federal Reserve, including a brilliant attack at Jackson Hole in 2008 which is detailed inside.


Source - UK Telegraph

Citigroup's Willem Buiter: an economist worth listening to

The Dutch-born scholar, a professor of political economy at the London School of Economics and former Bank of England Monetary Policy member, has never been afraid to speak his mind – even about past and present employers.

  • In 2008, Dr Buiter turned his fire on his hosts when the Fed invited him to its annual retreat in the Teton Mountains. “The Fed listens to Wall Street and believes what it hears,” he told an audience of central bank officials from the Fed and around the world. “This distortion into a partial and often highly distorted perception of reality is unhealthy and dangerous.”
  • Fed Governor Frederic Mishkin said at the same event that Buiter’s paper fired “a lot of unguided missiles,” and former Vice Chairman Alan Blinder “respectfully disagreed” with his analysis of the central bank’s crisis management.

He has degrees from the University of Amsterdam and Cambridge University and a doctorate from Yale University. He has taught at Princeton University, the University of Bristol, the London School of Economics, Yale University and Cambridge University. He was chief economist for the European Bank for Reconstruction and Development from 2000 to 2005.


DB here. Now onto the story from today's Telegraph.

There are no safe sovereigns

Source - UK Telegraph

Fears about the finances of eurozone nations will spread around the world to engulf the US and Japan, former Bank of England policy maker Willem Buiter has warned.

Worries about the risk of a sovereign state defaulting on its debt, which thrust the eurozone into crisis, will soon encompass the two major economies as well, according to Citigroup economists led by Mr Buiter, who sat on the Bank's Monetary Policy Committee.

The team has published a note forecasting much more strife to come in the wake of Greece and Ireland's recent bail-outs and eurozone governments' borrowing costs hitting record highs.

  • "Despite the recent drama, we believe we have only seen the opening and second act, with the rest of the plot still evolving," the team wrote. "There is no absolutely safe sovereigns."
  • There are likely to be several sovereign debt restructurings in the next few years, the analysts said, with Portugal likely to need to access the emergency funding facilities soon.

Against this backdrop, the US and Japan - dubbed the "fiscal sustainability deniers" - cannot keep ignoring the question of how safe their public finances are, the team said.

The fears about default will encompass the two economies "before long", they argued - particularly if a default is defined not just as a failure to meet the debt contract, but also as inflicting severe losses on debt holders through deliberately-engineered inflation or weakening the currency.

  • "Both Japan and US public finances are unsustainable, in our view, and in the absence of credible and substantial fiscal tightening both would eventually face painful discipline through the markets," the economists wrote.
  • It is only a matter of time before the US will have to raise funds by issuing debt offering "significantly higher" returns to bondholders, to reflect the level of risk surrounding it, they added.


Buiter at CFR...

Video - Citigroup's Chief Economist Willem Buiter discusses the future of sovereign debt in the wake of the crisis in Greece - May 2010

  • "There is no place for any nation to hide."


Buiter on the future of banking...


Willem Buiter on Bernanke's QE2 gamble...

More detail on this clip is here, including transcribed quotes...

And this is also an excellent clip from...


China's J-20 Stealth fighter jet makes first test flight

« Gov. Schwarzenegger Says F*** You To California Legislature »

Source - Tech Crunch

California Governor Arnold Schwarzenegger sent this letter (with acrostic mesage) to members of the State General Assembly recently. No way this was an accident.

  • The Governator is claiming this is an accident, but I did a little junior sleuthing, and I have to say “probably not.” First there is the raw numbers. Now I am no number cruncher but it seems that once the first letter, "F" is picked the chances that the remaining letters would be those exact ones would be 1 in 30,8915,776 (multiply 26 by itself six times).

Way to go Arnie. Maybe he was trying to upstage State Treasurer Bill Lockyer's recent hilarious tirade about junk spending.

MUST SEE Video: California Treasurer Bill Lockyer eats his own kind...


Check out today's slideshow...

Heads up - Fans of women's swimming (and high-heel shoes) might want to make sure to see pic #4...


Banks given go-ahead to pay unlimited bonuses

Ministers cave in to City and reject calls to tackle highest earners as No 10 seeks face-saving deal

Ed Miliband
Ed Miliband said the latest government moves were, in effect, a tax cut for bankers. Photograph: Dominic Lipinski/PA

Britain's banks have been given the go-ahead to pay unlimited bonuses, drawing to a close a two-year political battle to rein in the City.

After months in which a series of government ministers of all parties have threatened a toughening in the stance over City bonuses, Downing Street said the government did not intend to intervene in the pay of the UK's top bankers.

Ministers are instead hoping for a face-saving deal in which the banks agree to lending targets and improve the way they disclose their pay deals. One of the options being discussed is releasing information on the five highest paid individuals at each bank.

"We've made a broad statement which is about the need to see some restraint and some responsibility from the banks, but we are not going to set bonus pools for individual banks," the prime minister's spokesman said.

Labour accused the government of capitulation and letting the bankers off the hook, urging the government to extend the bonus tax, which raised £3.5bn after it was introduced by Alistair Darling as a one-off measure in December 2009.

The coalition government replaced that bonus tax with an annual levy on balance sheets which is estimated to yield about £2.5bn a year. Ed Miliband, the Labour leader, said this was, in effect, a tax cut for bankers.

Ministers rejected Labour's proposal, preferring to work a compromise deal that would placate Vince Cable, the Liberal Democrat business secretary who has been pressing for tougher measures.

The government said an extension of the bonus tax would be self-defeating because bankers would become more skilled at avoiding the tax.

The levy, the Conservatives said, would raise more money in the medium term.

City sources were reassured by the government's milder stance ahead of the appearance of Bob Diamond, Barclays' new chief executive, before a potentially hostile Treasury select committee today.

The government's stance will be seen as a retreat from some of the aggressive rhetoric from the Liberal Democrats, but the government believes a hard-headed approach requires the government to focus on disclosure and measures that will improve lending, seen as the single most effective way of helping the British economy recover for recession.

Government sources said even if the government managed to get the size of bonus pools reduced by half from the expected total £7bn projected this year, there would be political flak, and it is better to focus government leverage on increasing net lending to business.

Government officials also pointed out the Financial Services Authority has already adopted European Union rules curbing bonuses. Measures include the mandatory deferral of parts of a bonus, retention of portions paid in shares and strict conditions on guaranteed bonuses. The overall aim, the government said, was to curb risky banking practices in the pursuit of higher bonuses.

Nevertheless, Nick Clegg, the deputy prime minister, again urged the bankers to be sensitive. "I totally accept that the kind of sky-high numbers that are bandied about in the City of London seem to come from a parallel universe to many people who are struggling to deal with increased costs and so on.

"But I think the key issue of principle is this: those people who are running the state-owned banks, who have benefited from immense generosity from British taxpayers, they have to be sensitive to what British taxpayers want."

The chancellor, George Osborne, will continue to seek an EU-wide deal on disclosure of pay bands above £1m, along the lines proposed by the City grandee Sir David Walker. He had initially proposed a UK-only deal before arguing international competition in banking required an EU-wide deal. It is possible Cable will get a more limited UK deal in the next fortnight, but there are concerns in parts of government that full-pay disclosure requirements will lead to inflationary pay pressures in banking as bankers realise how much their colleagues are being paid.

The banks may be forced to agree to publish deals of their highest five paid staff without identifying them – only HSBC does this at the moment, under the Hong Kong listing rules. Even so, this does not go as far as the proposals outlined by Walker, which Labour was planning to implement.

Arguing his bonus tax would raise more than the bank levy Miliband said today: "It cannot be right that, when workers face below-inflation pay increases, if they get any rise at all, and families see prices on the high street rising, senior bankers keep raking in bonuses that are more in one year than most people can earn in a lifetime."

He urged ministers to "take action", adding: "They should not get the scale of bonuses that is being talked about."

Miliband also came under pressure to say the Labour government had allowed public spending to get out of control, contributing to the country's record peace-time deficit. The Labour leader is expected to argue in coming weeks that the Labour government had been wrong not to state earlier in public that the banking crash required spending cuts to adjust to sudden and permanent loss in tax receipts. A Comres poll today showed Labour had opened up an an eight point lead over the Conservatives with Labour on 42 and the Conservatives on 34.

« Video: Saying Goodbye To The 'Governator' »

As Schwarzenegger departs public office after seven years, the most populous state in the United States is left with a $28bn hole in its coffers.

This is probably my favorite story from the Schwarzenegger era...


This clip explains California's spending problem rather succinctly...

Video: California Treasurer Bill Lockyer eats his own kind...


Related stories...


Exclusive: America has ‘reached the point of no return,’ Reagan budget director warns

The Obama administration's $78 billion cut to US defense spending is a mere "pin-prick" to a behemoth military-industrial complex that must drastically shrink for the good of the republic, a former Reagan administration budget director recently told Raw Story.

"It amounts to a failed opportunity to recognize that we are now at a historical inflection point at which the time has arrived for a classic post-war demobilization of the entire military establishment," David Stockman said in an exclusive interview.

"The Cold War is long over," he continued. "The wars of occupation are almost over and were complete failures -- Afghanistan and Iraq. The American empire is done. There are no real seriously armed enemies left in the world that can possibly justify an $800 billion national defense and security establishment, including Homeland Security."

Short of that, he suggested, the United States has "reached the point of no return" with its artificial creation of wealth, and will eventually face a sharp economic decline.

Stockman last fall criticized the extension of the Bush tax cuts while the federal government continued to borrow money abroad to pay for its public welfare and warfare programs. His solution to deficit spending -- a huge across-the-board tax increase -- is contrary to the current anti-tax ideology shared among tea party activists as well as fiscal conservatives in the Republican Party.

Stockman, who was appointed by President Ronald Reagan in 1981 to run the Office of Management and Budget, offered two models for the US military's compulsory demobilization: the one after World War I in 1920 and the one after World War II in 1946.

Calling today's military spending running at 5.4 percent of GDP "simply an absurd level that begs for radical contraction and surgery," he said that a "reasonable target" to shrink the defense establishment would be 3 percent of GDP by 2015.

What budget cuts?

Republicans, who were elected to a majority in the House of Representatives on promises to cut government spending, promised to cut $100 billion from the budget in their first year. Relatively few have proposed significant decreases in defense spending, and GOP leadership has outright dismissed the possibility.

Some prominent members of the House GOP caucus have even suggested the sum of their austerity measures could fall to only $30 billion, if that.

Republicans in Congress have instead championed their success in extending President George W. Bush's tax cuts for the wealthiest Americans. The Congressional Research Service reported (PDF) that extending debased tax rates to the wealthy will add an additional $5.08 trillion to the US deficit over the next 10 years.

The Bush-era tax rates that Republicans had set to expire were continued for another two years in a legislative compromise that cleared the way for a series of Democratic legislative victories in Congress. President Obama vowed to press the issue again in 2012.

Among their first actions as the House majority, Republicans also pushed for a repeal of President Obama's health care reform laws, even as the Senate's Democratic majority vowed to block the measure. Repeal of the laws would cost an additional $230 billion, according to the Congressional Budget Office (PDF), and would likely drive the number of uninsured Americans to over 54 million by 2019.

But with the US national debt ballooning past $14 trillion in recent days, even a debasement of the military-industrial complex might be too little, too late.

Some analysts have warned the next debt crisis could be municipal bonds, where a $2 trillion market bubble currently exists. One, who correctly predicted the Citigroup credit crunch, even suggested that over 100 US cities may default in the process.

But very few, if anyone, in Congress, the National Security Council, the State or Defense Departments have even dared to publicly raise the prospect of reducing the military establishment and its spending to offset the national debt, Stockman said.

"Unless you have a profound change in foreign policy, you're not going to have the possibility of a radical change in defense spending. The later follows from the former," he said.

"This is a profound disappointment that there's not even a debate -- a serious debate about dramatic change in our imperialist foreign policy and war-making establishment in this administration -- allegedly the most left-wing administration that we've had in modern time."

"I don't have much hope that what needs to be done will be done until it's finally forced on us by a world bond market crisis, which will happen sooner or later," Stockman added.

The 'Ponzi scheme' of 'artificial prosperity'

Stockman, who described himself as a libertarian during a recent interview with, told Raw Story that the economy got into this mess because of the public and private sectors' addiction to "guns and butter Keynesianism," an economic policy that amounts to a Ponzi scheme that has ballooned since 1990.

"If we see what's going on carefully, we've reached the final unmasking of the Keynesian illusion, that Keynesianism is really nothing but borrowing, stealing from the future to induce consumption today," he said. "There are no multipliers. Every one of these programs we've had from 'cash for clunkers' to housing purchase credits have disappeared as soon as they expired and simple shifted activities in time by a few months."

Stockman explained that before 1980, it took about $1.50 of new borrowing -- public or private -- to generate $1 of GDP growth. By the mid-1990s, it was $2.50 or $3 of borrowing for a $1 of GDP growth. By 2007, before the big collapse and meltdown finally came, $7 of public and private debt was added to the national balance sheet in order to get $1 of GDP growth.

"When you get to the point of $7 of borrowing to get $1 of income, you're obviously on an unsustainable path and pretty close to hitting the wall, which more or less we have," he said.

"So the addicts in Washington are now unfortunately terrified to stop all this borrowing whether it's for guns or butter for fear of the economy will collapse.... That's why we're just at the beginning of solving this massive financial collapse we had in 2008 and not in the process of healthy recovery as some of the pals in the White House or on Capitol Hill or on Wall Street would have you believe."

America's "massive debt-created, artificial prosperity" is unprecedented in history, he continued. The dependence on consumption supported by public and private borrowing, not income, is a new stage for Western Europe as well.

A global public debt crisis was inevitable and likely unstoppable, given the political conditions, Stockman added.

"We've reached a point of no return. The size of the government. The massive size of the deficits and the national debt that has been created. The precedents that have been established for bailouts and intervention in every sector of the economy. The K Street lobbying system which totally dominates the Congress. All of these are very unhealthy developments.

"And I'm not sure how they are going to be reversed or eliminated," he concluded. "It may be a permanent way of life. Then, if it is, it'll be both a corruption of democracy and a serious weakening of the private capitalistic economy."

With additional reporting and editing by Stephen C. Webster.

RBS fined £2.8m for ‘inadequate’ handling of HALF of all customer complaints (while bank boss pockets £2.5m bonus) By Daily Mail Reporter

The RBS and NatWest banking group, which was saved from oblivion by the taxpayer, has been fined £2.8million for failing its customers.

Thousands of legitimate complaints were ignored or effectively treated with contempt, in some cases creating real hardship.

Some customers are thought to have suffered massive financial loss or even the threat of losing their home after being given bad advice or sold rip-off products by the group, which is 84 per cent-owned by the British taxpayer.

The fine was imposed by the City watchdog, the Financial Services Authority, which is investigating other high street banks for similar offences. Its inquiry related to the way complaints were dealt with in 2009, although its figures show problems continued last year.

NatWest generated 84,300 customer complaints in the first half of last year, which were subsequently referred to the Financial Ombudsman. Some 66 per cent of home loan complaints were upheld, along with 46 per cent on insurance policies and 23 per cent on general banking.

Royal Bank of Scotland generated 38,100 customer complaints in the same period. An overwhelming 71 per cent of mortgage complaints were upheld.

The fine comes in the wake of yesterday's revelations that RBS chief executive Stephen Hester is set to receive a total of £7m, just over two years after the bank received a taxpayer funded bailout worth billions of pounds.

This payment includes a £2.5m bonus awarded despite warnings to the banks from the Prime Minister not to be 'over-generous' in payments.

RBS's catalogue of failings included delays in responding to customers and poor quality investigations into complaints.

The ombudsman found that complaints handlers failed to obtain and take into account all relevant information when making a decision.

The group also issued correspondence which failed to fully address all of the concerns raised by customers, while it did not explain why complaints had been upheld or rejected.

Customers were also not given information on their right to refer their complaint to the Financial Ombudsman Service within the appropriate time period.

Overall, the FSA said that 53 per cent of the cases it reviewed showed deficient complaint handling, while in 62 per cent of cases the bank failed to follow FSA rules on giving people information on the Financial Ombudsman Service.

In 31 per cent of cases it did not demonstrate fair outcomes for consumers.

The regulator said the problems stemmed from the fact that the bank did not give staff adequate training and guidance on how to properly handle a complaint.

It also failed to monitor complaint handling in branches and the management information produced was not sufficient to assess whether customers were being treated fairly.

The magnitude of Stephen Hester's remuneration in the light of these failings is likely to be viewed by many as an insult to taxpayers who bailed the bank out.

Chief executive Hester was employed by RBS at the height of the 2008 financial crisis to turn its fortunes around.

Value for YOUR money? RBS, which is 84 per cent owned by the tax payer, has been fined £2.8 million for 'multiple failings' in the way it handled customers' complaints by the Financial Services Authority

Value for YOUR money? RBS, which is 84 per cent owned by the tax payer, has been fined £2.8 million for 'multiple failings' in the way it handled customers' complaints by the Financial Services Authority

He turned down a £1.6m bonus last year but it is believed he will take this year's cash and shares bonus when it is offered to him next month.

Speaking yesterday, David Cameron warned against 'banker-bashing' saying it was too easy to make banks the scapegoats for the recession.

He said that the details of Mr Hester's pay packet was 'pure speculation' but warned RBS should not pay out massive bonuses.

Mr Cameron told the BBC's Andrew Marr Show: 'On the general, I want to see the bonus pool smaller than last year, on the specific, Royal Bank of Scotland, as you rightly say, is owned by the Government.

'They should not be leading the way on bonuses, they should be a back-marker.'

Mr Cameron said he understood the public's anger over bankers' bonuses.

He said: 'I feel it because frankly the whole country has suffered from irresponsible lending practices, irresponsible behaviour.

'But we need to recognise though that there were a lot of people to blame for the mess we are in and that we shouldn't just think it's an easy scapegoat to pick one in view.

'Governments made mistakes, regulators made mistakes, politicians made mistakes, everyone was involved. Opposition made mistakes, dare I say it.'

David Cameron: 'Bankers should not be leading the way on bonuses, they should be a back-marker'

David Cameron: 'Bankers should not be leading the way on bonuses, they should be a back-marker'

Mr Cameron said banks needed to be more 'socially responsible', adding the Financial Services Authority had 'set out a very tough set of rules on bonuses', which now applied to 2,500 companies.

He added: 'Do we still need the banks to do more to demonstrate their social responsibility? Yes we do. But we as a Government and a country have got to get a settlement where we recognise that a successful banking sector is part of a successful market economy.

'What I want to see is socially responsible banks, behaving responsibly, lower bonus pools than last year's, responsible levels of remuneration and proper agreements on levels of lending to businesses large and small and being good citizens in the community.'

Sources at the bank described Cameron's comments as 'helpful' saying that bonuses had previously been paid out in shares spread over three years.

Shadow Chancellor Alan Johnson said the Government had failed to live up to the promise of the Coalition Agreement of dealing with the issue of bankers' bonuses.

The Government had legislation on the statute books which would allow it to force the banks to publish pay-outs of more than £1 million in bonuses but it had failed to do so, he told Sky News.

It's estimated that the City could pay out an astonishing £7billion in pay and bonuses this year.

Barclays' boss says banks should no longer be sorry for crisis (24 hours after his '£9m' bonus is revealed)

The head of Barclays today argued that the 'period of remorse and apology for banks needs to be over' - just a day after it emerged he is likely to receive a payout of £9million this year.

Bob Diamond, who claimed yesterday that the size of his bonus is evidence of 'financial restraint', told MPs that banks 'needed to be able to take risks' and that the 'blame game should be put behind us'.

The millionaire banker, added that banks should be 'allowed to fail' but that it was not acceptable to take bail-outs from the taxpayer.

Speaking to the cross-party Treasury Select Committee during its hearing into competition and choice in British banking, he said: 'There was a period of remorse and apology for banks - that period needs to be over. We need banks to be able to take risk, working with the private sector in the UK.'

The hearing comes as Britain's banks are in the process of totting up their bonus pots before full-year results are published.

Mr Diamond, who was once described as the 'unacceptable face of banking', said he was committed to being responsible on bonuses, though the payouts at Barclays have not yet been set.

Risk-taking at banks has rarely strayed from the limelight in recent months as new EU regulations designed to curb such behaviour were drawn up and politicians and industry leaders stepped up pressure on banks to show restraint with their pay packets.

Mr Diamond, who became chief executive of Barclays on January 1, has received pay and perks totalling £75m over the last five years.

But he believes that the sky-high sum is socially responsible because it is less than half the £20million a year he used to get as boss of Barclays’ investment banking arm.

He has waived his bonus for the last two years.

Mr Diamond's bonus for 2010 has yet to be finalised by Barclays, which is totting up its profit numbers.

Bank 'should raise rates to help savers', according to a leading pensions expert

John Mann, Labour MP for Bassetlaw, asked Mr Diamond if he would waive his bonus this year, but he would not be drawn.

Mr Diamond said: 'I've not been awarded a bonus yet. I'll make that decision with my family, as I did last year.'

Earlier, he conceded the shareholders would not be aware of the level of bonuses until they were determined by the board.

Mr Diamond added: 'We have to balance the responsibility we have and the recognition of the environment we operate in.

'The system needs to be safer and sounder in terms of how compensation works, but it's in the interests of everyone in the country that we shift growth to the private sector.

It doesn't feel right to pick up a bonus this year...

'I don't agree that I can isolate bonuses and assume that would have no consequences on the rest of the business.'

Discussing risk-taking in the bank sector, Mr Diamond said Barclays was 'not too big to fail'.

'No bank should ever be a burden on the taxpayer,' he added.

Mr Diamond said Barclays was working on plans and procedures for recovery if it was to get into trouble.

He was then asked about his stance on separating retail, or high street banking, from riskier investment banking - sometimes dubbed casino banking - the arm within which he made his name.

'The financial model is stronger as a result of the integrated business model,' Mr Diamond replied. 'It gives us a greater capacity for lending.'

Mr Diamond said the Prime Minister, Chancellor and Business Secretary were focused on reducing the deficit and the 'mantle for growth' must be passed to the private sector.

He added: 'Frankly, the biggest issue is how do we put some of the blame game behind us? There's been apologies and remorse, now we need to build some confidence.'

David Ruffley, Tory MP for Bury St Edmunds, grilled Mr Diamond over a Bank of England assertion that because Barclays is too big to fail it is more credit-worthy and can therefore borrow more cheaply.

Mr Ruffley asked: 'Are you grateful to the British taxpayer for subsidising you in this way?'

Mr Diamond said he was 'very grateful' to governments around the world for the action they took.

Mr Ruffley then stepped up pressure on Mr Diamond to put a figure on how much Barclays would lend to small and medium-sized enterprises this year, but Mr Diamond would not be drawn.


Robert Edward 'Bob' Diamond was born in Concord, Massachusetts, on July 27, 1951. He was brought up as one of nine children by second-generation Scottish and Irish immigrants.

Mr Diamond studied at the University of Connecticut and was awarded the top MBA from its business school. He began lecturing there but moved to Morgan Stanley in 1979 to work as a bond trader.

He became head of Asian operations at Credit Suisse in 1992, before joining Barclays in 1996, having been offered a job in its BZW stockbroking division.

He was voted 37th in New Statesman's annual survey of the world's 50 most influential figures Who Matter 2010

In 2008 Mr Diamond made a £15m profit from the sale of his house in Kensington, London. The seven-bedroomed neo-Georgian townhouse was bought for £10.5m three years earlier.

He is the chairman of Old Vic Productions - the company behind Billy Elliot the Musical

The father-of-three has taken British citizenship but describes himself as 'very, very American'.

He is a keen sports fan, supporting Chelsea and the Boston Red Sox.

Details of Mr Diamond’s likely bonus, to be awarded next month, have emerged in the City as ministers patched together a face-saving deal with the banks, which will force them to publicly disclose some details of such payouts.

The Government seems powerless to prevent another orgy of City spending that will see £7billion of bonuses handed out.

It is pinning its hopes on a deal under which executives at state-owned banks are expected to receive the least. Banks will also agree to lend more to small businesses and will have to publish details of bonuses.

Mr Diamond's supporters point out that the bank didn’t receive a penny in state support after the credit crunch, although it has benefited from the bail out of the banking system in 2008.

City sources say an award of between £8m and £9m is most likely, based on the fact that Barclays has performed reasonably well in a tough climate.

Much of it will be paid in shares.Were he to get the full bonus entitlement, this could amount to £10.1million in cash and shares, on top of his basic salary of £250,000 for last year.

Under the terms of his job as head of investment banking last year, his bonus could have been far higher.

But he is likely to ask for his bonus to be paid on a par with chief executives of other major banks rather than investment bankers.

While Barclays did not profit directly from the taxpayer-funded bailout of RBS, Lloyds and Northern Rock, MPs said they will demand action to show solidarity with taxpayers for propping up the whole financial system.

Chukka Umunna, a Labour member of the Treasury committee, told the Mail: ‘We will want an acknowledgement in a tangible form of the £1.2trillion of support that the taxpayer has put into the sector.

‘The simple fact is that they would not exist and operate as they do today were it not for the public investment. A bonus of £8million to £9million will be greeted with incredulity by my constituents.’

Analysis of annual reports shows that Mr Diamond earned £23m during 2006, when investment bankers were coining in the cash.

In 2007, he was paid £18m including bonus and shares deals and in 2008, he got £17.5m. His package fell to £8m in 2009, during the height of the banking crisis, however he was able to supplement his income by selling shares in Barclays Global Investors for £24m.

He once said he doesn’t like the word bonuses, saying: ‘I prefer the phrase incentive compensation.’

Lord Oakeshott, a Lib Dem Treasury spokesman, said: ‘If Bob Diamond makes another £9m he’ll have taken £75m over the last five years. That’s 75m reasons why he should not be running a mainstream British bank on which thousands of British businesses and homebuyers depend.’

The peer said Mr Diamond’s reputation as an investment banker means he should not run RBS.

‘Bob’s a great gambler, but he shouldn’t be doing it backstopped by taxpayers’ money. It’s heads Bob wins, tails the taxpayer loses.’

Deepening crisis traps America's have-nots

The US is drifting from a financial crisis to a deeper and more insidious social crisis. Self-congratulation by the US authorities that they have this time avoided a repeat of the 1930s is premature.

Anthony Freda Illustration
Ambrose Evans-Pritchard

There is a telling detail in the US retail chain store data for December. Stephen Lewis from Monument Securities points out that luxury outlets saw an 8.1pc rise from a year ago, but discount stores catering to America’s poorer half rose just 1.2pc.

Tiffany’s, Nordstrom, and Saks Fifth Avenue are booming. Sales of Cadillac cars have jumped 35pc, while Porsche’s US sales are up 29pc.

Cartier and Louis Vuitton have helped boost the luxury goods stock index by almost 50pc since October. Yet Best Buy, Target, and Walmart have languished.

Such is the blighted fruit of Federal Reserve policy. The Fed no longer even denies that the purpose of its latest blast of bond purchases, or QE2, is to drive up Wall Street, perhaps because it has so signally failed to achieve its other purpose of driving down borrowing costs.

Yet surely Ben Bernanke’s `trickle down’ strategy risks corroding America’s ethic of solidarity long before it does much to help America’s poor.

Read Full Article

'One poor harvest away from chaos'

Millions of the world’s poorest people and the state of the global economy are threatened by the food price rises

Geoffrey Lean

'Within a decade," promised the top representative of the world's mightiest country, "no man, woman or child will go to bed hungry."

Dr Henry Kissinger, at the height of his powers as US Secretary of State, was speaking to the landmark 1974 World Food Conference. Since then, the number of hungry people worldwide has almost exactly doubled: from 460 million to 925 million.

And this week the airwaves have been full of warnings that the formidable figure could be about to increase further, as a new food crisis takes hold. Some experts warned that the world could be on the verge of a "nightmare scenario" of cut‑throat competition for the control of shrinking supplies.

The cause of such alarm? On Wednesday, the Food and Agriculture Organisation (FAO) reported that global food prices had hit a record high and were likely to go on rising, entering what Abdolreza Abbassian, its senior grains economist, called "danger territory".

That is bad enough for Britain, adding to the inflationary pressures from the soaring cost of oil and other commodities, not to mention the VAT increase. But for the world's poor, who have to spend 80 per cent of their income on food, it could be catastrophic.

Robert Zoellick, president of the World Bank, warns that the rising prices are "a threat to global growth and social stability", and Nicolas Sarkozy has identified them as a priority for the G20, which he chairs this year.

Already they are higher than in 2008, when they drove the tally of the malnourished briefly above a billion for the first time in history, and caused riots in countries as far apart as Indonesia, Cameroon and Mexico. That ended nearly two decades during which the number of hungry people had stayed the same, while the world population grew by 1.2 billion, so that the proportion of an increasing humanity without enough to eat steadily fell.

Read Full Article

'CIA-created Frankenstein': US turns blind eye on terrorist?

Will Cathay Rule the Waves in the North Pacific?

China used to be one of the world’s leading naval powers. But in the 1400’s, the isolationist Ming Dynasty ordered China’s large fleets dismantled and its ports closed.

The next time Chinese warships put to sea was during the Sino-Japanese War of 1894 when they were quickly demolished by the Imperial Japanese Navy.

Now, China is back as a rising sea power.

We are still so steeped in Cold War thinking that the prospect of US naval power no longer having a free run in the North Pacific is causing shock and deep consternation in Washington even though this development was perfectly predictable and inevitable.

Ever since 1945, the North Pacific has been pretty much America’s "mare nostrum." The powerful US 7th Fleet policed the region’s waters, ready to intervene along the coasts of China, Taiwan, Korea and Japan. Both the Korean War and Vietnam War were supported by the 7th Fleet’s carrier battle groups and surface warships.

Our imperial mode of thinking says it’s right and normal for the US Navy to enforce and protect America’s maritime interests, oil supplies and world trade. But when another power seeks to do the same – in this case China, which now imports more oil by sea than the US – cries of alarm are sounded. It was precisely this type of thinking that led to Anglo-German naval rivalry, a key factor in unleashing World War I. Now the US and India are raising alarms about China’s still modest blue water navy.

Until recently, no naval force in the Pacific or Indian Ocean could challenge the US Navy. But the steady increase in China’s military power over the past three decades has given the People’s Republic the capability of at least blunting the 7th Fleet’s power in China’s waters, or even driving it far away from the mainland.

China’s growing challenge to US domination of the North Pacific became ever more evident last week as the People’s Republic revealed a new, long-ranged, radar-evading stealth aircraft, the J-20.

The J-20 is likely five years from deployment. Its radar-evading ability is unknown, and probably no match for the operational US F-22 stealth fighter.

But this news has been the biggest cause of dismay to the US Navy since a Chinese attack submarine embarrassingly popped up in the middle of a US Navy fleet exercise off China.

China has also managed to deploy 60 modern submarines, a small number nuclear-powered, that are silent and deadly, in contrast to China’s older generation of noisy, vulnerable subs.

Adding to US concerns, China has completed an unfinished Soviet aircraft carrier, "Varyag," that it brought from Ukraine a decade ago. This writer has been observing its completion at the northern Chinese port of Dalian.

Two new, 50,000-ton aircraft carriers are being built in Shanghai, to be launched 2014 and 2020. The new Chinese carriers will likely be equipped with Chinese-made naval fighters or naval versions of the formidable Russian Sukhoi warplanes.

Developing aircraft carriers and properly training their crews can take generations. China is only at the first day in school.

US carriers are one of the world’s most elaborate creations: 100,000 ton floating cities with a million barrels of fuel in their holds, massive amounts of explosives, and highly skilled crews operating 24/7 like clockwork. I sailed aboard the US carrier "Abraham Lincoln" and even as a veteran war correspondent, I was awed by the professionalism and skill of its crew and the complexity of this gigantic creation.

But the US Navy is currently more concerned about China’s rapidly-growing arsenal of anti-ship missiles than Chinese aircraft carriers. Last year’s impressive military parade at Beijing displayed a new generation of powerful anti-ship missiles that can be launched from land, sea, air, and underwater.

In addition, the US Navy is very worried about China’s work on a new ballistic missile, the DF-21D, that can reportedly be launched from mobile, shore-based launchers and hit large, moving targets at sea. The DF-21D is said to be vectored into its target by satellite, aircraft, surface vessels, submarines or drone aircraft.

Even with doubtful accuracy, such anti-ship ballistic missiles could keep the US Navy far out at sea. Carriers and their escorts cost $25 billion – they are too expensive and fragile to risk. Yet these mighty carriers are the ultimate expression of American power in the region.

Over the past decade, China has been slowly building the capability to force the US Navy away from its coasts and deep in the Pacific. Beijing was horrified and mortified when during the 1996 Taiwan crisis, a US battle group led by the carrier "Nimitz" boldly sailed down the Taiwan Strait almost within sight of mainland China.

Imagine if a Chinese naval battle group sailed off New York’s Long Island, into the Florida Strait off Cuba, or in the Gulf of Mexico? The US would erupt in fury. But this is what the US Navy has been doing off China for half a century.

Now, Beijing’s new anti-ship missiles are putting US carrier battle groups at grave risk if they come too close to the mainland. This writer has observed numerous naval simulation war games and can attest that no surface vessels, particularly not huge carriers, can withstand barrages of high-speed anti-ship missiles fired from 360 degrees. Some will eventually leak through the US Navy’s layered defenses.

In war, offense almost always commands a decisive advantage over defense. Just one large, high-speed anti-ship missile could put a carrier out of action. Both the Chinese and Indian Navies have deployed such powerful anti-ship missiles specifically configured to damage or sink large aircraft carriers.

However, the US Navy is run by carrier admirals who are as loathe to junk their flattops as were battleship admirals early in World War II. The answer clearly is less super-carriers and more small vessels with remotely piloted aircraft. But that sea change will only come slowly.

Meanwhile, the US must clearly adjust to China’s growing military strength. The days when the US Navy could rule China’s coasts and rivers are long gone. China is set on enforcing a 300-mile strategic maritime limit and is increasingly pressing claims to large areas of its coastal waters that has alarmed its neighbors and Washington.

The US and China are clearly risking future naval or aerial clashes unless they develop a modus vivendi regulating naval operations in the seas around China.

Inevitably, this will mean a more restrained US naval presence in the North Pacific. US Secretary of Defense Robert Gates was in Beijing this week to conduct talks on this very important issue. Redefining the Sino-American naval and overall strategic relationship and the question of Taiwan is one of America’s most urgent policy issues.

Bogus HPD bust could cost the city big bucks

A ruling that Mansour Arekat's arrest violated his rights puts Honolulu on the hook for thousands

The city could end up paying hundreds of thousands of dollars in a lawsuit involving a Kuwaiti-born Honolulu man whose arrest under mental health statutes was prompted, his attorney says, by being unjustly suspected of terrorist proclivities.

Key events

» Dec. 15, 2003: Mansour Arekat is arrested without a warrant under the state emergency mental health law. He is examined at the Queen's Medical Center and released. No charges are filed.
» Dec. 29, 2003: Arekat files a federal civil lawsuit against the Honolulu Police Department.
» Jan. 11, 2006: A jury finds in favor of three police officers involved in the arrest.
» Nov. 19: In a 2-1 decision, the 9th U.S. Circuit Court of Appeals sets aside the jury verdict and finds that Arekat's civil rights were violated.
» Last Monday: The appellate court refuses to revisit the case.
A city attorney disputes that suspicions of terrorism played a role in the arrest, but acknowledged that a decision by the 9th U.S. Circuit Court of Appeals last week cleared the way for the city to pay Mansour Arekat's legal expenses.

In January 2006 a jury ruled in a federal civil lawsuit that three police officers were not liable for Arekat's arrest three years earlier. But that verdict was set aside by a three-judge panel that found the arrest violated his civil rights, and the appeals court refused last week to take up the matter further.

The panel sent the case back to U.S. District Court to determine the amount of damages the city must pay Arekat.

Because Arekat prevailed in the case, his attorney, Eric Seitz, also will be entitled, under the federal civil rights law, to fees and costs that he estimates will be in the hundreds of thousands of dollars and possibly more than $500,000.

City Deputy Corporation Counsel D. Scott Dodd said the city has already paid $205,000 to the private lawyers who defended the three officers named in the case and would also pay for any judgment against them.

Dodd said the city is reviewing its options, which include an appeal to the U.S. Supreme Court, but he and Seitz said they are in discussions to settle the case.

Arekat, 45, owner of Arekat Pacific Security, a Honolulu security firm, was arrested Dec. 15, 2003, without a warrant under the state emergency mental health law. He was taken to the Queen's Medical Center, where he was examined and released.

The law allows police to take into custody for examination a person who is "imminently dangerous to self or others, or is gravely disabled or is obviously ill."

Seitz said that in the wake of the Sept. 11, 2001, terrorist attacks, police Officer Letha DeCaires suspected that Arekat might be a terrorist because he came from the Middle East.

In addition, a former Arekat Pacific Security employee told DeCaires that Arekat was associated with terrorism and reported that Arekat had model airplanes at his apartment that resembled the airliners hijacked in the Sept. 11, 2001, attacks, Seitz said.

Even though the FBI warned her that they had no reason to believe Arekat was a terrorist, DeCaires used the emergency state law as a way to confiscate three registered firearms Arekat kept in a safe at his office for his security business, Seitz said.

Arekat, a naturalized U.S. citizen, served in the Army from 1987 to 1990 at Schofield Barracks and was honorably discharged.

Police searched Arekat's home and later found him staying at a Waikiki hotel, but he was on his way to talk to the police because he had heard they were looking for him, Seitz said.

Arekat was taken to his office, where police took the three firearms, then transported to Queen's, where he was examined by a doctor who concluded there was no reason to detain him, Seitz said. Seitz estimated his client was in custody for about seven or eight hours before he was released.

Arekat was not charged with any crime, and the firearms were returned to him, Seitz said.

Dodd said Seitz brought up his theory that Arekat was arrested because of terrorism suspicions during the trial, but did not produce any evidence to support it. On the witness stand, DeCaires denied that suspicions of terrorism were a motivating factor in the arrest, Dodd said.

In a 2-1 decision in November, the appeals court panel did not discuss suspicions about terrorism.

But Judges Stephen Reinhardt and Raymond Fisher ruled that the evidence was "insufficient" to allow any reasonable jury to conclude that police had "probable cause" or a legal basis for the arrest.

They said the evidence did not establish Arekat was "a danger to others, let alone that he was imminently dangerous or even that he suffered from a serious mental illness."

The majority noted that Arekat went to the FBI about a month before his arrest about his concerns that he was under surveillance by business competitors and that those competitors were involved in organized crime.

But the interview did not include any threat or act by Arekat that constituted he would harm anyone, the majority said.

The majority also discounted information by the former worker, David Engle, described by the judges as "a disgruntled" former employee.

Engle told police about Arekat's behavior at his apartment a month before the arrest and alleged that Arekat assaulted him when he tried to collect a paycheck after being fired, the majority said.

But Engle did not have a history of providing police with reliable information, and police knew he had recent criminal convictions and was a longtime drug addict, the majority said.

The majority said Engle was "not a reliable source."

In dissent, appeals court Judge Consuelo Callahan said the jury's verdict "should not be set aside because two appellate judges, on the cold record, would have weighed the evidence differently."

She said the police made "a courageous decision to detain Arekat."

"If the officers had done nothing and Arekat had proceeded to shoot someone, defendants undoubtedly would have been sued for failing to detain Arekat," Callahan said.

Seitz declined to say how much he will be seeking from the city, but said in addition to that amount, the city must pay his fees and costs for the hundreds of hours of work for the trial and the appeal, interest on that amount and a possible multiplier that would increase the fee award.

Unless the case is settled, a judge will review the request and determine the fees and cost amount.