Vermont State Employees Union Votes For 3% Pay Cut

In a move that I would call too little too late, but nonetheless a small step in the right direction Vermont state employees OK pay cut.

MONTPELIER -- Unionized state employees overwhelmingly agreed to a 3 percent pay cut, voting to ratify a two-year contract that takes effect in July. The cut is expected to save the state $2 million in the budget for fiscal year 2011, which has a projected $150 million shortfall because of declining state revenues.

About 83 percent of the 2,300 voting union members supported the contract, Kraus said. Voting turnout was about twice what it normally is, he said. The contract covers some 7,000 state workers.

Employees had been warned that if they didn't go along with the 3 percent pay cut, they might fare worse. The union and the Douglas administration had reached that figure on the suggestion of a fact-finder after coming to an impasse. The administration had sought a 7 percent cut.

Gov. Jim Douglas said previously he hoped the contract would serve as a model for Vermont municipalities.

Model? Model For What?

Until we see cutbacks in pension benefits we have no model. Moreover, this cutback only saves $2 million out of a needed $150 million. If that is a model, it is a model of ineptitude in two ways.

1) It does not remotely begin to cure the current budget problem
2) It does not address the long term problem of pensions and pension benefits

It is a step in the right direction, but a only baby step when giant steps are required. Gov. Jim Douglas has nothing to be bragging about.

By the way, I received the link for the article above moments ago thanks to a soldier in Afghanistan.

I will not use his name for obvious reasons but "BP" writes:

I saw this story in the Burlington (Vermont) Free Press . I�m sitting here in Afghanistan reading your blog�as always, it is great!!!

Such is the power of the internet, instant communication and sharing to the remotest of places.

To all the military, most of who are in places they do not want to be, many of who are in places they do not even believe they should be ......

Happy New Year

Mish

TDC Top Ten!

Well, here it is folks. The end of another year. I can hardly even believe it. It went by in a blink, didn�t it? I for one am really looking forward to 2010! :)

So here is the list, in all it�s glory. This was my first full year of blogging, so I had more to pick from compared to last year�s list. I was going to go in order of comments, lowest to highest, but I�m running out of time today. I�d really like to publish this before the new year. ;)

So let�s just go randomly, and I�ll end with the post with the most comments.

First off, my dining room redo was oh-so-popular. I was such a brat and kind of strung you along for the whole redo, so I really appreciate that you all hung in there with me!

The DIY centerpiece post can be found here.

The table setting made up of items from Pier 1, Stein Mart, Target and HomeGoods can be found here.

And the reveal of the whole room can be found here.

All that�s left to do in here is take it all out to install new floors! Easy, right?! Crikey.

You all loved my insane obsession dislike for icky cords:

You Squeezies totally get me. You can find out the method to my madness here.

I took a couple $20 lamps and customized them with spray paint and wall paint:

You can find out more here.

I grouped a few of the holiday posts into one entry. There are really going to be about 20 links on this post, but whateva whateva, it�s my blog so I can. :)

The ornament wreath can be found here, the Christmas dining table here and the fall door decor ideas here.

YES, I decorated above the pot-tay. And YES, I did it with a table runner:

You can see how I did it here. ;)

One weekend I decided I would teach myself how to tile. It happened to work out pretty well:

You can see the process here.

We transformed our deck this summer, finally. It wasn�t necessarily cheap, but we weren�t using the space every summer, and now we do!

We actually added a fire pit as well, I�ll show you that next summer. :) To see more, go here.

You all loved how I harassed my sister repurposed an item I found in the neighbor�s trash:

I love to boss her around. I don�t care if she�s not five anymore. You can see the process I went through with this piece here.

I droned on and on and ON about my beadboard island earlier this year. I just love it, I can�t help it!:

You can see how it looked before here.

I like to yell at you a lot about GETTING RID OF YOUR CRAP! In the nicest way possible.

My love of decluttering and organizing is shown in these two posts that you loved too:

Our unfinished basement transformation can be found here. And I brag about my closet here. Don�t worry � they don�t always look like this. Just most of the time. Hate me.

This year I plan to purge a TON more from the basement, and we are really hoping to finish it off too, but we�ll see. And I hope to show you our master closet soon too � it�s the one spot in the house I cannot keep clean and organized to save my life.

You know what I love? My posts I label �love� are some of the most popular, by far.

The top five from this year were:

1. A post about rocking my baby found here.
2. Where I share all I know about blogging here. (A second edition is coming soon!)
3. I decided I would have No More Mondays here.
4. You all sending your love to my family here.
5. And probably my favorite post of the year -- your life and home does not have to be perfect to be perfect for YOU. You can find it here.

The �Perfect� post was my most popular of the year with 175 comments. I�m glad you all found it worthwhile to read, and I am so happy I wrote it.

THANK YOU SO MUCH for a fantastic, fun, inspiring year! I can�t wait to share more with you in 2010! I hope you all have a happy and safe New Year. We are staying home and clinking Pepsi cans. ;) OK, maybe a margarita. I�m going to make some fondue and popcorn and we�re all going to relax and enjoy being together.

Happy New Year!!!

Evanston Illinois' Social Experiment To Solve Budget Deficit

Like most cities Evanston, Illinois is struggling with budget problems. Its solution was to ask residents what to do about the problems. Any solution was fair game. The results are interesting.

Please consider Evanston goes Web route for budget help.

Most communities don't advertise proposed budget cuts on their Web site -- much less invite residents to vote on what they want trimmed.

But an unusual experiment in Evanston showed that citizens have plenty of proposals and are willing to cast a ballot to get their message across.

Mike Vasilko was among about 40 residents who toiled in workshops to develop ideas on how to close a gaping $9.5 million hole in next year's budget. Some of those same proposals were recently posted for an online vote, with everything from trimming staff and work hours to closing two of the city's three libraries on the table.

In all, about 1,000 people participated in the online voting earlier this month, said city manager Wally Bobkiewicz. The city also telecast the four budget workshops on its public-access channel.

Though such community involvement is rare, Illinois Municipal League Executive Director Larry Frang said increasing budget pressures will spur creative tactics in dealing with shortfalls.

Bobkiewicz, who said he unsuccessfully searched for similar community engagement closer to home, wound up finding inspiration for Evanston's program in Cologne, Germany. The first step, he said, was creating a Web site that allowed participation at every stage.

"I gave (the German) Web site to our internal developer. I said, 'This is what I have in mind ... use the technology that we have available,' " he said.

The city then solicited in e-mails and on its Web site citizens who might be interested in participating, he said, and did its best to convince everyone that the plan was no dog-and-pony show. Residents, Bobkiewicz said, had to believe their opinions would be valued.

The budget Web site, www.cityofevanston.org/budget, is here to stay, Bobkiewicz said, and officials hope to encourage even more participation next year.

Bobkiewicz said he took the votes culled from the process into consideration when drafting the budget "road map" he offered to the council Dec. 18. He recommended 41 layoffs in full-time, temporary and contractual employees.

"Putting it out there to the public, I hope, (improves) the transparency of the budget deliberation process," she said. "The most valuable part was the process."

Residents like Brugliera said they'll reserve judgment about how worthwhile their efforts were until the council's final vote on the budget.

"You can be optimistic about it, or you can be cynical about it," he said. "Recommendations have been made," and all that can be done now is to wait and "see what they're going to do with them."

I wholeheartedly endorse this process. There is a lot of talent that citizens in communities have and many are willing to volunteer that time. Also, who better to decide to raise taxes or close libraries than the community itself.



The above from the Evanston 2010/11 Budget Process

Click on above link to participate.

However, reading through the recommendations, I am disappointed that Evanston is only cutting around the edges without addressing the crucial issues. Those issues are the same virtually everywhere: Union salaries and pension benefits that are simply out of line with the private sector.

These paragraphs helps frame the problem.

And though most of the residents disagreed with some of the top vote-getters, all appreciated being able to share their opinions. Reducing staff expenses -- in a combination of layoffs and hour reductions -- was a tough recommendation, some of them said, but one they couldn't avoid.

"If you look at it rationally, if 75 percent of your budget is people, you know what you have to do," said Vito Brugliera, who has lived in Evanston since 1965.

Why is it that layoffs and hour reductions are the first things that come to mind instead of lower wages and benefits? In this environment, people should be more than happy to have a job at any reasonable wage vs. the private sector.

Furthermore, hour reductions, even layoffs, do not even fix the structural problems of pension benefits out of control.

Closing a library is a onetime event. Reducing the cost of office space is likewise a one time event. Reducing hours can only go so far. When all the quick fixes are in, what then?

The three biggest salary expenses for most cities are

• Police
• Fire
• Teachers

Cities will continue to struggle unless and until wages and benefits for those groups are addressed. Indeed, the single most important thing any city can do immediately is scrap all defined benefit pension plans for future hires.

Cities and municipalities must address union wages and the pension time-bomb, or as the saying goes they are "just pissing in the wind".

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Fujifilm FinePix Z37 - A Perfect Gift with 10 MP Camera

A Perfect Gift for your beloved ones. Ideal for teenagers and those around 20. The Fujifilm FinePix Z37 looks handy but packed with useful features. It is easy to carry in your hand as the camera is provides with a handsome pouch.The amazing feature of Fujifilm FinePix Z37 is how simple it is to use. The camera features an effective design full of fun like �Blog mode� and �1-touch Movie mode�. The buttons are laid on the back with easy navigation functions. If you love to Blog, you can easily do that in the �Blog mode� and you can also instantly upload your photos and share with your friends.
With 10 MP Camera, Fujifilm FinePix Z37 has a stylish and handy looks that will definitely attract you. The LCD Screen size is 2.7 inches which can easily display up to 100 thumbnail photos.

Fujifilm FinePix Z37

Tax Laws Encourage Euthanasia In 2010

A lifetime friend Dave writes: "Because Congress is populated by venal idiots, the estate tax expires on January 1, 2010 only to rise again on January 1, 2011. So rich old people everywhere are deliberately engineering their lives to end during the next calendar year"

With that backdrop, please consider Rich Cling to Life to Beat Tax Man

Starting Jan. 1, the estate tax -- which can erase nearly half of a wealthy person's estate -- goes away for a year. For families facing end-of-life decisions in the immediate future, the change is making one of life's most trying episodes only more complex.

"I have two clients on life support, and the families are struggling with whether to continue heroic measures for a few more days," says Joshua Rubenstein, a lawyer with Katten Muchin Rosenman LLP in New York. "Do they want to live for the rest of their lives having made serious medical decisions based on estate-tax law?"

The macabre situation stems from 2001, when Congress raised estate-tax exemptions, culminating with the tax's disappearance next year. However, due to budget constraints, lawmakers didn't make the change permanent. So the estate tax is due to come back to life in 2011 -- at a higher rate and lower exemption.

To make it easier on their heirs, some clients are putting provisions into their health-care proxies allowing whoever makes end-of-life medical decisions to consider changes in estate-tax law. "We have done this at least a dozen times, and have gotten more calls recently," says Andrew Katzenstein, a lawyer with Proskauer Rose LLP in Los Angeles.

Of course, plenty of taxpayers themselves are eager to live to see the new year. One wealthy, terminally ill real-estate entrepreneur has told his doctors he is determined to live until the law changes.

"Whenever he wakes up," says his lawyer, "He says: 'What day is it? Is it Jan. 1 yet?'"

Under current laws in effect until the end of this year, the size of the exemption is $3.5 million per individual or up to $7 million per couple. The tax is slated to disappear entirely on Jan 1.

But estate planning in 2010 will be complicated by a new twist: a complex tax on capital gains that will affect a broader swath of taxpayers. The estate tax is scheduled to return in 2011 at a 55% rate with an exemption of slightly more than $1 million.

"I've been practicing for more than 30 years, and never has the timing of death made such a financial difference," says Dennis Belcher, president of the American College of Trust and Estate Counsel. "People have a hard enough time talking about death and addressing estate planning without this."

The situation is causing at least one person to add the prospect of euthanasia to his estate-planning mix, according to Mr. Katzenstein of Proskauer Rose. An elderly, infirm client of his recently asked whether undergoing euthanasia next year in Holland, where it's legal, might allow his estate to dodge the tax.

His answer: Yes.

If you are wealthy, please don't die in 2009. Hang on for another day.

Then, if you are terminally ill but with some time to live, consider moving to Holland where euthanasia is legal. Such is the idiocy of US tax law.

My Stand? I am all in favor of the right to die. However, I am opposed to laws that make it enormously tax advantageous to kill yourself (or for that matter someone to kill you).

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Congressional Legislation Introduced By Barney Frank Pre-Approves $4 Trillion For Next Crisis

Barney Frank introduced H. R. 4173 purportedly "To provide for financial regulatory reform, to protect consumers and investors, to enhance Federal understanding of insurance issues, to regulate the over-the-counter derivatives markets, and for other purposes."

The bill is 1,279 pages long. I did not read it in entirety but Bloomberg columnist David Reilly did. It is amazing the things Barney Frank buried in a bill that is supposed to protect consumers. The bill does nothing for consumers, but does allocate $4 trillion to fighting the next financial crisis.

Please consider Bankers Get $4 Trillion Gift From Barney Frank: David Reilly.

To close out 2009, I decided to do something I bet no member of Congress has done -- actually read from cover to cover one of the pieces of sweeping legislation bouncing around Capitol Hill.

Hunkering down by the fire, I snuggled up with H.R. 4173, the financial-reform legislation passed earlier this month by the House of Representatives. I quickly discovered why members of Congress rarely read legislation like this. At 1,279 pages, the �Wall Street Reform and Consumer Protection Act� is a real slog.

Here are some of the nuggets I gleaned from days spent reading Frank�s handiwork:

For all its heft, the bill doesn�t once mention the words �too-big-to-fail,� the main issue confronting the financial system.

Instead, it supports the biggest banks. It authorizes Federal Reserve banks to provide as much as $4 trillion in emergency funding the next time Wall Street crashes. So much for �no-more-bailouts� talk. That is more than twice what the Fed pumped into markets this time around. The size of the fund makes the bribes in the Senate�s health-care bill look minuscule.

Oh, hold on, the Federal Reserve and Treasury Secretary can�t authorize these funds unless �there is at least a 99 percent likelihood that all funds and interest will be paid back.� Too bad the same models used to foresee the housing meltdown probably will be used to predict this likelihood as well.

The bill also allows regulators to �prohibit any incentive-based payment arrangement.� In other words, banker bonuses are still in play.

The bill isn�t all bad, though. It creates a new Consumer Financial Protection Agency, the brainchild of Elizabeth Warren, currently head of a panel overseeing TARP. And the first director gets the cool job of designing a seal for the new agency. My suggestion: Warren riding a fiery chariot while hurling lightning bolts at Federal Reserve Chairman Ben Bernanke.

Best of all, the bill contains a provision that, in the event of another government request for emergency aid to prop up the financial system, debate in Congress be limited to just 10 hours. Anything that can get Congress to shut up can�t be all bad.

There's much more in Reilly's article. I was hoping this was a spoof, but sadly it is not. Here is the section of H. R. 4173 allocating up to $4 trillion.

FINANCIAL CRISIS MANAGEMENT
(1) IN GENERAL.

In unusual and exigent circumstances, the Board of Governors of the Federal Reserve System, upon the written determination, pursuant to section 1109 of the Financial Stability Improvement Act of 2009, of the Financial Stability Oversight Council, that a liquidity event exists that could destabilize the financial system .... and with the written consent of the Secretary of the Treasury (after certification by the President that an emergency exists), may authorize any Federal reserve bank, ....

Upon making any determination under this paragraph, with the consent of the Secretary of the Treasury, the Financial Stability Oversight Council shall promptly submit a notice of such determination to the Congress. The amounts made available under this subsection shall not exceed $4,000,000,000,000.

Don't worry there is a 99% chance the money will come back as low quality collateral is excluded.

CLARIFICATION OF �SECURED TO THE SATISFACTION OF THE FEDERAL RESERVE BANK�.

No member of the Board of Governors of the Federal Reserve System shall vote to authorize any action permitted under paragraph (1) and the Secretary of the Treasury shall not provide the written consent required by paragraph (1) unless that member believes and the Secretary of the Treasury believes:

��(A) that there is at least a 99 percent likelihood that all funds disbursed or put at risk by such action will be repaid to the Federal Reserve System; and ��(B) that there is at least a 99 percent likelihood that all interest due on any funds disbursed will also be paid to the Federal Reserve System.

��(3) LOW QUALITY ASSETS EXCLUDED.

The notes, drafts, and bills of exchange available for discount for purposes of paragraph (1), and the security for those notes, drafts and bills of exchange may only include any of the following assets if such asset is used to further enhance the security for those notes, drafts and bills of exchange which shall be fully secured with assets that are not any of the following assets: ....

Gee, I sure hope that makes you feel better.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Today's archidose #381

Img2007-09-22-010, originally uploaded by picturenarrative.

The Westside Sales Centre in Toronto, Ontario by Alsop Architects, 2006. Not sure if this building still stands, but according to this recent article the loft building it was designed for has "been scuppered."

To contribute your Flickr images for consideration, just:

:: Join and add photos to the archidose pool, and/or
:: Tag your photos archidose

Steel Tariffs Show Protectionism On The Rise

Price of steel is going up. Is that a good thing? For who? Please consider U.S. Trade Panel Rules for Domestic Steelmakers Against Chinese Imports.

The U.S. International Trade Commission sided with U.S. steelmakers in a case over Chinese steel Wednesday, voting that U.S. industry has been damaged by a flood of imports of subsidized steel from China.

In the ITC's largest-ever steel case, all six commissioners voted in the affirmative that imports of so-called oil country tubular goods from China have injured U.S. manufacturers. The commission will provide details of its decision later Wednesday.

The ruling, which will likely result in duties on future imports of Chinese steel pipes, adds more tension to the U.S.-China trade relationship. Ties between Washington and Beijing are already frayed by the Obama administration's imposition of duties on Chinese tire imports and China's criticism of U.S. moves as protectionist.

Last month, the Commerce Department imposed countervailing duties on the steel pipes ranging from 10.4% to 15.8%. The ITC's decision Wednesday allows the government to finalize those duties. The commission will make a separate decision on antidumping duties next spring.

In the case, brought by U.S. steel manufacturers and the United Steelworkers union, the domestic industry has framed its case in terms of potential job losses -- thousands of steel workers have been laid off or had their mills closed. In China, job losses have been few, as Chinese mills continue to operate despite weakened world demand.

The case was filed by Maverick Tube Corp.; United States Steel Corp.; TMK IPSCO; V&M Star LP; Wheatland Tube Corp.; Evraz Rocky Mountain Steel; and the United Steel, Paper and Forestry, Rubber, Manufacturing, Energy, Allied Industrial and Service Workers International Union.

Steel Grating Tariffs

It's not just steel pipe under review. Please consider US imposes duties on China steel grating.

The US Commerce Department said on Tuesday that it has set preliminary anti-dumping duties (AD) on imports of steel grating from China, a move that might escalate trade disputes between the two countries.

The department said it "preliminarily determined that Chinese producers/exporters have sold steel grating in the United States at 14.36 to 145.18 percent less than normal value."

As a result of this preliminary determination, Commerce will instruct US Customs and Border Protection to collect a cash deposit or bond based on these preliminary rates.

The Commerce Department said it set a preliminary anti-dumping duty of 14.36 percent on four Chinese producers or exporters in the steel grating investigations.

All other Chinese exporters or producers received an anti-dumping duty rate of 145.18 percent, the Commerce Department said.

The new case followed US President Barack Obama's recent decision to impose punitive tariffs on all car and light truck tires from China for three years, a move quickly denounced by China as a "serious act of trade protectionism."

145% tariffs?!
Wow.

Who Benefits From This?

Essentially no one. Potentially a few hundred steel workers get jobs back, but everyone using those products has to pay more. Demand will slow and price pressures will increase on everyone using those products. In aggregate, more jobs will be lost as a result of these tariffs than gained.

And that is just on the surface. Think China will not react? A nice clear message would be for China to cancel plane orders from Boeing or industrial goods from GE. Even if China is not so overt in its message, it is foolish to think there will be no repercussions over this.

The rising tide of protectionism is not a good thing. It never is.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Union Battles In Las Vegas, Simi California, Hawaii, Massachusetts

Union battles over benefits are starting to appear all over the place. Here are a few stories from the past two days.

Las Vegas: City firefighters launch campaign against cutbacks

Las Vegas� firefighters union has taken a hard stance against the city�s budget cuts, alleging that reductions will hurt emergency responses along with fire insurance rating for homes and businesses.

City officials, meanwhile, said the union is engaging in irresponsible �scare tactics� at a time when the city is facing economic difficulties.

The back-and-forth comes as the city readies for a series of town hall meetings scheduled from January to March to hear resident feedback on what city services are most important.

It also comes as the city is considering back-to-back 8 percent salary rollbacks and freezes for all employees, including firefighters, although a union official declined to comment today on the union�s positions on these wage proposals.

The union has created a Web site as well as a radio advertisement warning that cuts could increase response times, result in fewer people on duty, reduce the city�s ability to respond to disasters and hurt the city�s fire insurance rating, which is at the highest level.

This discussion is just one part of the ongoing wrangling over the city�s budget, which has seen an ever-widening deficit since the economic downturn began.

The city has already cut operating costs, eliminated vacant positions and announced some layoffs. City management has also proposed an 8 percent wage rollback in each of the next two budget years to avoid layoffs, a proposal being evaluated by the unions that represent city workers.

My recommendation to Las Vegas is to declare bankruptcy and let the unions see what they can get in court.

Simi California: Simi, police union agree to contract

The Simi Valley City Council on Wednesday approved a new agreement with the Simi Valley Police Officers� Association for an 18-month employee contract that includes a 3 percent salary decrease for sworn police officers and sergeants.

The unanimous approval came after the council went into a closed session meeting late Wednesday afternoon with attorneys and representatives from both the city and police association.

Significant provisions of the MOU approved Wednesday include:

For fiscal year 2009-2010, the base salaries and monthly salary ranges for all police unit classifications will be decreased by 3.43 percent. To address the issue of retroactivity, the city will capture the decrease by reducing base salary of all police unit employees by 6.86 percent Dec. 21, 2009 to June 20, 2010. Effective with the payroll period beginning on June 21, 2010, base salaries will be increased so that the reduction is back to 3.43 percent.

A two-tiered retiree medical program, with any new employees hired after Jan. 1, 2010, receiving a defined contribution retiree medical benefit. Police unit employees as of Dec. 31, 2009, who retire from the city are eligible to remain on the city�s group health plans and the city will contribute to the full amount of the premium. Employees hired after Jan. 1, 2010 are not eligible to receive retiree health insurance benefits, but rather will receive a contribution in the amount of $300 per month placed in a type of retiree health savings account.

Modified provisions regarding assignments, shift scheduling, and the use of annual leave.

A provision providing for an expanded Civilian, Volunteer and Reserve Officer program ....

I had to read that twice. The police union agreed to work rule changes, pay cuts, and benefit cuts including a two-tiered program for new officers. Wow. I commend the city of Simi for standing tough and of course I commend the police union for seeing the writing on the wall and recognizing the need to phase out defined benefit medical plans. I am sure there there is much more work to be done in regards to pensions but this appears to be a genuine start.

Hawaii: University of Hawaii will reduce faculty pay by 6.7 percent

The University of Ha-wai'i will cut salaries for most faculty by 6.7 percent beginning Friday.

UH President M.R.C. "Marci" Greenwood said she decided to cut salaries because negotiations with the faculty union were at an impasse and time was running out to reduce the school's budget.

J.N. Musto, executive director and chief negotiator for the University of Hawai'i Professional Assembly, said Greenwood's decision violates an existing agreement and the union "will take action to protect the rights of the faculty and to preserve a legitimate collective bargaining agreement in whatever court or venue is necessary."

It may ultimately be up to a judge to determine what happens.

"It may very well be that this will get resolved in the courts," Greenwood said.

Greenwood said if the salary cuts are not instituted, layoffs and other actions will have to be considered to help make up for a $154 million loss in revenue, about 13.8 percent, from the state over the current fiscal year and the next.

Systemwide, the average salary for a UH faculty member is about $84,000. The payroll reduction affects UHPA's roughly 3,500 members, consisting of lecturers and professors. Those faculty members paid through nonappropriated funds such as extramural contracts and grants won't be affected, nor will faculty members who retire before June 30, 2010.

The current UHPA contract ran out on June 30, but Musto said UH is bound to follow it until a new contract is negotiated.

What is it that unions in general do not understand about layoffs and budget deficits? Things clearly have to change and not just salaries either.

Boston: Judge rejects transportation workers effort to block benefit cuts

A Suffolk Superior Court judge has dealt a significant blow to MBTA employees fighting a cut in their benefits, saying in a key ruling released yesterday that a group of 22 labor unions was unlikely to win a lawsuit attempting to block Governor Patrick's transportation plan.

The unions had argued in a lawsuit filed in September that Patrick's plan to save up to $30 million a year through cuts to worker and retiree benefits illegally subverts collective bargaining rights by changing their benefits without going to the negotiating table.

They say they earned the benefits over many years and that the T's real problem is the debt that has piled up from years of unfunded expansion projects.

But Judge Christine M. Roach denied an attempt by the union to block benefit cuts on an emergency basis. The initial cuts are targeted at a small group of employees and retirees starting Jan. 1; the majority of employees would be affected on July 1.

Understanding the Massachusetts Bay Transit Authority [MTBA] problem

Please consider Time to end ludicrous MBTA benefits

I turned on the local news this morning, and heard, once again, that the MBTA has to increase fares and reduce service in order to make ends meet this fiscal year. As a business person who has had total profit and loss responsibility for several firms over the years, I was curious how reducing product quality and increasing the price charged to customers could ever work in the marketplace. So, I started to look into the MBTA budget for 2009. The first thing I noticed (and you can also go to the MBTA Web site and follow along) is that salaries and fringe benefits are nearly HALF of the total operating expenses. Having been the vice president of a major ground transportation company at one time, it was a rule that salaries and fringe could not exceed 1/3 of total operating expenses in order to remain viable and competitive. But unlike a "for profit" private sector business, the "T" doesn't have to control costs - it just has to increase fares and cut services.

As I continued to peruse the budget, I searched for the cost of pensions and health insurance for retirees - since they have to be fully funded and increased each year to keep up with the rising costs, and since they combined to be the Achilles heal for General Motors, I thought I'd be able to find out what kind of burden they continue to impose. Unfortunately, unlike any other public agency in the commonwealth, the MBTA does not have to publish its pension obligations because it operates outside the state's retirement agency. I was able to find out a few of the generalities of the burden all commuters are paying - maybe you knew this, but as a daily commuter looking at working to pay off my home, my kid's college debt and keep up with rising taxes, I was appalled - especially since I will still be working at age 75 in order to pay everything off!

MBTA workers can receive a full pension after 23 years of service, regardless of age. So, if an MBTA worker graduated from high school and got a job at age 19, he or she is eligible to receive a full pension at age 42! Not only that, he or she will also receive free health insurance for life. And, since 42 is a prime working age, MBTA pensioners can work at other jobs and earn as much as possible, unlike other state retirees, and pile those wages on top of their MBTA pension.

So, when I heard that commuter rail weekend service may be suspended, and that there is a real potential for weekday service reductions - AND, fares may have to be increased dramatically, I asked myself, "Why are the struggling commuters who are paying the salaries of these people, just sitting there and taking it?" The MBTA general manager, Dan Grabuaskas, says his hands are tied. In fact, according to a local daily paper, Grabuaskas even tried to give his management team a 9 percent pay raise, until pressure from the governor's office convinced him to back it off to 3 percent. ....

The Man Who Never Returned

In honor of the Massachusetts Bay Transit Authority it's time for a Kingston Trio song:

Let me tell you the story
Of a man named Charlie
On a tragic and fateful day
He put ten cents in his pocket,
Kissed his wife and family
Went to ride on the MTA

Charlie handed in his dime
At the Kendall Square Station
And he changed for Jamaica Plain
When he got there the conductor told him,
"One more nickel."
Charlie could not get off that train.

Chorus:
Did he ever return,
No he never returned
And his fate is still unlearn'd
He may ride forever
'neath the streets of Boston
He's the man who never returned.

Now you citizens of Boston,
Don't you think it's a scandal
That the people have to pay and pay
Fight the fare increase!
Vote for George O'Brien!
Get poor Charlie off the MTA.

The above part of the lyrics of a great Kingston Trio song Charlie on the MTA

In the 1940s, the MTA fare-schedule was very complicated - at one time, the booklet that explained it was 9 pages long. Fare increases were implemented by means of an "exit fare". Rather than modify all the turnstiles for the new rate, they just collected the extra money when leaving the train. (Exit fares currently exist on the Braintree branch of the Red Line.) One of the key points of the platform of Walter A. O'Brien, a Progressive Party candidate for mayor of Boston, was to fight fare increases and make the fare schedule more uniform. Charlie was born.

The text of the song was written in 1949 by Jacqueline Steiner and Bess Lomax Hawes. It was one of seven songs written for O'Brien's campaign, each one emphasized a key point of his platform. One recording was made of each song, and they were broadcast from a sound truck that drove around the streets of Boston. This earned O'Brien a $10 fine for disturbing the peace.

...

In 1959, The Kingston Trio released a recording of the song. The name Walter A. was changed to George to avoid problems. Thus ended Walter O'Brien's claim to fame.

Walter A. O'Brien lost the election, by the way. He moved back to his home state of Maine in 1957 and became a school librarian and a bookstore owner. He died in July of 1998.

There are more verses and more information in the above link.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Craftalicious

One of my sweet bloggy friends, who has a little old blog called The Lettered Cottage (maybe you�ve heard of her? Hmmm?), asked me today to share a few thrifty tips. I was happy to oblige, and as I was looking through old posts for ideas, I was feeling a little nostalgic about some of the cauuute projects I�ve worked on this year.

I will do another recap of the year like I did last December (probably tomorrow?) but I couldn�t pass up sharing a few of my favorite crafty projects that may not make the cut (I determine the recap by posts with the most comments).

Looking back through the blog is like looking at old photo albums. Some of you have seen all of these, but it�s fun to reminisce, eh?

First project I loved � Squishy�s gumball machine casa! I don�t know if this is really considered a craft, but it involves glue and fish, and what craft project would be complete without fish? I mean, really�

To see how I made the gumball fishbowl, click here.

Next up, my placemat and table runner pillows:

Umkay, again, maybe not so crafty. But easy and cheap and WOW, these have held up GREAT!! I�m so pleasantly surprised. To see how I made them, go here and here.

My jute lurve started when I saw something I had. to. have. in the Ballard Designs catalog (shocker) and knew I could recreate something similar for cheap:

The vase was a project from the spring. I love the natural look of these jute items. Usually I crave more color but they are a great accent, and they are perfect for this time of year � fresh and simple. Want to know how I made them? Huh? Do ya? Go here and here.

I had a ton of fun working on my son�s playroom this year. I used paper to create fun, functional storage. I also took an old tool box from Goodwill and made it into a cute art caddy:

To see more of these project, go here. Or here for the whole look at the playroom.

I�m all about trying to figure out how to fill wall space in inexpensive ways. Inspired by Ballard Designs yet again, I made this wall art for very little cash. I think it was $20?:

To make your own Ballard Designs art, check it out here.

And I can�t forget the holidays. A couple of my favorites are from the past few months. I love the little ghouly votive holders for Halloween, and the Santa craft still makes me giddy when I walk past it!:

To see the votive holders, go here. For the Santa cones, go here.

Did I forget anything fun?

OH MY GOODNESS, I am soooo itching to get moving on new projects! I have a few lined up, and a list a mile long written down, so there should be plenty of content for 2010. I actually wonder sometimes if I�ll run out of things to blog about! Ha! That�s crazy talk.

Credit Card Delinquencies, Chargeoffs Rise Again; Bank of America Has Credit Card Headaches

Given there has been a financial recovery of sorts, but no recovery at all on main street, it should not be surprising to see Credit-Card Delinquencies Rise Again.

The rate of charge-offs on U.S. credit cards rose more than a half-percentage point in November, snapping a two-month run of drops from an all-time high in August, and delinquencies rose for the fourth consecutive month, Moody's Investors Service said.

Charge-offs, which are those loans a credit-card company doesn't think it will be able to collect, were 10.6% for November, compared with 10% in October. The ratings firm also said the delinquency rate, which gives a glimpse of issuers' potential losses and how much they may need to set aside in reserves, rose to 6.2% in November.

Bank of America Now Choking on Growth at any Cost Policy

Please consider New Chief at Bank of America Seeks Credit-Card Fix

When Bank of America Corp.'s new chief executive takes over next week, one of the first problems he will face is one he's already been grappling with�the bank's credit-card business.

"We gave a lot of cards out to our customers," Mr. Moynihan said in a Nov. 5 speech. "We were giving them to too many people." He discussed a "repositioning" of the business that would rely less on borrowing and more on card transactions, while acknowledging that the business won't be as big or as profitable as it used to be.

Bank of America is the second-largest U.S. card issuer, after J.P. Morgan Chase & Co., and the card division accounts for 23% of BofA's revenue through the first nine months of 2009. Yet cards also lost $4.5 billion during that same period, making it the worst-performing Bank of America business line. It also had a default rate higher than other major rivals, at 13%.

The current problems have their root in Bank of America's push to become No. 1 in the card business. In 2006, it purchased MBNA Corp., one of the nation's biggest credit card issuers, for $35 billion, hoping to combine the card company's marketing and underwriting skills with its own massive branch network.

But in its pursuit of market share, Bank of America made poor underwriting decisions and the banking crisis of the last two years exposed many of those flaws. While trying to become the nation's No. 1 small-business lender it offered unsecured credit lines of up to $100,000 to start-ups, some in business for only one day. Bank of America's small-business default rate hit 17.5% in the third quarter of 2009.

Another misstep for Bank of America, said FBR Capital Markets analyst Paul Miller, was that it took too long to cut credit lines as customers went delinquent. BofA "always took a more optimistic view of the economy," he said.

Bank of America Credit Chargeoffs vs. Allowances



Chart from the WSJ article above, I added the arrows.

Note that chargeoffs are increasing while provisions are collapsing. Also note that the chart only pertains to credit cards. What about residential real estate, home equity loans, commercial real estate, industrial loans, etc etc?

While some keep pretending there are excess reserves to be lent out, I scoff at the idea.

Assets at Banks whose ALLL exceeds their Nonperforming Loans



The above chart courtesy of the St. Louis Fed.

Because allowances for loan losses are a direct hit to earnings, and because allowances are at ridiculously low levels, bank earnings (and capitalization ratios) are wildly over-stated.

Excess Reserves? Please be serious.

For more on excess reserves please see Fictional Reserve Lending And The Myth Of Excess Reserves.

With unemployment at 10% and not headed significantly lower for years, and with allowances for loans and lease losses in the gutter, expect banks to be forced to raise more capital as credit card losses continue to mount.

Still more shareholder dilution via secondary offerings is on the way.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Hussman on Valuation; Stocks Higher? Bulls Dance On Edge Of Cliff

Inquiring minds are reading Clarity and Valuation by John Hussman.

Last week, the dividend yield on the S&P 500 dropped below 2%, versus a historical average closer to double that level. While part of the reason for the paucity of yield in the current market can be explained by the 20% plunge in dividend payouts over the past year, as financial companies have cut or halted dividends to conserve cash, the fact is that current payouts are not at all out of line with their historical relationship to revenues, and even a full recovery of the past year's dividend cuts would still leave the yield at a paltry 2.5%. The October 1987 crash occurred from a yield of 2.65%, which was, at the time, the lowest yield observed in history, matched only by the 1972 peak prior to the brutal 1973-74 bear market.

Those two periods had a few other things in common. In the weeks immediately preceding the market downturn, stocks were overbought, had advanced significantly over prior weeks, bond yields were creeping higher, and investment advisory bearishness had dropped below 19%. All of those features should be familiar, because we observed them at the 1987 and 1972 peaks, and we observe them now.

On the basis of normalized profit margins, the average price/earnings ratio for the S&P 500, prior to 1995, was only about 13. Higher historical �norms� reflect the addition into that average of extremely high �recession P/Es,� based on dividing the S&P 500 by extremely low, but temporarily depressed earnings. For example, the P/E for the S&P 500 currently is 86, because earnings have been devastated, but it would be foolish to take that figure at face value, and equally foolish to work it into a historical �average� P/E. The pre-1995 norm of 13 for price-to-normalized earnings is important, because at present � and again, we are not using current depressed earnings, but properly normalized values � the S&P 500 P/E would currently be over 20. That's higher than 1987 and 1972, and about even with 1929. Of course, valuations have been regularly higher in the period since the late 1990's (and not surprisingly, subsequent returns, even after the recent advance, have been dismal overall, with the S&P 500 posting a negative total return for the past decade).

So overvalued, check. Overbought, check. Overbullish, check. Upward pressure on yields, check. Market internals? � certainly mixed, but not bad � and there's the wild card.

It's important to recognize that when I quote probabilities, I am generally using a form of Bayes' Rule. So when I say, for example, that I estimate a probability of about 80% of fresh credit difficulties accompanied by a market plunge over the coming year, that figure is based on various combinations of historical evidence, and what has (and has not) happened afterward, and how often. As a side note, a �market plunge� in this context need not be a �crash.� In the context of a credit-driven crash and rebound (which is what I believe we've observed), a typical post-rebound correction would be about -28%, but even that would take stocks to less than 20% above the March lows.

From current valuations, durable market returns appear very unlikely. As I noted last week, whatever merit there might be in stocks is decidedly speculative. That doesn't mean that the returns must be (or even over the very short term, are likely to be) negative. What it does mean is that whatever returns emerge are unlikely to be durably positive. Market gains from these levels will most probably be given back, possibly very abruptly.

Stocks Higher? New Bull Market?

New bull market for the new year? Famed bond investor El-Erian of Pimco says don't bet on it.

Homes are selling at their fastest clip in nearly three years, the unemployment rate is falling and stocks are up 66 percent since their March lows -- the best performance since the 1930s.

What's not to like?

Plenty, according to Mohamed El-Erian, chief executive of giant bond manager Pimco. The investor says the recovery may be gaining steam but is no different than a kid who eats too much candy at one of the birthday parties his 6-year-old daughter attends.

"We're on a sugar high," El-Erian says. "It feels good for a while but is unsustainable."

His point: This burst of economic activity fed by government spending and near-zero interest rates will soon peter out.

As CEO at Newport Beach, Calif.-based Pimco, El-Erian, 51, oversees nearly $1 trillion in assets, more than the gross domestic product of most countries. So when he talks, people listen.

What he's saying now:

--Stocks will drop 10 percent in the space of three or four weeks, bringing the Standard & Poor's 500 index below 1,000 -- though he's not predicting when.

--The unemployment rate will be hovering above 8 percent a year from now.

El-Erian says people are fooling themselves if they think all the bullish data of late means a strong recovery is in the offing. So he's buying Treasurys and selling riskier stuff.

His bet: Investors will get scared again and want U.S.-guaranteed debt so they know they'll get repaid.

James Paulsen, chief strategist at Wells Capital Management in Minneapolis, with $355 billion under management, has been pounding the table for months to buy stocks. Just like in the early 1980s, the recovery will take the form of a "V," he says. The reason: Companies have cut inventories and payrolls to the bone, so just a little revenue growth could translate into a bumper crop of profits.

El-Erian says many of the bulls don't appreciate just how much the government props still under the economy are masking its weakness. Instead of focusing on the fundamentals today, he says, they're looking to the past, expecting a quick economic rebound because that's what's happened before.

We're trained to think the "farther you fall, the higher you'll bounce back," El-Erian says. "We're hostage to the V."

El-Erian says we've probably seen the worst of the crisis but consumers, and not just Washington, need to start spending again for the recovery to really take hold.

He doesn't expect that to happen soon. Like in the Great Depression, Americans are saving more and borrowing less -- a shift in attitudes toward family finances that Pimco thinks will last a generation.

That, plus the impact of more regulation and higher taxes, El-Erian says, will crimp growth for years to come.

El-Erian Is An Optimist

As I see it, El-Erian is an optimist. A year from now it is extremely unlikely the unemployment rate will approach 8%. Please note El-Erian is not calling for 8% unemployment, he is only saying it will be above 8%.

How much above 8% are we talking about? Arguably, the answer to that question is another question: How nuts will Congress get with more stimulus packages? Then again, the current stimulus package did not create any lasting jobs, so why would the next one?

It is pretty clear the bulk of the current stimulus efforts is behind us. We will see the results in 4th quarter GDP, with some additional but smaller effect in the 1st quarter 2010 GDP. What then?

Hussman's viewpoint is very similar to mine. I think the bottom may be in, but returns going forward are unlikely to be very good, and a strong pullback is very likely.

Other possibilities include a scenario in which the market goes nowhere (say +-150 S&P points) in either direction, for a number of years. There is also a 20% chance Congress and the administration totally wrecks the US dollar and stocks magically go flying.

I think the probabilities look something like this:

• 20% chance of a durable rally
• 20% chance the market meanders nowhere for as long as 5 years
• 30% chance of of a hard 25-30% correction
• 30% chance the bottom is not even in

Unlike Hussman, I have not done any statistical analysis of those estimates. Certainly his "estimate a probability of about 80% of fresh credit difficulties accompanied by a market plunge over the coming year" is reasonable enough.

Note that Hussman's 80% probability of a plunge encompasses a plunge where the bottom holds and also where it doesn't.

The key for me is that on average it does not pay to be fully invested here, regardless of what the stampede of bulls say. Bear in mind, the bulls were saying exactly the same thing as they are now right at the October 2007 high. I received taunts for several months for my market top call late summer of 2007, about 3% and 3 months early.

Is the top in now? No one knows, but that is not even the right question to be asking. A far better question to be asking is "Is the bottom in?" Even if it is, a major test coming of that bottom down the road is highly likely and that will gore a lot of overly complacent bulls along the way.

In 2007, Chuck Prince former CEO of Citigroup proclaimed �When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you�ve got to get up and dance. We�re still dancing."

Once again, bulls are dancing on a clifftop, oblivious to the fact that the next step might be right over the edge.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Morgan Stanley Predicts 5.5% 10-Year Treasuries, 30 Year Mortgages at 7.5%; I'll Take the Under

David Greenlaw, chief fixed-income economist at Morgan Stanley Sees 5.5% Note as U.S. Faces Deficits.

If Morgan Stanley is right, the best sale of U.S. Treasuries for 2010 may be the short sale.

Yields on benchmark 10-year notes will climb about 40 percent to 5.5 percent, the biggest annual increase since 1999, according to David Greenlaw, chief fixed-income economist at Morgan Stanley in New York. The surge will push interest rates on 30-year fixed mortgages to 7.5 percent to 8 percent, almost the highest in a decade, Greenlaw said.

When you take these kinds of aggressive policy actions to prevent a depression, you have to clean up after yourself,� Greenlaw said in a telephone interview. �Market signals will ultimately spur some policy action but I�m not naive enough to think it will be a very pleasant environment.�

Speculators, including hedge-fund managers, increased bets that 10-year note futures would decline more than fivefold in the week ending Dec. 15, according to U.S. Commodity Futures Trading Commission data. Speculative short positions, or bets prices will fall, outnumbered long positions by 52,781 contracts on the Chicago Board of Trade. It was the biggest increase since October 2008.

Edward McKelvey, senior economist in New York at Goldman Sachs Group Inc., the top-ranked U.S. economic forecasters in 2009, according to data compiled by Bloomberg, expects yields to drop to 3.25 percent. Goldman Sachs says unemployment will average 10.3 percent in 2010, hindering the recovery.

�This is the re-emergence of the bond market vigilantes,� said Mitchell Stapley, the Grand Rapids, Michigan-based chief fixed-income officer for Fifth Third Asset Management, who oversees $22 billion. �The vigilantes are saying, OK guys you want to do this, you�re going to pay a higher price for it.�

I'll Easily Take The Under

5.5% on 10-year treasuries? I'll take the under. I'll also take the under on 7.5% mortgages as well.

Goldman Sachs' call for 3.25% on the 10-year based on the unemployment rate averaging 10.3% seems like a very good guess. However, anything from 2.75% to 4.75% should be in the ballpark.

I freely admit 2 points is a very large park. Yet, as wide as that range is, it is quite possible that we see something near both ends of that range at some point during the year given the factors in play.

Six Factors In Play

1. If there is a spike, it is far more likely earlier in the year than later and we are headed into 2010 currently at 3.84%. Another 75 basis points certainly seems possible with the "hate treasury trade" back in vogue.
   


2. Treasuries are in an unseasonably favorable period right now, and that lasts all the way through May.


3. If there is a chain of favorable data such as a surprise to the upside in GDP for the 4th quarter of 2009 or 1st quarter of 2010, that too can contribute to a spike in yields. But all the way to 5.5%? Sustained? I'll put the odds of that at 15%.


4. Most analysts seem cock-sure the bottom in the stock is in and we are off to the races. The bottom may be in, but even if so the odds of a hard correction are very high in my opinion. Should that happen, there can easily be another flight to safety trade.


5. Unemployment is unlikely to dip substantially below 10% in 2010 and could easily rise to 11%+. That would kill a sustained rise in consumer spending, put a damper on earnings, and lead to higher chargeoffs on credit cards. Such events would be favorable for treasuries.


6. The global recovery can easily falter in the second half of 2010. That too would be favorable for government bonds in general.
   

Wildcard: Congress may go berserk with additional fiscal stimulus efforts. Note this would be a two-edged sword. If Congress does go berserk , the economy would likely be in the gutter and yields already falling even though the action itself would be supportive of higher yields.

The concentration of upside yield risks in the first half, and downside yield risks in the second half account for the large ballpark for where yields may go in 2010. For where the 10-year note ends 2010, I will guess a much narrower 3.0% to 3.5%.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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26 Mile Long Glut Of Idle Oil Tankers

Bloomberg is reporting Tanker Glut Signals 25% Drop on 26-Mile Line of Ships.

A 26-mile-long line of idled oil tankers, enough to blockade the English Channel, may signal a 25 percent slump in freight rates next year.

The ships will unload 26 percent of the crude and oil products they are storing in six months, adding to vessel supply and pushing rates for supertankers down to an average of $30,000 a day next year, compared with $40,212 now, according to the median estimate in a Bloomberg News survey of 15 analysts, traders and shipbrokers.

That�s below what Frontline Ltd., the biggest operator of the ships, says it needs to break even.

Traders booked a record number of ships for storage this year, seeking to profit from longer-dated energy futures trading at a premium to contracts for immediate delivery, according to SSY Consultancy & Research Ltd., a unit of the world�s second- largest shipbroker. Ships taken out of that trade would return to compete for cargoes just as deliveries from shipyards� largest-ever order book swell the global fleet.

�The tanker market has been defying gravity,� said Martin Stopford, a London-based director at Clarkson Plc, the world�s largest shipbroker. Stopford has covered shipping since 1971.

More than half of the ships are in European waters, with the rest spread out across Asia, the U.S. and West Africa. Lined up end to end, they would stretch for about 26 miles.

Storing Crude

Traders are storing enough crude at sea to supply the 27- nation European Union for more than three days. Royal Dutch Shell Plc, Europe�s biggest oil company; London-based BP Plc; JPMorgan Chase & Co.; and Morgan Stanley were among those that sought vessels for storage.

The storage trade is profitable so long as the spread between energy contracts exceeds ship rental, insurance and financing costs. A year ago, the spread between the first and sixth Brent crude-oil contracts traded on the London-based ICE Futures Europe exchange was 23 percent. Now, it�s 4 percent.

Speculation is one of the things propping up energy prices. Belief in a sustainable recovery is another, and rampant money supply growth in China is a third.

Regardless, with contango spreads tightening, demand for 26 miles of oil tankers will collapse.

Crude Prices



Click on chart for sharper image.

The floating storage trade is becoming riskier and riskier. The spread all the way out to January 2011 is only $7 and there is certainly no guarantee or even likelihood oil prices will be that high then. One also has to factor in lease and crew costs.

It was one thing to store oil when crude was below $40 and future months were much higher. Risk factors are much higher now and the floating tanker trade will soon be unwound.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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The Most Redeeming Feature of Capitalism is Failure

There is an interesting interview in Barron's with two hedge fund managers called Shorting the Economic Recovery.

The fund managers who correctly predicted the housing collapse and the rise in gold, now predict the economy's next leg down. The second theme in the article is on capitalism, fractional reserve lending and what the government should have done.

Here are some interesting interview snips pertaining to capitalism and fractional reserve lending. The rest of the article is by subscription only.

PERHAPS ONE OF THE greatest failings in the run-up to the financial meltdown was a lack of perspective -- an inability by many market participants to see the big picture. Not so with Kevin Duffy and Bill Laggner, principals of the Dallas-based hedge fund Bearing Asset Management. With the help of their proprietary credit-bubble index, developed in 2004, the managers sounded early warnings on housing and credit excesses, and capitalized handsomely on their forecasts by shorting Fannie Mae, Freddie Mac, money-center banks and brokers, builders, mortgage insurers and the like.

Students of the Austrian school of economics, which espouses a free-market philosophy that ascribes business-cycle booms and busts to government meddling with interest rates, the pair is solidly in the contrarian camp, believing that the worst for the markets may be yet to come.

Barron's: You've said that perhaps the most redeeming feature of capitalism is failure. Please explain.

Duffy: Any healthy system needs a way to correct error and remove waste. Nature has extinction, the economy has loss, bankruptcy, liquidation. Interfering in this process lengthens feedback loops. Error and waste are allowed to accumulate, and you ultimately get a massive collapse.

Capitalism is primarily attacked by two groups: utopians who wish to impose a more "compassionate" system, and political capitalists who want to enjoy the fruits of success without bearing the pain of failure. They use the coercion of the state to gain privileges, at the expense of everyone else.

As a country we've become less tolerant of economic failure. The result has been a series of interventions, such as meddling in the credit markets, promoting homeownership and creating a variety of safety nets for investors. Each crisis leads to an even greater crisis. The solution is always greater doses of intervention. So the system becomes increasingly unstable. The interventionists never see the bust coming, then blame it on "capitalism."

Barron's: What would you have done differently as the credit bubble was bursting and the Fed and the Treasury were declaring that the world would come to an end without an $800 billion bailout package?

Duffy: Allow those who essentially bet wrongly to fail, instead of bailing out people with friends in high places.

Barron's: What about the argument that a financial panic would have ensued and crushed the little guy?

Duffy: The little guy actually has been crushed. The little guy is always going to be the last one in the soup line. So he will get a bone tossed to him, like cash for clunkers. But if you are Goldman Sachs or if you have got essentially the red bat-phone to Washington, D.C., you are first in line.

Laggner: There is still a multi-trillion dollar shadow banking system that FASB [the Financial Accounting Standards Board] wants to address next year. The central planners have already spent $3.15 trillion on various bailouts, credit backstops, guarantees, etc., and given approximately $17.5 trillion of government commitments, etc., while allowing many of these institutions to remain in place, with the same people running them.

Barron's: What else could have been done?

Laggner: We could have isolated the money centers and put them in temporary receivership. Then, we could have created -- with a mere $100 billion -- a thousand community banks. If you believe in fractional reserve lending [in which banks lend multiples of their deposits], something we don't support, they could have created a trillion dollars in new credit that would have flowed to small and medium-sized businesses. Those are the parts of the economy that are choking.

Barron's: What kind of financial reform would you like to see?

Laggner: We don't believe in a central bank. The idea that banks can speculate with essentially free money from the [Federal Reserve], which ultimately is the taxpayer, and that when they lose money the Fed bails them out and then passes that invoice to the taxpayer -- that whole model is broken and needs to go away.

Duffy: To get to the heart of the problem, we need to address fractional-reserve banking, which is causing the instability. We have essentially socialized deposit insurance and prevented the bank run, which used to impose discipline on this unstable system. At least it had some check on those who were acting most recklessly. Until we address the root of the problem, we are going to have a series of crises, greater responses and intervention, and more bubbles -- and the system will keep perpetuating itself.

Misguided Blaming Of Capitalism

Duffy hits the nail on the head when it comes to regulation and intervention: The interventionists never see the bust coming, then blame it on "capitalism."

Intervention created Fannie Mae, Freddie Mac, and the "AAA" rating of pure junk via government sponsorship of Moody's Fitch, and the S&P.

Furthermore, FDIC regulation designed to prevent bank failures and runs on banks did nothing of the kind. Instead, the FDIC created a false sense of security for decades, followed by a massive collapse of banks, including the largest bank failures in history.

In 2009, 140 banks failed and that number will likely be topped in 2010.

FDIC is a moral hazard as well as Ponzi scheme of immense proportion. It allows marginal banks to raise needed funds by offering above market government guaranteed CDs. Such guarantees helped fund ridiculous condo projects by Bank United, Corus Bank, and others. Indeed, many regional banks jumped on board with enormous leverage in commercial real estate.

Very few understand how destabilizing FDIC is to the banking system.

Fractional Reserve Lending Disaster

I also agree with Laggner that Fractional Reserve Lending is a bad idea.

For example, if Fannie and Freddie had to back up their mortgages 100% with bonds of matching duration instead of the mere 3% now in place, if 100% reserves were required on checking accounts, and if there was no FDIC, it is highly doubtful things would have gotten so out of hand.

Laggner suggests the creation of 1000 new community banks with deposits of $100 billion would have kicked off a $trillion in lending. I disagree on this point given that reserves are not the primary lending constraint as noted in Fictional Reserve Lending And The Myth Of Excess Reserves.

Excess Reserve Recap

1) Lending comes first and what little reserves there are (if any) come later.
2) There really are no excess reserves.
3) Not only are there no excess reserves, there are essentially no reserves to speak of at all. Indeed, bank reserves are completely "fictional".
4) Banks are capital constrained not reserve constrained.
5) Banks aren't lending because there are few credit worthy borrowers worth the risk.

In Laggner's scenario, unless those 1000 banks did not care about losses, points number 4 would and 5 would have come into play.

Of course government could have decided to bankroll capital losses at those new banks, just as it now does with Fannie Mae and Freddie Mac.

Please see All Hail The Grand Poobah; Blank Checks For Fannie and Freddie for a discussion of Obama's Christmas eve decision to cover an unlimited amount of losses at the mortgage-finance giants Fannie Mae and Freddie Mac over the next three years.

Interestingly, the legislation that created Fannie and Freddie explicitly states that its securities are not backed by the government. Supposedly, the GSE's were to receive no direct government funding or backing.

Both president Bush and president Obama (as well as the treasury departments under each administration) have shown little concern for such technicalities. Increasingly presidents are of the mind "we have to destroy capitalism to save it" or as President Bush stated (and Obama practices)�I�ve abandoned free-market principles to save the free-market system.�

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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