"Shock Doctrine" Applied to Europe

Jacob Lew was in Brussels yesterday where he appeared at a press conference with Herman Van Rompuy, head of the European Council. Annie Lowrey covers it in a story, "In Effort to ‘Rebalance,’ Europe Appears Committed to Austerity Plan," that appears in this morning's paper:

“Our economic recovery is gathering strength,” Mr. Lew said. “The U.S. economy has expanded for 14 consecutive quarters, and although the pace of job creation is not as fast as we would like, the private sector has added jobs for 37 straight months.”

In contrast, the euro zone continues to struggle with shrinking economies and rising unemployment, with Germany, France and Spain all contracting in the fourth quarter of 2012. That has made meeting Europe’s goals of reducing fiscal deficits even harder.

Van Rompuy stuck to the austerity script:

But Mr. Van Rompuy reaffirmed the Continent’s strategy, rather than indicating a change in direction despite the rising unemployment and worse than expected contraction. 

“The European economies face a high level of debt, deep structural medium-term challenges and short-term economic headwinds that we need to confront,” he added. “There is no room for complacency.”

We've always been told in this country that Europe, because of its parliamentary system and strong labor unions, has a richer social democracy than the United States. Well, the welfare state in Europe is being dismantled, and this is bad news for the rest of us wherever it is that we live.

The financial system failed, but it is the social safety net that must be cut. It's a complete validation of the Naomi Klein's book The Shock Doctrine. Crises provide cover to implement neoliberal "reforms," even when neoliberal reforms create the crises to begin with (such as the repeal of Glass-Steagall). It's not clear that we have a way out of this circle of cannibalization. If Europe can't do it, we're in serious trouble.

The fact that Portugal's constitutional court pushed back against austerity is good news. Possibly the judiciary can do what the people's representatives in the legislature and executive have up until now failed to do -- halt the cannibalization. Raphael Minder's story today, "Portugal Warns Citizens of More Economic Pain," reports on plutocratic worries over developments in Portugal as revealed in a Fitch report from yesterday:

The decision has now called into question how the government can meet its budgetary goals in the near term and raised the broader issue of just how much austerity will be tolerated, not only by disgruntled citizens but also by justices who often act as the guardians of the Continent’s cherished social welfare system.

“The ruling could be interpreted as saying that all public spending cuts that affect civil servants are unconstitutional,” Fitch, the credit rating agency, wrote on Monday. “If that interpretation is correct, the ruling represents a setback to future fiscal adjustment efforts in Portugal.” 

It added, “This is a greater concern than its immediate impact.”

The Case Against Standard & Poor's

Peter Eavis in a story that appears on page A3 of today's paper explains that the heart of DOJ's case against Standard & Poor's has to do with the computer models the company used to analyze both collateralized debt obligations and the underlying mortgages. The models were cooked, bogus, jiggered with to produce the high credit rating that the issuer wanted. As Eavis explains,

As home prices soared and buyers clamored for properties, banks began to churn out more loans and bundle them into mortgage securities. To analyze mortgages, S.& P. used a program called Levels version 5.6 at the time. S.& P. used that data to come up with its credit ratings for mortgage-backed bonds.

As early as 2004, S.& P. considered broadening the pool of loans in the model. The upgrade was intended to create a more realistic model called Levels 6.0, and S.& P. announced it was forthcoming. But the model was never released, the lawsuit claims.

Instead, S.& P. introduced a more modest upgrade in 2006, Levels 5.7, according to the suit. But the Justice Department contends that model did not provide an accurate picture of the loans. The suit said that an executive made a change to the model that would keep ratings artificially high. 

Ms. Mathis, the S.& P. spokeswoman, said the description of the adjustment to Levels 5.7 was inaccurate. “We are not aware of any changes made to the 5.7 model that were not analytically justified, nor that any changes were made by an individual as opposed to a committee,” she said.

As to the inference by the S&P spokeswoman that model adjustments were kosher as long as they were made by committee, Mary Williams Walsh and Ron Nixon address it in their frontpage story about Attorney General Eric Holder's announcement of the lawsuit to the media yesterday:

Remarks that S.& P. employees made in internal memos and electronic communications show that as early as spring 2004, certain executives wanted to change the firm’s rating methodology, but only after polling “an appropriate number of issuers and investment bankers” as to the “rating implications.” 

The idea of asking bankers what they thought about a change in the firm’s methods shocked some S.& P. analysts and executives, including one who fired back, “What does ‘rating implication’ have to do with the search for truth? Are you implying that we might actually reject or stifle ‘superior analytics’ for market considerations?” 

In May 2004, an analyst warned that S.&. P. had just lost to its competitor Moody’s Investors Service the chance to rate a very large deal by being too hard-nosed about the amount of collateral that would be required to get a good rating. More collateral would mean less profit for Mizuho, the bank putting that deal together. 

“We must address this now,” she said — otherwise the firm would lose more deals. 

The complaint describes a debate in 2004 and 2005 about whether S.& P. should change its model for rating C.D.O.’s and what effect the proposed changes might have on its business. The change was scheduled for July 2005, but before it could happen, an analyst sent an e-mail saying that according to the investment bank Bear Stearns, the older model “had been the ‘best’ ” at rating weaker pools of mortgages, compared with Moody’s and Fitch.

DOJ's case looks solid and easy to understand. In order to make garbage look like gold S&P ran the garbage through a computer model; it popped out as gold. If the computer model popped out something different, say, lead or bronze, a new computer model was devised. People can understand that. It's called fraud.

Fraud at the Rating Agencies

Since the meltdown of the economy in 2008 a narrative has formed as to how we got there. At the center of that narrative are the rating agencies -- Standard & Poor's, Fitch, Moody's Investor Service -- because without their AAA ratings of collateralized debt obligations, CDO's, it's hard to see how the house of cards that collapsed five years ago gets erected in the first place. 

Finally, as revealed in a frontpage story today by Andrew Ross Sorkin and Mary Williams Walsh, the Department of Justice is charging one of the credit-rating agencies, S&P, with fraud: 

From September 2004 through October 2007, S.&P. “knowingly and with the intent to defraud, devised, participated in, and executed a scheme to defraud investors” in certain mortgage-related securities, according to the suit filed against the agency and its parent company, McGraw-Hill Companies. S.&P. also falsely represented that its ratings “were objective, independent, uninfluenced by any conflicts of interest,” the suit said.

S.& P., first contacted by federal enforcement officials three years ago, said in a statement Monday in anticipation of the suit that it had acted in good faith in issuing the ratings.

“A D.O.J. lawsuit would be entirely without factual or legal merit,” it said, adding that its competitors had given exactly the same ratings to all the securities it believed to be in question.

Settlement talks between S.& P. and the Justice Department broke down in the last two weeks after prosecutors sought a penalty in excess of $1 billion and insisted that the company admit wrongdoing, several people with knowledge of the talks said. That amount would wipe out the profits of McGraw-Hill for an entire year. S.& P. had proposed a settlement of around $100 million, the people said.

S.& P. also sought a deal that would allow it to neither admit nor deny guilt; the government pressed for an admission of guilt to at least one count of fraud, said the people. S.& P. told prosecutors it could not admit guilt without exposing itself to liability in a multitude of civil cases. 

It was unclear whether state and federal authorities were looking at the other two major ratings agencies, Moody’s Investors Service and Fitch.

This morning's naked capitalism blog points out that the previous dismal track record of investor suits against the rating agencies doesn't apply here because the DOJ is relying on a new legal theory. As Sorkin and Walsh explain in their DealBook story:

The federal action will be the first time a credit-rating agency has been charged under a 1989 law intended to protect taxpayers from frauds involving federally insured financial institutions, which since the financial crisis has been used against a number of federally insured banks, including Wells Fargo, Bank of America and Citigroup.

The government is taking a novel approach by accusing S.& P. of defrauding a federally insured institution and therefore injuring the taxpayer.

Among others, the compliant includes the demise of Wescorp, a federally insured credit union in Los Angeles that went bankrupt after investing in mortgage securities rated by S.& P. Wescorp is included as one example of the contended fraud, and as a way to bring the case in California. The suit was filed in Federal District Court for the Central District of California.

The naked capitalism post says that if successful this prosecution could be a watershed moment:

As indicated, the reason this suit might fly is that the causes of action rely on different statues than previously invoked, and the focus is on SPs misrepresentation of its own process: that it presented it as objective and unbiased, when it had significant conflicts of interests and its employees believed it was concerned only about profit, and that it may also have failed to adhere to its own procedures.

While getting a ratings agency scalp is small potatoes compared to getting the executives at one of the many financial institutions that helped bring about the crisis, Ill take my victories where I can get them. Winning a case against a public company that is really keen not to lose (tons of private litigation would follow) would break a long losing streak in the DoJ and SEC on the finance front. Although the agencies have been craven, they apparently really were demoralized after losing their misguided suit against Bear Stearns hedge fund managers, and theyve been gun shy. That does not mean they would not have lost in a fight against the Treasury if they had wanted to go after any targets, but lets not kid ourselves: these fights never occurred. Breuer in a significant role was also a big part of the problem, but people who know something about the DoJ say the agencys learned timidity was an even bigger impediment. They really lost their mojo after the Bear Stearns fiasco. You could have imagined a less cowardly DoJ filing suits against safe and obvious targets like WaMu.

Lets hope that the DoJs prosecutorial efforts live up to the caliber of their filing. Too often the Feds have proven to be great draftsmen but lousy prosecutors. Well see if they can up their game.

It would be amazing -- almost too grand a thought to think -- if Obama's second term turned out to be the opposite of the usual fecklessness and avariciousness (just think Bill Clinton) that define administrations headed out to pasture.

House GOP Quick Kicks Debt Ceiling

House Republicans decide to "punt" on the debt ceiling.  The story by Ashley Parker (she covered the Romney campaign during the past presidential election) in yesterday's paper about the Republican retreat in Williamsburg revealed that Paul Ryan was arguing for a short-term extension of the debt ceiling. I thought that this would take time to play out, like a week, as the Republicans haggled among themselves. But by Friday House Republicans had uncharacteristically reached consensus. Here's how Jonathan Weisman lays it out in today's frontpage story:

The decision represents a victory — at least for now — for Mr. Obama, who has said for months that he will not negotiate budget cuts under the threat of a debt default. By punting that threat into the spring, budget negotiations instead will center on two earlier points of leverage: March 1, when $1 trillion in across-the-board military and domestic cuts are set to begin, and March 27, when a stopgap law financing the government will expire.

Reordering the sequences of those hurdles was central to the delicate Republican deliberations that resulted in the new plan. In the days leading to the Williamsburg retreat, Representative Paul D. Ryan of Wisconsin, the House Budget Committee chairman and former vice-presidential nominee, had been meeting with the leader and three past chairmen of the conservative House Republican Study Committee to discuss a way through the debt ceiling morass.

Those conversations led into Thursday morning, when Mr. Boehner and Representative Eric Cantor of Virginia, the No. 2 House Republican, opened the retreat by going through the timeline for the coming budget fights, according to aides who were there.

They turned the floor over to Representative Dave Camp of Michigan, the House Ways and Means chairman, who delivered a blow-by-blow description of the economic disaster that could be wrought by a government default. Mr. Camp also talked through the notion held by some Republicans that the Treasury Department could manage a debt ceiling breach by channeling the daily in-flow of tax dollars to the most pressing needs, paying government creditors, sending out Social Security checks and financing the military. His message was that it would not work, the aides said.

Then Mr. Ryan stood to talk over the options he had developed with the House conservative leaders. They could do a longer-term debt ceiling extension with specific demands, like converting Medicare into a voucherlike program. Or they could lower expectations, reorder the budget hurdles with a three-month punt, and add the “no budget, no pay” provision.

Persuading Republicans who adamantly oppose raising the debt ceiling took some time, and the ensuing discussion stretched on and on, breaking at noon for lunch on Thursday, resuming at 2:30, until 4 p.m., then concluding Friday.

Representative Kevin McCarthy of California, the House majority whip, met with freshmen early Friday to make sure they were on board. Mr. Boehner and Mr. Cantor joined Mr. Ryan for one last meeting with conservative leaders — Representatives Steve Scalise of Louisiana, Jim Jordan of Ohio, Jeb Hensarling of Texas and Tom Price of Georgia — to make sure they were on board. Then the top four leaders sealed the agreement midmorning.

I would call it more of a quick kick than a punt.  Quick kicks are not done anymore in the NFL. Dan Pastorini was the last guy I saw do a quick kick (maybe Danny White did one that I saw, but I don't remember). It's when the quarterback takes the snap from center, usually on third down, and punts it into the secondary. It catches the defense off guard and leads in theory to better field position than running a regular play on third down and then bringing out the punting team on fourth. The quick kick was a third-and-long play. Quick kicks aren't done anymore because passing attacks are much more sophisticated now and picking up long yardage on third down is a regular occurrence; also, passers used to be punters; punting was a skill set expected of your quarterback. No more.

House Republicans quick kicked wisely I believe. They're on more solid footing to extract their social welfare cuts when the sequester kicks in and then after that when the continuing resolution expires. The closer we got to February the greater the chance for another downgrade by one of the rating agencies; Fitch had said as much. When S&P dropped U.S. debt one notch from AAA to AA+ because of the last debt-ceiling standoff it cost taxpayers billions, not to say anything about loses in the markets. If the GOP Mad Mullahs in the House had pressed ahead with a default it would have been insanely destructive to global capitalism, which, as the Monthly Review argues, is largely concentrated in one country, the United States.