Don't Bet Against China: This is a Market Correction Not a Financial Crisis

On my way out of town when the global market slide commenced at the end of last week, I was not able to stay abreast of the news coverage. Old friends who I met asked what I thought. Were we heading into another financial crisis? My answer, for what it is worth, was no. People have been predicting a China meltdown for years, and it hasn't happened yet. The Communist Party has been able to centrally manage impressive growth year in and year out for decades; there is no reason to believe that they can't succeed in converting China to a mature, Western-style consumption-based economy.

That being said, something is definitely happening here. Chinese demand for raw materials is slackening, which has an effect on commodity prices worldwide. Then there is the issue of currency. The dollar has run up in value, which prompted a devaluation in the renminbi earlier this month; and prior to that, the yen. Draped on top of all this is the jingoistic Western press which wants to fix blame squarely with China for the stock selloff. (A good example of this today is Eduardo Porter's fabulistic "Political Risks May Foil Economic Reform in China," or Thomas Friedman's shrill "Bonfire of the Assets, With Trump Lighting Matches.")

I think Chinese prime minister Li Keqiang gets it right (see Neil Gough and Chris Buckley, "China Again Cuts Interest Rates as Concerns Mount Over Economy"):

“Currently, global economic trends are opaque and confusing, and market volatility is quite large, and this has had some impact on the Chinese economy,” Mr. Li said, according to a report on Chinese television news. “But fundamentally the overall stability of the Chinese economy has not changed, and positive factors sustaining a turn for the better in the real economy are accumulating.”

China, he added, would be able to fulfill its economic goals for the year. Mr. Li also noted that there would be no continued depreciation of China’s currency, the renminbi, after a sharp devaluation earlier this month. The currency “can maintain fundamental stability at a reasonable and balanced level,” he said.

This point of view -- that China, the world's second largest economy, is fundamentally sound -- is echoed from both poles of the political spectrum. On the one hand, you have Michael Hudson, in the Democracy Now! video at the top of the post, saying that the Chinese are successfully managing the conversion of their economy away from an export-dominated model, and that the stock drop in the U.S. is basically panic selling to get out of the market before the bubble bursts; while on the other hand, you have an op-ed, "False Alarm on a Crisis in China," by Nicholas Lardy, senior fellow at the Peterson Institute, in fundamental agreement with contrarian firebrand Hudson -- China's economy is strong; what we are witnessing here is a market correction:

Washington — CHINA, many believe, is in a financial and economic meltdown causing anxiety and panic everywhere. China’s stock market dive first dragged down other emerging markets and has now spread to the United States, slicing trillions of dollars off the value of stocks traded here and in other global markets. Since China is the world’s second largest economy and has growing financial ties around the world, developments there clearly have enormous potential implications for both developed and emerging markets.

But the popular narrative is not well supported by the facts. There is little evidence that China’s economy is slowing significantly from the 7 percent pace reported by the government for the first part of the year. Wage growth is running at about 10 percent annually; the pace of creation of nonagricultural jobs is stronger than in any recent year; both real disposable income and consumption expenditures of Chinese households are growing strongly. It is not the picture of an economy heading for a hard landing. 

Services, not industry, are driving China’s growth, as has been the case for three full years. This is likely to continue since per capita incomes in China are reaching a level where a growing share of spending is on entertainment, travel and other services rather than on goods.

Naysayers question government economic data, continuing to focus on weakness in China’s industrial sector and the extremely slow growth of electric power output. But steel production, for example, is significantly more energy intensive than entertainment, so the demand for electricity has fallen sharply as the structure of the economy has evolved.

Assuming that electric power growth is a good proxy for China’s overall economic expansion is like trying to drive a car by looking in the rearview mirror.

Some economists watching from abroad believe that the country is in the midst of a financial crisis because of the excessive debt burden it incurred in recent years. But that view is even less well supported. After a very modest two-day depreciation earlier this month, the exchange rate of the renminbi has changed little against the dollar for eight consecutive trading days; capital outflows continue at a moderate, very sustainable pace; bank liquidity remains strong. This does not yet look remotely like a financial crisis.

Rather than a financial and economic meltdown, China is experiencing an overdue correction in its equity market. And the connection between China’s equity market and China’s real economy has always been tenuous.

Don't bet against China.

Barbara Garson's "Going Underwater in the Long Recession"

Barbara Garson had a great post on TomDispatch last week, "Going Underwater in the Long Recession." The Long Recession refers to the wage stagnation and job loss of the American working class since the middle-1970s. In Garson's piece she looks at this phenomenon through the prism of her encounters over the decades with a GI she originally met in a Hippie coffee house where she worked. Here is her tidy sketch of neoliberalism:

Between 1971 and 2007, real hourly wages in the U.S. rose by only 4%.  (That’s not 4% a year, but 4% over 36 years!)  During those same decades, productivity essentially doubled, increasing by 99%.  In other words, the average worker’s productivity rose 25 times more than his or her pay.

This was, of course, a bonanza for corporations and for the richest Americans.  In 1976, the top 1% of U.S. families held 19% of the country’s wealth.  By 2000, they held 40% of it.  In those same years, 58% of every dollar of income growth went to the top 1%.

There was, however, one small problem: we Americans sell to one another more than 70% of what we produce.  If the majority of American workers were producing more without earning more, who was going to buy all the stuff?

CEOs and financiers were desperate to answer that question, for during those years of high productivity and low wages, immense profits and “returns” kept accumulating in brokerage accounts and banks.  But a bank can’t keep its money in the bank.  Under the pressure of those swelling piles of capital, the answer they offered to worker-consumers like Duane was: instead of paying you enough to buy what you produce, we’ll lend you the money.

First, they loaned for big-ticket items: cars, homes, college educations; then, through credit cards, for everyday household expenses.  As we came to realize after the meltdown of 2008, the ultimate Ponzi scheme of the era would involve bundling and reselling mortgage loans made to people who couldn’t afford houses in the first place.

The answer offered to those who had ever less money to spend was: take out more loans.  The folly of lending money to people with stagnant or declining wages may seem obvious now, but like many houses of cards it must have looked solid enough to some back then. 

The power of the piece is really in Garson's telling of the story of the veteran Duane, a guy who as a machinist stayed one step ahead of the downsizing and offshoring curve but still ended up at the time of his death with a home mortgage underwater and $6,000 in credit card debt.

Arbitrage

Last night I streamed Arbitrage, starring Richard Gere. Written and directed by the young Nicholas Jarecki, Arbitrage is a melodrama with a film noir plot about the owner of a hedge fund, played by Richard Gere, trying to sell his company before it is discovered that he has cooked its books and killed his mistress. The film cashes in on the public's post-meltdown loathing of the 1%. But by the movie's end, the clever young Jarecki has the 99% rooting for the plutocrat to outwit his foes in the police and banking industry and get away with fraud and negligent homicide. The final scene is a celebration of ambiguity and alienation. The rich inhabit a bright, loveless, frigid marble and gold world of lies.

Despite the interesting ending, the film is not a success. (Several times during the one hour and forty minutes I found my self looking at my watch. To me this is the ultimate sign of success or failure. If I never consult my watch while sitting at my computer table then I am entranced; if I'm frequently checking the time, I am not.)

Even though Tim Roth and Susan Sarandon appear in Arbitrage their roles are minor. No, this is a Richard Gere show. And over the decades with Richard Gere you know what you're going to get. The same mannerisms, the same emotional range. It's Richard Gere. (Though I must say I thought his portrayal of a cowardly, torpent beat cop nearing retirement in Antoine Fuqua's Brooklyn's Finest was interesting, if only because it deviated, slightly, from the usual Richard Gere cookie cutter performance.)

Last Sunday night I streamed Andrew Dominik's Killing Them Softly. The Australian Dominik wrote and directed one of my favorite films of the last ten years, The Assassination of Jesse James by the Coward Robert Ford. Killing Them Softly is not as visually compelling but the writing is. I've never read George V. Higgins' Cogan's Trade which is the novel the screenplay of Killing Them Softly adapts. So I can't say how much of the dialogue is lifted from Higgins. But having read The Friends of Eddie Coyle I'd guess very little.

There are three scenes where the writing is amazing. The first is a dialogue between the two petty criminals who rob the card game (which is the focus of the movie). They're discussing women and how they are when they have sex. I've never seen anything like it in a Hollywood movie. It's ugly, misogynistic and true. The next is a dialogue in a hotel room between the two hitmen, played by Brad Pitt and James Gandolfini. Gandolfini discusses his passion for cooze. Once again, it's boundary crossing; I haven't really seen anything like it in a Hollywood film. It's a harsh but accurate look at how hard men talk to each other about women. Then there is the final scene in a dive bar where Brad Pitt's up until now laconic character sprouts oratorical wings and takes off on a discourse about Obama, Jefferson and America, which concludes: "This guy wants to tell me we're living in a community? Don't make me laugh. I'm living in America, and in America, you're on your own. America is not a country; it's a business. Now fucking pay me."

Killing Me Softly is a movie that should be seen. It is a study of the nuts and bolts of organized criminality set against the backdrop of the 2008 financial meltdown and presidential election. The message is obvious. The system, capitalism, is criminal; whether a president or a junky trigger man, it's all robbery.

States Slashing Unemployment Insurance

North Carolina joins a growing number of states that have reduced unemployment benefits since the 2008 meltdown. According to today's story by Robbie Brown, the states besides North Carolina that have cut benefits to the unemployed are Arkansas, Florida, Georgia, Illinois, Michigan, Missouri and South Carolina. All except Illinois, I would guess, are under Republican control. What makes North Carolina's new unemployment compensation bill, passed by a Republican-controlled legislature and soon to be signed into law by Republican Governor Pat McCrory, the most draconian is not the 35% reduction in the maximum weekly benefit from $535 to $350; nor is it the fact that North Carolina has the fifth highest unemployment rate in the country, at 9.2% when the national average is 7.9%; rather, it is the drop in the maximum number of weeks for collecting benefits below 26:

The bill also disqualifies 170,000 unemployed people — 39 percent of the 438,000 jobless — from federal emergency extended benefits because it reduces the number of weeks people can receive benefits to below 26. The federal government has set 26 weeks as the national requirement for receiving federal funds.

“Families struggling to secure their place in the middle class will suffer a grievous blow, and the state’s economy will lose $780 million in federal funds that are vital to reducing North Carolina’s high unemployment rate,” said Seth D. Harris, the acting labor secretary.

The reduction of the maximum number of weeks for collecting benefits to between 12 and 20 seems designed to prevent unemployed workers from tapping into the federal Emergency Unemployment Compensation (EUC) money -- another GOP-hatched scheme, among myriad other plots, to pauperize the working class; to return us to a Jim Crow, Dust Bowl, pre-Wagner Act America, the fevered fantasy of the neo-Dixiecrat Republican politician of today.

Life on unemployment is not a luxurious one of idle splendor. Having been laid off twice in the last decade and living in a state with good unemployment insurance, I still had to reduce my expenses substantially and supplement the weekly check from employment security by drawing down my savings account. Finding work is a brutal process. The weeks wash away quickly. I think six months, 26 weeks, the established baseline for eligibility, is fair; it assumes one is looking diligently in a regular job market. But in a new, difficult environment where we're dealing with 8% unemployment that appears almost structural, 26 weeks is not enough. EUC is vital.

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.

Banging the Drum for Austerity

Mitch McConnell did the Sunday morning talk shows yesterday banging the drum for austerity.  Krugman in his column this morning mentions that the paper creating the most buzz at the annual meeting of the American Economic Association is one by Olivier Blanchard and Daniel Leigh of the IMF; it is a recantation of austerity.  Krugman provides a thumbnail sketch of the 2008 financial meltdown, a gigantic crisis that required governments not just to prime the pump by keeping interest rates low but to step in and start spending -- run deficits -- until the private sector recovered.

But it all went wrong in 2010. The crisis in Greece was taken, wrongly, as a sign that all governments had better slash spending and deficits right away. Austerity became the order of the day, and supposed experts who should have known better cheered the process on, while the warnings of some (but not enough) economists that austerity would derail recovery were ignored. For example, the president of the European Central Bank confidently asserted that “the idea that austerity measures could trigger stagnation is incorrect.”  

Speaking a Greece, there is an excellent opinion page piece by Kostas Vaxevanis, the embattled publisher of Hot Doc, who made the Lagarde list public and then was arrested and prosecuted by the government and eventually acquited.  Vaxevanis' story is about the rotten oligarchy that rules Greece but it speaks to how government works in all countries.

December Jobs Report

There is a frontpage story today by Catherine Rampell detailing yesterday's job report.  One-hundred-fifty-five-thousand jobs were added in December which kept the unemployment rate steady at 7.8%. "But it was not enough to reduce the backlog of 12.2 million jobless workers, underscoring the challenge facing Washington politicians as they continue to wrestle over how to address the budget deficit."

It has been over four years since the bankruptcy of Lehman Brothers pushed the Dow into freefall, and still high unemployment persists. I'm a reader of the Monthly Review, a small socialist magazine, and to me their perspective is persuasive. Advanced capitalist economies like the United States, Western Europe and Japan have difficulty posting high annual GDP growth.  This leads to financialization or casino capitalism -- the resort to legerdemain in the form of complex investment devices like derivatives to juke the growth numbers.  This paradigm is bust and another bubble has yet to come along to replace it.  The class war raging in D.C. between Republicans and Democrats is in many ways about the nature of the next bubble. Democrats like Obama are meekly, tepidly pointing the way to a green economy. Republicans are energetically -- look at all the money super PACs raised during the election -- attempting to re-inflate the go-go days of the Wall Street through the repeal of Dodd-Frank, slashing the top tax brackets, voucherizing Medicare, privatizing Social Security. What is so bizarre about the Republican point of view is how anti-majoritarian it is; it clearly benefits only a tiny elite -- the 1% -- yet it dominates one (if not both) of the major political parties.  It speaks to the power of capital and the electronic forms of communication at its command.

One-hundred-fifty-five-thousand jobs for the month absorbs those entering the work force due to population increase but not much more.  At the current rate of job creation it will take, according to Rampell, "seven years to reduce the unemployment rate to its prerecession level."

Given the uncertainty over what Congress will do, estimates of the unemployment rate’s path this year vary wildly. The more optimistic forecasts for the end of 2013 predict that unemployment will fall to just above 7 percent, which would be considerably below its most recent peak of 10 percent in October 2009, but still higher than its prerecession level of 5 percent.

Rampell, who from watching her on New York Times webcasts has a slightly arrogant manner, ends her story with a description of what the extension of emergency unemployment benefits (as part of the fiscal cliff deal) actually means for laid off workers.  It's compelling.

Armed Private Security at BofA Branches Post-Occupy

What's in a New Year?  The calendar rolls over.  We celebrate the day; most of us don't have to go to work; a lot probably sleep until the afternoon.

The morning is clear here with frost on the rooftops.

In any event there is never enough time.  Aspirations soar at the beginning of a four-day weekend only to come crashing down on New Year's Eve.  Last night it sounded like a block party on Harrison Street below my studio window.  Fireworks, festive banter, alcohol-lubricated hoots.  M-80s boomed.  The big show at the Space Needle drew cheers.  All that was missing was the club music that's normally blasted during the annual summer Gay Pride celebration.  Not bad though.  I managed to mostly sleep through the ruckus.

This morning I attempted to deposit a check using an ATM at the newly opened Bank of America branch on the corner of Broadway and Thomas.  No longer are the ATMs street accessible.  You have to enter a lobby that's part of the new behemoth building at 230 Broadway and all doors were locked, no doubt because of the holiday.  Still, I suppose the days of being able to stand on the sidewalk and access one's money are before long going to be a thing of the past.  This must be part of the trend we're seeing of armed private security guards at bank branches; a post-Occupy, post-meltdown trend.