IEA to Pension Funds: Don’t Bet on Oil, Coal, Gas

Speaking of investments and Climate Change, the International Energy Agency has a little advice for pension funds: don’t bet on oil, coal, or gas because most of it has to stay in the ground if we are going to survive.

About two-thirds of all proven reserves of oil, gas and coal will have to be left undeveloped if the world is to achieve the goal of limiting global warming at two degrees Celsius, according to the chief economist at the International Energy Agency.

Addressing participants in the latest round of UN climate talks in Bonn, Fatih Birol said this should be an “eye-opener” for pension funds with significant investments in the energy sector – particularly in coal – as well as for ratings agencies.

He predicted coal would be hardest hit in the “unburnable carbon” scenario, followed by oil and gas. “We cannot afford to burn all the fossil fuels we have. If we did that, it [average global surface temperature] would go higher than four degrees.

Why pension funds? Because they’re in it for the long-haul. And for them, not investing in dirty energy is a twofer — they won’t lose money and they won’t turn their pensioners’ lives into Hell on Earth.

401(k)s Aren’t Cutting It

401(k)s were supposed to replace pensions. Less headaches for companies, plus workers will get the benefit from the power of the market! As Bloomberg’s Josh Barros shows, that’s not how it worked out. A 2012 paper by Boston College Professor Alicia Munnell analyzed

a “typical” pre-retirement household. These are the mean holdings of a household in the middle net worth decile among households headed by people age 55 to 64.

Social Security is dominant: Forty-nine percent of this household’s wealth is in the form of the expectation of drawing government benefits in the future.

The next largest slice, 23 percent, is accrued benefits in traditional pension plans. But that figure is skewed by a handful of workers who are lucky enough to participate in such plans; as of 2010, only 14 percent of U.S. workers were earning benefits in such a plan.

Private saving for retirement is woeful. This typical near-retirement household has just $42,000 in [401(k)/IRA] retirement accounts and $18,300 in other financial assets. For most Americans, Social Security isn’t augmenting private saving; private saving is (just barely) augmenting Social Security.

The end result: after the devastating financial crisis,

Munnell and her colleagues estimate that as of 2010, 53 percent of American households were on track to be more than 10 percent below the amount of assets they would need at age 65 to maintain their standard of living in retirement, up from 44 percent in 2007.

Barros says either expanding Social Security and cutting Medicare or a program for compulsory savings is the way to go. I think we ought to take a look at bringing back pensions, possibly in the form of a national/regional pension system paid for by a mix of payroll tax & corporate profits tax, a modest part of which could be invested in long-term infrastructure projects or other relatively safe bets that create more good jobs and growth over the long term. But whatever we do, the answer isn’t going to be the 401(k)s we have now.

Wall Street’s Meltdown Really Was Built on a Foundation of Fraud

When Wall Street melted down, some liberals and lefties said it was because Wall Street was rotten to the core with corruption. I’m usually skeptical of arguments like this — the worst stuff usually isn’t because of corruption, of acts that were illegal, it’s what’s legal that does the real damage. But in the case of Wall Street, I was wrong. As Frontline’s new documentary shows, the crisis was literally built on a foundation of fraud.

At its heart, the Wall Street meltdown was about a housing bubble. Mortgage lenders created lots of home mortgages that were either likely to blow up or were just plain crap, and then these mortgage loans were packaged together and then sold, mostly as pieces of these packages, to investors, who leveraged them to the point where if anything went wrong the investors would go broke.

The key to making it work was getting enough mortgages to package together. No more mortgages, no more new “financial instruments” — and that meant no more big, fat Wall Street fees for packaging, selling, and repackaging them. But mortgage brokers aren’t supposed to be able to give home loans to just anyone. They’ve got to have a reasonable expectation that they’ll get paid back.

And as the housing bubble inflated and housing prices got higher, it got harder and harder to find folks who wanted to buy a house and could afford it. If Mortgage brokers and the financial types who bought their mortgages played by the rules, the highly lucrative game would have to stop early. So, as the Frontline Documentary shows, they cheated.

The mortgage lenders made tons of loans that fraudulently broke their own lending standards. The people at the mortgage lenders who were supposed to check for fraud and abuse were told to ignore it — or the standards were lowered until, say, marking down a waitress as having a salary of $12,000 a month was no longer considered fraud. Over and over in the documentary, we meet whistleblowers who said that more than half of the loans they were auditing were clearly fraudulent.

Without this fraud, the housing bubble would’ve popped years before 2008.

And so it went up the chain of mortgage financial games. Financial firms that bought bundles of loans and packaged them fraudulently asserted that the loans were ok. In turn they got ratings agencies to take packages of loans that were bound to fail and gave them a AAA rating, without which pension funds and certain other investors couldn’t legally purchase them. And everybody got a cut that made committing this fraud very lucrative.

So yeah, when it comes to the Wall Street meltdown, fraud really was at the core. And — unlike the S&L crisis — not a single high level Wall St exec has been jailed for it, Obama has all but guaranteed it’ll happen again.

UPDATE: just to be clear, it’s not that the evidence about what folks did wasn’t out there before the Frontline documentary. The elements of the basic story have been out there for a very long time. Bt what I didn’t get was how much of the behavior wasn’t simply greedily suicidal, it was also pretty clear cut fraud.

For example, it was perfectly legal to make “interest-only” mortgage loans where borrowers only paid the interest and not the principle for the first few years, then had their mortgage jacked up to almost certainly unaffordable levels once they had to start paying off the principle (i.e., the money they had borrowed). For most folks who got one of these loans, they were essentially being given a big stack of money to gamble that the housing bubble would keep going, sending the value of their house skyrocketing fast enough that they could get out of the loan into something more sensible before the principle was due. No sane housing or financial market should legalize this form of gambling, but it was legal.

What the Frontline documentary added to the story — or maybe more accurately, my understanding of the story — was the degree to which fraud was involved. the question the documentary asked was, how come no major Wall St execs have gone to jail? To explain why, they interviewed whistleblower after whistleblower who explained just how much of the behavior they saw was clearly fraudulent.

Is Nate Silver Naïve?

During the election I became a big fan of Nate Silver’s FiveThirtyEight blog. If you wanted to know what was going on in the polls without freaking out over the latest blip, it was the place to go. A lot of Beltway & right-wing political hacks/columnists trashed him, but at the end of the game it was Hacks 0, Silver 1.

Silver also came out with a book this year, The Signal and the Noise, that got mostly great reviews. But mathbabe, a really sharp modeler who worked on Wall Street and then Occupied it, is less impressed. When Silver is covering his own worlds – politics and baseball – she thought he was spot on. But when it came to Wall Street, she says, he drops the ball.

The problem, she says, is that he assumes that the financial crisis was caused or driven by the results of inaccurate models.

Silver confuses cause and effect. We didn’t have a financial crisis because of a bad model or a few bad models. We had bad models because of a corrupt and criminally fraudulent financial system.

Take the example of the ratings agencies.

The ratings agencies, which famously put AAA ratings on terrible loans, and spoke among themselves as being willing to rate things that were structured by cows, did not accidentally have bad underlying models. The bankers packaging and selling these deals, which amongst themselves they called sacks of shit, did not blithely believe in their safety because of those ratings.

Rather, the entire industry crucially depended on the false models. Indeed they changed the data to conform with the models, which is to say it was an intentional combination of using flawed models and using irrelevant historical data (see points 64-69 here for more).

In baseball, a team can’t create bad or misleading data to game the models of other teams in order to get an edge. But in the financial markets, parties to a model can and do.

Ditto for the other pieces of the financial crisis. The problem wasn’t that the models failed – as mathbabe points out, they were very successful for a lot of the people calling the shots, who made out like bandits.

The underlying problem, she says, is with Silver’s model of the world:

Silver has an unswerving assumption, which he repeats several times, that the only goal of a modeler is to produce an accurate model. (Actually, he made an exception for stock analysts.)

This assumption generally holds in his experience: poker, baseball, and polling are all arenas in which one’s incentive is to be as accurate as possible. But he falls prey to some of the very mistakes he warns about in his book, namely over-confidence and over-generalization. He assumes that, since he’s an expert in those arenas, he can generalize to the field of finance, where he is not an expert.

The logical result of this assumption is his definition of failure as something where the underlying mathematical model is inaccurate. But that’s not how most people would define failure, and it is dangerously naive.

I haven’t read Silver’s book yet; I’m waiting for it to arrive courtesy of Santa’s elves. Once I’ve read it, I’ll post my thoughts on her take on his book.

Obama Can Move on Jobs, Too – If He (or We) Can Get the Fed to Go along

The “Obama can’t really do anything” meme is starting to crumble. Last week, we saw that even if Obama can’t get any bills passed, he’s got the power the power via the EPA to make a real difference on climate change. Turns out the same is true for creating jobs. Or to be more precise, the Fed does – and that’s an audience that he, or we, could move a lot easier than the House Republicans.

As William Greider explained in the Nation a few weeks ago, Fed chairman Bernanke is starting to get really worried about the long-term effects of unemployment – which, Bernanke says could “wreak structural damage on our economy that could last for many years.” Since the rest of the government isn’t doing anything about unemployment, he’s tiptoeing towards more radical steps. For example, Bernanke is

exploring a special program recently launched by the Bank of England dubbed “funding for lending.” The British central bank will reward commercial banks with favorable rates if they provide more generous credit to help businesses wanting to expand—that is, to create jobs. The scheme will also penalize banks if they fail to meet those goals.

And if banks wouldn’t go along, “it could offer the same deal to financial institutions that are not banks.” Similarly,

The Fed could help restart the enfeebled housing sector by collaborating on debt reduction for the millions of underwater home mortgages. It could help organize and finance major infrastructure projects, like modernizing the national electrical grid, building high-speed rail systems and cleaning up after Hurricane Sandy—public works that create jobs the old-fashioned way. The Fed could influence the investment decisions of private capital by backstopping public-private bonds needed to finance the long-neglected overhaul of the nation’s common assets.

How do we know the Fed could actually do this? Because that’s exactly what it did the last time our economy was in really bad shape.

During the Great Depression, the Federal Reserve was given open-ended legal authority [via Section 13.3 of the Federal Reserve Act] to lend to practically anyone if its Board of Governors declared an economic emergency. This remains the law today. The central bank can lend to industrial corporations and small businesses, including partnerships, individuals, and other entities that are not commercial banks or even financial firms. The Fed made thousands of direct loans to private businesses during the New Deal, and the practice continued for twenty years.… Fed governors must now get approval from the treasury secretary, but they do not have to ask Congress for permission.

In fact, the Fed used Section 13.3 several times during the 2008 crisis, “lending $29 billion to grease the JPMorgan Chase takeover of Bear Stearns” as well as repeatedly using it during the massive bailout of the insurance company AIG. Its bailout of AIG so aggravated Congress that Congress changedSection 13.3 so the Fed can no longer intervene to save a single company. But the very fact that Congress still left the Fed with loads of room to maneuver via Section 13.3 makes it pretty hard to argue that using it to help save the economy and the middle class wouldn’t be kosher. Continue reading

Wealth and the Great Recession: 1% Made out like Bandits, Everybody Else Got Hammered

Now that Obama has been reelected for a few weeks – and most of the Turkey/vegan loaf you snarfed down on Thanksgiving has finally been digested – it’s time to start thinking about where we go next. In case you needed any encouragement, here’s Exhibit 23 of why we need to gear up to kick some ass:

New research from NYU economics professor Edward Wolff, flagged by Think Progress, found that the median wealth of American households plummeted over the years 2007 to 2010, and by 2010 was at its lowest level since 1969. Meanwhile, the late 2000′s saw a high rise inequality: while the median wealth fell, the top 1 percent increased their wealth by 71 percent between 2007 and 2010…

Wolff argues that while “the debt of the middle class exploded from 1983 to 2007, already creating a very fragile middle class in the United States… their position deteriorated even more over the ‘Great Recession.’” His research also detailed how the household wealth of racial minorities and young people dropped to an even greater extent in the wake of the housing bubble’s burst, when house prices collapsed.

The 1% Stole Your Twinkies

Hostess just bit the dust, and the mainstream media is blaming it on unions. They were just too greedy – they wouldn’t accept enough cuts and they stopped the company from changing fast enough to keep up with the times.

Let’s start with those pay cuts about which the workers were being so unreasonable. When Hostess went into bankruptcy the first time in 2004,

the workforce agreed to massive pay and benefit cuts in an attempt to keep the company afloat. One 14-year veteran of the company describes the $150 million annual givebacks the union agreed to: “In 2005, before concessions I made $48,000, last year I made $34,000.” Pensions and healthcare were cut as well, with labor’s total loss equaling $110 million annually.

Imagine what it would mean to go from making $48,000 a year to $34,000 a year. Imagine the kind of sacrifices a family would have to make to survive with that big pay cut. And now? The proposal workers rejected by 92%

would have doubled insurance premiums, negated all pension obligations, and slashed pay by 27 to 32 percent. Again, the 14-year Hostess bakery veteran: “Remember how I said I made $48,000 in 2005 and $34,000 last year? I would make $25,000 in five years if I took their offer.”

At this point, why would any sane person take the deal? As a 14 year veteran put it,

It will be hard to replace the job I had, but it will be easy to replace the job they were trying to give me.

And that’s while management has asked

a bankruptcy judge permission to pay executives $1.75 million in bonuses to oversee the dissolution of the company (and 18,000-plus union jobs). And that’s after a round of executive pay raises earlier this year.

Union workers also weren’t responsible for the fact that Hostess never figure out a strategy to deal with fewer Americans eating Twinkies and Wonder Bread.

Being slow to respond to a changing market would’ve eventually tanked Hostess. But what pushed it over the cliff much sooner were the hedge funds. They loaded it up with massive amounts of debt, helping to push it into bankruptcy in 2004. And then they did it again as it emerged from bankruptcy – up to $1 billion by 2011. And although in 2011 the company made $2.5 billion in profit – down from what it had made in the past but still respectable – but lost a total of $341 million by the end of the year under the weight of the enormous interest payments on its debt.

So no, unions didn’t kill off Twinkies. The 1% did.

This Just in: Bankers Admit They Have No Idea What They Are Doing

Neil Barofsky, former inspector General of TARP and author of the mindblowing book Bailout, is not happy about a report in the Wall Street Journal article on bank stress tests conducted by the Fed. These stress tests are critical to our finding out banks are in trouble before they once again drag the economy over a cliff. And if they are going to mean anythng, the numbers have to be right.

But at the end of the [WSJ] article the reporters reveal that the Fed recently “backed off” a requirement that the CFOs of the banks actually confirm that the numbers they are providing are accurate. The reason? The banks argued, and the Fed apparently agreed, that providing data about what’s going on in the banks is simply too “confusing for any CFO to be able to be sure his bank had gotten it right.”

So the next time someone says government regulators will just slow down banks because can’t possibly understand what those sophisticated folks at the banks are doing, let em know they’re right — but the people who’re supposedly running the banks are equally clueless.

Big Banks: We Can't Break up, We'd Lose Our Best Corporate Welfare!

“Stockholders, analysts, and industry veterans,” says Business Week, are calling on big banks to break up. Why aren’t they? Because if they sold off their investing arm, that new investment firm would lose all of that big, fat, juicy corporate welfare it’s depending on now.

A securities firm or investment bank that didn’t accept deposits and couldn’t turn to the government for help in a crisis would have to pay a premium to bondholders to reflect the lack of a safety net.… “If you divorce them from the mother ship, you’d also be divorcing them from the government at the same time, and that’s where the subsidy is,” says Cornelius Hurley, director of the Boston University Center for Finance, Law, & Policy.

Not only would they need to have more capital “as a cushion against losses,” they’d also need more capital to convince investors to invest in them. A major investor explains why:

Bank of America, JPMorgan Chase (JPM), and Goldman Sachs are safer to own than a “high-risk security” such as Jefferies, says William Larkin, a fixed-income money manager who helps oversee $500 million at Cabot Money Management. He says he doesn’t believe statements by government officials and regulators that no bank is too big to fail. “When I look at companies, I think, ‘What can kill the company?’ And right off the bat, I say the exact opposite of what the government says. I say, ‘That’s a company that’s too big to fail,’ ” he says of Bank of America. “So that protects me.”

And it would also mean losing the enormous subsidy of getting money cheaply – which is a really, really big deal when you’re in the money business.

As record-low interest rates limit returns on loans, banks have become more focused than ever on keeping their own borrowing costs down. That’s led them to lean more on the cheapest form of money available: federally insured deposits. Bank of America pays about $500 million a quarter in interest for its $1 trillion of deposits, compared with about $2.5 billion for $300 billion of long-term debt, CEO Brian Moynihan said on a July 18 investor call. Eric Aboaf, treasurer of Citigroup, told a similar story to investors on a July 20 call. “We have focused on reducing our borrowing costs by substituting maturing long-term debt in the bank, which is a more expensive source of funding, with deposits, our lowest cost of funds,” he said.

JPMorgan, led by Weill’s former deputy Jamie Dimon, finances its operations with $1.12 trillion of deposits and $982.7 billion of market borrowing. Goldman Sachs has more than doubled its deposit base to $57 billion since 2008 and wants to raise more because it is a cheaper way to borrow money than issuing debt: It pays 2 percentage points less on three-year deposits than it does on three-year bonds, Treasurer Elizabeth Beshel Robinson said on a July 24 call.

When folks talk about whether they are in favor of “big government” or “less government,” it’s important to remember that what government directly spends is only a small part of how it subsidizes players in the market. If somebody ever complains to you about “welfare queens” or the “culture of dependence,” just ask, “are you talking about Bank of America or Citi?”

Just How Much Leverage Did We Have over Banks: Remember Robosigning?

This week, several bloggers got into a dustup with Ezra Klein over whether Obama could have done more on the housing crisis (Ezra said Obama was basically hamstrung by the Republicans). In the course of that dustup, law prof Adam Levetin made an interesting point:

But while we’re on the topic of missed opportunities, there’s a huge one that’s been omitted from the list: the robosigning investigation. There have been three times when the Administration has had enormous leverage over the banks: the initial bailout, the first stress tests, and the robosigning investigation. Each time the Administration had the ability to force the banks to reduce principal or do whatever else it wanted, and each time it shied away. Bottom line here was that the Administration chose to protect the banks rather than deal with the losses in the housing market, and that’s not a decision it can disown.

Mind you, the whole conversation fell into the trap of focusing on what Obama could’ve done rather than what we could’ve twisted his arm into doing. Expecting any president to stand up to the banks given how much power they have seems incredibly naïve. But it does point out a key leverage point that we could have dragged him into using.

It also points out one of the challenges of Occupy Wall Street. The robosigning scandal broke after Occupy Wall Street had taken off, and yet Occupy Wall Street wasn’t able to turn it into a cudgel. Why OWS didn’t use that opportunity is a question worth trying to answer – not as way of beating up on OWS but as a useful lesson for the next time there’s an upsurge of activism.