Evergreene Digest A Journal of Progress for the Rest of Us

A New York Times article by Louise Story asks, “Do widening gaps between rich and poor necessarily lead to financial crises?” (Aug. 21)  The answer is yes, for a reason observed over 100 years ago by American economist and reformer Henry George: Economic growth enhances the value of titles to real estate and other natural resources (like broadcast spectrum). This widens the wealth gap between individual or corporate title-holders and the rest of the population. As growth progresses, overoptimistic projections of future growth widen the gap even further. Come the inevitable collapse, imaginary wealth evaporates, and the gap shrinks. Only, as pointed out by Gretchen Morgenson (“Debt’s Deadly Grip” Aug 22), this time is different. By holding short-term interest rates near zero for the big banks, the Fed is supporting the value of their toxic assets at the expense of everyone else.

[N.B.:  First three items by our fabulous summer intern Elizabeth Murphy, who also chose this post's Possibly Irrelevant Image. Sorry for the delay posting these!]

(1) The Bureau of Labor Statistics released the July unemployment numbers last Friday (Aug.6) and they do not look pretty.

Unemployment remains exactly where it was at the end of the recession at 9.5%, with 14.6 million unemployed persons. The Center for Economic and Policy Research writes,

“For the second consecutive month, the economy created virtually no jobs, net of temporary Census jobs. The Labor Department reported that the economy lost 131,000 jobs in July, 12,000 less than the 143,000 drop in the number of temporary Census workers. The June numbers were revised down by 100,000 to show a gain of only 4,000 non-Census jobs.”

If anyone is looking for a more in-depth look at the unemployment figures, you should check out the Economic Policy Institute’s Economy Track. They have an interactive map of the U.S. which details unemployment figures for each state. Nevada is still the state with the highest unemployment at 14.2%.

–Elizabeth Murphy

(2) According to some statistics, theses unemployment figures correspond with an ongoing trend in U.S. economic recovery.

Pragmatic Capitalism offers Some Perspective on the High Unemployment Rate:

“Assuming that the recession ended in June 2009, the current unemployment rate is exactly where it was at the end of the recession (9.5%). For some perspective on the current state of the labor market, today’s chart illustrates the amount of time it took for the unemployment rate to ultimately dip below (and stay below) its recession-end level for each recession since the late 1940s. For example, at the end of the recession that ended in November 1982, the unemployment rate stood at 10.8%. As the chart illustrates, it took two months for the unemployment rate to drop below (and stay below) the recession-end level of 10.8%. It is noteworthy that, over the past two decades, it has taken significantly longer (on average) for the unemployment rate to drop below its recession-end level. The reasons for this increased time for the unemployment rate to turn around varies. However, one explanation has it that following World War II, the US found itself in a strong/dominant economic position. It took time, but eventually many of the remaining world economies began to recover and we are currently witnessing increased competition as a result of the rise of the rest.”

The article (by Chart of the Day) includes a great chart showing how long it took after each recession for unemployment levels to drop below recession end levels starting in 1949. It shows that in 2001, it took nearly 36 months!

–Elizabeth Murphy

(3) As worrying as these unemployment figures are, even more worrisome is the lack of action being taken to fix unemployment. Brad Delong vents his frustration at TheWeek.com:

“where is the panic, the sense of urgency? The Obama administration and the Democratic majority in Congress passed a fiscal stimulus plan half the size recommended by Democratic economists fifteen months ago. Since then, they have been unable to assemble a political majority to finish the second half of the job. There seems to be no appetite for addressing ten percent unemployment.

Instead, we have the Obama administration calling for a three-year spending freeze on programs unrelated to national security. We have Democratic Congressional Campaign Committee chairman Chris van Hollen calling for deeper short-term spending cuts. We have an administration experiencing difficulty finding $23 billion to prevent additional teacher layoffs, even though maintaining — no, expanding — investment in education in a recession is the no-brainiest of no-brainers.

Why the enormous disconnect?”

A calm, passive approach to unemployment is not going to help improve these unemployment figure, but panic probably won’t help much either. Delong ends his article with interesting and unnerving questions. And as far as the last question is concerned, I sincerely hope the answer is no:  “Are we passively watching an unrepresented underclass of the long-term unemployed created before our eyes?”

–Elizabeth Murphy

(4) Today’s New York Times has an interesting article, Rates Fall as Market Fears Economic Weakness, suggests that bond traders, far from being “bond vigilantes” pressuring governments toward austerity, may actually be worried that deficit hawks are leading us to a double-dip recession:

The governments are seeking ways to bring down budget deficits, fearing that without austerity they could go so far into debt that they would never be able to borrow again. Investors in the financial markets seem to be much more concerned by the possibility of renewed recession and a general deflation that could send asset values and prices down.

That market reaction is the opposite of what happened in the late 1970s and early 1980s. Then “bond vigilantes” were reluctant to invest in United States Treasury securities because they feared runaway inflation. Their refusal drove up the interest rates the government had to pay on its borrowings and eventually led the Federal Reserve, under Paul A. Volcker, to wage war against inflation even if it meant choking off economic growth.

Now, far from showing a reluctance to finance the American government, investors are seeking safety and evidently believe American government debt is the safest possible investment. They have rushed to send money to the Treasury, thereby reducing borrowing costs for the government.

By late 2009, interest rates had fallen to levels previously thought inconceivable. The annual yield on a two-year Treasury note dipped below 1 percent. But it has since traded barely above one-half percent.

Perhaps investors are nervous because they fear governments will swing too far toward austerity. When economies weakened three years ago, talk immediately turned to economic stimulus. This time, much of the discussion in Washington, as well as in many European capitals, has focused on the need to reduce spending and deficits, rather than on the possibility that additional stimulus might be needed to avert a new worldwide downturn.

And the article concludes:

Economics is a notoriously uncertain discipline. It is possible that a surprisingly strong employment report, or some other unanticipated event, could begin to disperse the fog of economic pessimism that has engulfed investors and sent interest rates to record lows.

But for now, the financial markets seem to fear recession and deflation much more than they fear deficit spending.

Maybe the markets are smarter than we thought, this time around?

–Chris Sturr

On vacation in Colorado, we drive through the Littleton shopping mall. There it is, a two-story building, black and empty behind its glass facade. Mervyn’s Department Store. Founded in 1949, Mervyn’s grew to a chain of 189 stores in 10 Western states. But in 2008, Mervyn’s went bankrupt , laying off 18,000 employees without severance or vacation pay. Just an ordinary casualty of the recession? Hardly.

In The Buyout of America Josh Kosman introduces us to the private equity or PE firms. They are a major force behind what Barry Lynn called “the economics of destruction.”

The players:

PE firms. You haven’t heard of most of them, and they like to keep it that way. A few better-known ones are the Carlyle Group, Goldman Sachs, Kohlberg Kravis Roberts, and the Blackstone Group. They are the descendants of the notorious leveraged buyout operators of the 1970s.

Target corporations. These are typically midsize to largish corporations, steadily profitable but not exciting. Often, like hospital chains, they are not especially well-managed.

Investors. These are mostly pension funds, desperate for higher returns to compensate for prior underinvestment. They include public pension funds, like the giant California Public Employees Retirement System.

Banks. These are mostly the big banks, like JP Morgan Chase or Citicorp, eager for loans that they can “securitize” and sell off.

Purchasers of securitized loans. These are also mostly pension funds, seeking super-safe passive investments for the bulk of their portfolios.

US federal and state taxpayers.

The game:

Step one. A PE firm lines up investors, who typically commit to supply funds over a period of up to 10 years. The PE firm promises spectacular returns.

Step two. The PE firm bids for a target corporation. It may put up 5% of the bid while its investors supply the rest.  For the balance of the purchase price, some 70% to 80% of the total, it arranges a huge bank loan, which it puts on the target’s books. The target essentially assumes the debt to buy itself out. Under terms of the deal, the target may pay interest only on the loan for five or six years, before the principal becomes due.

Step three. Because interest on the loan is deductible, federal and state taxpayers pick up a big piece of the loan interest, 35% federal, plus whatever state tax piggybacks on the federal.

Step four. The bank securitizes the loan, combining it with other loans to create what are called “collateralized loan obligations,” or CLO’s. CLO’s are equivalent to the “collateralized debt obligations”, or CDO’s, which banks created from mortgages.  As with the CDO’s, the bank divides the CLO’s into “tranches”, gets Standard & Poor’s or Moody’s to rate the top tranches AAA, and sells them to further investors.

Step five. The PE firm installs its own management, which starts raising prices and cutting costs, including laying off employees and scaling back R&D. The PE firm has three objectives here: first, it must enable the target to pay the interest on its debt.  Second, it must make the target look profitable in the short run so it can sell it when the debt principal comes due in a few years. Third, it seeks to liberate cash to reward itself and its investors during the few years it owns the target.

Step six. The PE firm starts extracting money. It charges its investors a 2% annual fee. It charges the target a 15% “management fee.” It may pay itself a huge dividend. Cerberus Capital Management, which bought Mervyn’s department stores, split the company in two: a real estate division and a Mervyn’s store division. The real estate division promptly jacked up the rent on the store division.

Step seven. The PE firm sells the target, now crippled by debt and underinvestment. Or the target goes bankrupt, like Mervyn’s.

Consequences.

Within a few years, fees and dividends have earned the PE firm many times its original small investment. The PE firm’s investors sometimes do well, but often not, especially when the target goes bankrupt. The buyers of CLO’s from the banks also lose when the target goes bankrupt. Employees lose, both during initial cutbacks and eventual bankruptcy. Customers lose vital services, as when PE-owned hospitals cut nursing staff.  The whole economy loses, as once-competitive firms are weakened or destroyed.

But there’s worse to come. The PE firms went on a feeding frenzy during the bubble years leading up to 2008. They now own over 2000 target companies whose loan principal comes due around 2012. If half these go bankrupt, Kosman estimates, some 2 million of the 7.5 million PE firm employees could lose their jobs. And the collapse of CLO’s could wreak further havoc on the banking system.

Reforms?

An end to interest deductibility, or at least deductibility for buyout loans, would stop PE firms in their tracks. So would limits on corporate debt, or requirements that buyers of corporations hold them for at least five years. Eliminating the “carried interest” loophole, which allows financial managers to pay only the 15% capital gains rate, would also weaken PE firm’s tax advantages.

Kosman isn’t optimistic. Four of the past eight Treasury Secretaries now lead PE firms. New York Senator Chuck Schumer, the “senator from Wall Street,” raises buckets of money from PE firms for Democratic candidates. Efforts over the years to modify interest deductibility have gone nowhere. Even President Obama’s barely-controversial proposal to close the carried interest loophole did not make it into the final financial reform bill.

Meanwhile, with bank lending frozen, the PE firms have found new games. They still have $450 billion in committed funds from their investors. They are using these, with government help, to buy failing banks and tap into cheap government credit. They are also buying from one another, enabling them to charge their long-suffering investors new management fees.

(1) Possibly Irrelevant Image:

It's Going to Get Worse

Which  New York Times article are we to believe?

(2) Bernanke Says Rising Wages Will Lift Spending, from yesterday’s New York Times (check out the goofy pic of Geithner):

Federal Reserve Chairman Ben S. Bernanke said rising wages would probably spur household spending in the next few quarters, even as weak job gains dragged down consumer confidence.

Ben S. Bernanke, the Federal Reserve chief, spoke in South Carolina.

…

While the United States has “a considerable way to go” for a full recovery, “rising demand from households and businesses should help sustain growth,” Mr. Bernanke said on Monday in a speech in Charleston, S.C. “We are maintaining strong monetary policy support for the recovery,” he said in response to an audience question, without discussing any further action the Fed could take to aid growth.

Read the full article.

or (3) More Workers Face Pay Cuts, Not Furloughs, from today’s Times:

The furloughs that popped up during the recession are being replaced by a highly unusual tactic: actual cuts in pay.

Local and state governments, as well as some companies, are squeezing their employees to work the same amount for less money in cost-saving measures that are often described as a last-ditch effort to avoid layoffs.

A new report on Tuesday showed a slight dip in overall wages and salaries in June, caused partly by employees working fewer hours.

Though average hourly pay is still higher than when the recession began, the new wage rollbacks feed worries that the economy has weakened and could even be at risk of deflation. That is when the prices of goods and assets fall and people withhold spending as they wait for prices to drop further, a familiar idea to those following the recent housing market.

The article includes a picture of a worker from the Mott’s (apple juice) plant in Williamson, NY, where workers have gone on strike rather than accept pay cuts.

This article says that there’s a risk of deflation, whereas the other article, from happier, more optimistic times (viz., earlier this week) has the goofy Geithner saying that the economy is “healing,” and that the economy is “in no danger of confronting a deflationary threat like the challenges that have faced the Japanese economy.”

(4) Employers Strike–Because They Can, John Miller’s column from the current issue of Dollars & Sense.  Same reason they cut wages–unless the sisters and brothers at Mott’s have something to say about it.

–Chris Sturr

PS:  Ok, I couldn’t resist Photoshopping today’s Potentially Irrelevant Image with the goofy picture of Geithner:

I hope I’m not violating anyone’s intellectual property rights…

(1) Possibly Irrelevant Image:

I've Got My Eye on You

(2) Top Secret America: The series of articles by Dana Priest and William M. Arkin in the Washington Post about the growth of the national security sector, and especially of private contractors doing surveillance work for the government, has made a splash. (I like how WashPo has given the series its own dedicated multimedia website–very cool.)

Our feature article by Tom Barry, Synergy in Security, in our March/April 2010 issue, covers some of the same ground, though without the investigative resources.  Both tell about the vast growth of the security sector, overlap between military contractors and security contractors, unaccountability, and how contractors have become so intertwined with the military and government departments that the latter are dependent on the former, and the former end up performing “inherently government functions” (which they aren’t supposed to).  (I don’t like the way that phrase is constructed–shouldn’t it be “inherently governmental functions”? But that’s the phrase they use, according to the series’ second article National Security Inc.)

Here’s an interesting tidbit from the third article in the series, The Secrets Next Door, whose subtitle reads: “In suburbs across the nation, the intelligence community goes about its anonymous business. Its work isn’t seen, but its impact is surely felt.” The counties where security contractors are concentrated are among the wealthiest in the country:

“These are some of the most brilliant people in the world,” said Ken Ulman, executive of Howard County, one of six counties in NSA’s geographic sphere of influence. “They demand good schools and a high quality of life.”

The schools, indeed, are among the best, and some are adopting a curriculum this fall that will teach students as young as 10 what kind of lifestyle it takes to get a security clearance and what kind of behavior would disqualify them.

Outside one school is the jarring sight of yellow school buses lined up across from a building where personnel from the “Five Eye” allies – the United States, Britain, Canada, Australia and New Zealand – share top-secret information about the entire world.

****The buses deliver children to neighborhoods that are among the wealthiest in the country; affluence is another attribute of Top Secret America. Six of the 10 richest counties in the United States, according to Census Bureau data, are in these clusters.****

Loudoun County, ranked as the wealthiest county in the country, helps supply the workforce of the nearby National Reconnaissance Office headquarters, which manages spy satellites. Fairfax County, the second-wealthiest, is home to the NRO, the CIA and the Office of the Director of National Intelligence. Arlington County, ranked ninth, hosts the Pentagon and major intelligence agencies. Montgomery County, ranked 10th, is home to the National Geospatial-Intelligence Agency. And Howard County, ranked third, is home to 8,000 NSA employees.”

Hat tip to our intern Elizabeth Murphy for finding this passage. Read the whole series.  Read our article, Synergy in Security.

(3) Gleen Greenwald on Project Vigilant:  Hat-tip to Aslam K. for pointing us to Glenn Greenwald’s piece at Salon.com about a “highly secretive group called Project Vigilant”;  the group played a role in the discovery of the source of the Wikileaks leaks about Afghanistan:

Forbes‘ technology writer Andy Greenberg reports that at the Defcon Security Conference yesterday, an individual named Chet Uber appeared with revelations about the case of accused WikiLeaks leaker Bradley Manning and government informant Adrian Lamo.  These revelations are both remarkable in their own right and, more important, highlight some extremely significant, under-examined developments unrelated to that case.  This is a somewhat complex story and it raises even more complex issues, but it is extremely worthwhile to examine.

Uber is the Executive Director of a highly secretive group called Project Vigilant, which, as Greenberg writes, “monitors the traffic of 12 regional Internet service providers” and “hands much of that information to federal agencies.” More on that in a minute.  Uber revealed yesterday that Lamo, the hacker who turned in Manning to the federal government for allegedly confessing to being the WikiLeaks leaker, was a “volunteer analyst” for Project Vigilant; that it was Uber who directed Lamo to federal authorities to inform on Manning by using his contacts to put Lamo in touch with the “highest level people in the government” at “three letter agencies”; and, according to a Wired report this morning, it was Uber who strongly pressured Lamo to inform by telling him (falsely) that he’d likely be arrested if he failed to turn over to federal agents everything he received from Manning.

So, while Lamo has repeatedly denied (including in his interview with me) that he ever worked with federal authorities, it turns out that he was a “volunteer analyst” for an entity which collects private Internet data in order to process it and turn it over to the Federal Government.  That makes the whole Manning case all the more strange:  Manning not only abruptly contacted a disreputable hacker out of the blue and confessed to major crimes over the Interent, but the hacker he arbitrarily chose just happened to be an “analyst” for a group that monitors on a massive scale the private Internet activities of American citizens in order to inform on them to U.S. law enforcement agencies (on a side note, if you want to judge what Adrian Lamo is, watch him in this amazing BBC interview; I’ve never seen someone behave quite like him on television before).

(I love that this guy’s name is “Uber.”) Someone should crosscheck to see whether Project Uber, I mean Project Vigilant, is mentioned in the WashPo series. Elizabeth?

Read the whole post.

–Chris Sturr