Wednesday, July 8, 2009

Should Congress or President Obama Restore The Funds Earmarked For Social Security?

In a comment On July 07, 2009, at 7:50 PM re the Motley Fool article I discussed in my prior post, "LessGovernment" detailed a useful timeline. I need to compare it to the one in an earlier post of mine:

However, I believe the author of the comment makes a few incorrect points and confuses "less government" with honest government:

With respect to Social Security Insurance the author writes "You have to look back at the government's ability to predict what these plans will cost to see how bad government's planning really is. For example, when social security was first introduced, it was funded with a 1% tax on the first $3000 of wages, or $30 per year. How has that funding mechanism stood the test of time and plan expansion? Well, today, the bite from payroll taxes is 15.3% of the first $102,000 ignoring the taxes applied above that point which are still substantial, but for arguments sake, I am keeping this simple. Plan expansion has resulted in tax expansion to the point that $30 per year has morphed into $15,606 dollars per year for higher compensated workers, yet these plans are still under funded."

The writer goes on: "It obviously makes no difference how much the government takes in payroll taxes, these plans will never be fully funded because the government has not been able to save one thin dime in our 233 year history..."
I disagree. Social Security was sold as an insurance plan. The premiums were originally kept track of as a unique item within the general fund. The plan worked properly until President Clinton removed the special label of Social Security account funds to make his budget look like it had less of a deficit. To preserve the Social Security Insurance's ability to pay into the future, we must restore the earmarked funds and their compound interest over the years that were removed by the Clinton administration and the Bush administration. Of course, that will increase the current budget shortfall, but Social Security will be honestly and better funded, thank you. Thieves have robbed the capital from our Social Security insurance policies. Your policy, my policy, and our children's and grandchildren's... Those stolen monies should be repaid today. I will be happy to help calculate how much was stolen and how much compound interest for each year's stolen funds must be returned to the Social Security account forthwith.

In my opinion, "LessGovernment" is wrong about needing less government. All the rules put in by the Roosevelt Administration were essential to the preservation of our economy and of our social fabric. What we do need is honest government.

Below is a good portion of the comment by LesGovernment..

by LessGovernment
July 07, 2009, at 7:50 PM


Following the last great depression, Congress met and discussed the root causes of what killed the economy way back there in 1929. The result of their findings was that reckless behavior and speculative buying on wall street created a bubble that was not supportable by balance sheet assets. Stocks, banks, and life savings crashed as a result.

In 1933,

to keep this problem from occurring again, Congress created some support for the bank depositor in the form of the FDIC (Federal Deposit Insurance Corporation) and also mandated through the Glass-Steagall Act that banks that were federally insured would not be allowed to engage in insurance and other high risk businesses. If the government was going to insure your deposits at the local bank for your benefit and security, the local bank was going to behave and not engage in risky activities. We had learned a lesson in 1929 at great cost for the education, and this legislation was going to prevent the depression from happening again.

In 1971,

Congress passed the Federal Election Campaign Act which permitted Political Action Committees to make larger contributions to Congressional candidates than what was allowed by law for individuals. In short, Congress passed their own version of campaign finance reform that created the ability to have unlimited funding since there is no limit on the number of PAC's that can be created and nothing to prevent multiple PAC's from contributing to the same candidate. This (bad) legislation was intended to give the incumbent a definite edge over any challenger and help insure political dynasties.

In 1974,

Congress passed legislation called ERISA (Employee Retirement Income Security Act) through which the taxpayer would guarantee retirement expenses for any defined benefit plan that went into default. With this legislation also came the mandate for Congressional oversight through sub agencies that would require businesses to fully fund their plans. Well, oversight did not occur and plan administrators were allowed to use wildly optimistic assumptions to show the plans were funded when in fact they were not fully funded. These assumptions went something like this "The assets in the plan next year will earn 18% in the stock market, so we don't have to invest earnings into the plan and in fact, can remove money from the plan because based on our assumptions, the plan is over funded". As a result of the lack of oversight and enforcement, under funded retirement plans are now common. The Pension Benefit Guarantee Corporation (the fund now guaranteeing these plans that was created under ERISA) lacks sufficient funds to perform its function of guaranteeing these under funded plans. As a result of the lax oversight and the regulators allowing the use of the wildly optimistic assumptions as to funding needs, this Act will claim more and more taxpayer monies as more and more plans that have not been funded as required by law will have to be funded by the government (taxpayers). What has been set in motion is taxpayers with drastically reduced discretionary incomes for now and well into the future will now be the source of funding for the under funded plans that have on average much higher benefits than anything the average taxpayer now providing the funding will ever receive. Just another of the many unintended consequences of government run amuck as government drives headlong into socializing corporate losses to the taxpayer.

In 1977,

The Community Reinvestment Act (CRA) was passed. This act, as stated in its own words, "intended to encourage depository institutions to help meet the credit needs of the communities in which they operate, including low and moderate income neighborhoods, consistent with safe and sound banking operations". What was intended, and what occurred through enforcement are two entirely different results. This Act would later become instrumental in the economic disaster of 2007, some 30 years after passage of this act, because this Act enabled Congress and at least one President to "manage" (socialize) banking, mortgages, and credit which directly caused an overall lowering of quality of the mortgages used to back securities sold around the world. This was especially true during the Clinton administration from which pressure was applied to Fannie Mae and Freddie Mac to ease the credit restrictions on the mortgages they were buying. This was done to allow those without sufficient credit to still have access to a mortgage with only a slight increase in the interest rate to be paid. In other words, under enforcement of this act, the higher risk of loaning money to less credit worthy applicants was not to be offset with higher potential rewards in the form of a much higher interest rate. In fact, the interest rate differential for the much higher risk of default was only 1 percentage point and even then for only two years if the loan was paid on time. This "socialist" approach to the mortgage industry was obviously dangerous, and accordingly, the alarm was sounded by New York times writer Steven A. Holmes in an article entitled Fannie Mae Eases Credit To Aid Mortgage Lending dated September 30, 1999 (Google it to read it). Unfortunately, few if any of those that read the article (including all members of Congress) understood the ultimate scope and horrific impact this credit easing would eventually have. Few if any also understood how this very credit easing would ultimately lead to a major problem in the banking industry due to the failure of derivatives based on the mortgages created using these lax credit standards. This act, as enforced and regulated, actually lowered the mortgage standards for the entire mortgage industry and helped create the atmosphere of lax enforcement that also allowed shoddy appraisal work, little or no verification of ability to repay the loan, sloppy ratings of collateralized debt instruments, and what later became known as "predatory lending". In addition, enforcement of this act time and again caused banks to pay what amounted to extortion in order to gain regulatory approval for a new branch or an acquisition of another bank. This Act, and its socialist enforcement severely weakened the banking and credit industries.

In 1997,

Congressional oversight allowed Citi Bank to buy Travelers Insurance even though this transaction was in total violation of the Glass-Steagall Act passed by Congress in 1933. Thus the illegal birth of the era of "Financial Services" in which banking businesses insured by the government through the FDIC and other agencies were now to be allowed to get involved in the riskier aspects of financial services such as insurance and investment banking while still being federally insured.

In 1997,

Congress granted the illegal new business entity now called Citi-Group an exemption to the Glass-Steagall Act so it could operate in the temporary legal status of violating the Glass-Steagall Act but do so with permission from Congress. This is about as close to a Congressional "Get out of jail Free" card as you will ever see. PAC's were at the heart of this exemption being granted.

In 1999,

the Graham-Leach-Bliley Act was passed basically repealing the Glass-Steagall Act altogether. Citi-Group, as well as many, many others, could now legally operate without the Glass-Steagall Act exemption granted by Congress. The doors were now wide open to mix federally insured banking with risky investment banking, insurance, and "insurance like" businesses such as credit default swaps. Out the window went the knowledge and lessens learned from the great depression, and the stage was now set for a repeat of history as PAC's applied pressure to Congress for more and more deregulation in exchange for more and more campaign funds. The only thing now standing between loosely regulated banking and federal insurance and total banking failure is the requirement to hold sufficient amounts of capital to backup the "insurance like" promises of credit default swaps and debt instruments and derivatives. The exact wording in this legislation as to these important aspects follows:

Repeals the restrictions on banks affiliating with securities firms contained in sections 20 and 32 of the Glass-Steagall Act.

Creates a new "financial holding company" under section 4 of the Bank Holding Company Act. Such holding company can engage in a statutorily provided list of financial activities, including insurance and securities underwriting and agency activities, merchant banking and insurance company portfolio investment activities.

Oddly, this act did ask for a study to be conducted on derivatives and their risk, but apparently, no one got the message or if they did, they either performed a bad study (surprised?) or they failed to share it with anyone. This act also shows that as early as 1999, there was growing concern over the Frankenstein of banking "sort-of-banking" that this legislation was bringing to life. Frankenstein would later be known as "to big to fail". The exact wording in this legislation as to this important aspect follows:

Provides for a study of the use of subordinated debt to protect the financial system and deposit funds from "too big to fail" institutions and a study on the effect of financial modernization on the accessibility of small business and farm loans.

This piece of legislation, not yet harmful enough, also reinforced the Community Reinvestment Act (CRA) of 1977 in a couple of significant and harmful ways. This was done by withholding Federal Reserve permits for a new branch or to form a new bank holding company if the entity applying for the permit did not rate "high" enough during the latest CRA compliance exam. CRA compliance regulators now had the power to stop a bank's growth or even withhold its permit to operate. This provision is referred to in the 1977 CRA paragraph above as having "…caused banks to pay what amounted to extortion". The exact wording (and it is despicable) in this legislation that did this follows:

The Federal Reserve may not permit a company to form a financial holding company if any of its insured depository institution subsidiaries are not well capitalized and well managed, or did not receive at least a satisfactory rating in their most recent CRA exam.

If any insured depository institution or insured depository institution affiliate of a financial holding company received less than a satisfactory rating in its most recent CRA exam, the appropriate Federal banking agency may not approve any additional new activities or acquisitions under the authorities granted under the Act.

My Explanation of the above- If any single branch of your thousands of branches (if you are a large bank) did not "earn" a satisfactory rating from the CRA examiner, the entire banking operation had a big problem. The CRA examiner at this point has too much power, the CRA exam is too suggestive, and the CRA exam has absolutely nothing to do with sound banking practices, and in fact, throws sound banking out the window as the CRA forces banks to be politically correct at the expense of sound banking. This is where the banks were forced to pay "extortion" in the form of knowingly making bad loans in order to survive and prosper under CRA. This is a world gone mad and the entire world will pay a dear price for this in 2007-2008-2009-2010-2011 and beyond.

In 2000,

The Commodity Futures Modernization Act was passed with support from Fed Chairman Alan Greenspan and mostly Republican support in congress. It and was introduced and supported in the House as H. R. 5660 by Thomas Ewing (R-IL), Thomas J. Bliley, Jr. (R-VA), Larry Combest (R-TX), John J. LaFalce (D-NY), Jim Leach (R-IA), and was introduced and supported in the Senate as S. 3283 and was sponsored and supported by Sen. Richard Lugar (R-IN), Sen. Peter Fitzgerald (R-IL), Sen. Phil Gramm (R-TX), Sen. Chuck Hagel (R-NE), Sen. Thomas Harkin (D-IA), and Sen. Tim Johnson (D-SD).

This Act was signed into law by President Bill Clinton (the same president that had been pushing Fannie and Freddie to lower credit standards on the loans they would buy) in December 2000

What this Act did that was so bad was simply to make most over-the-counter derivatives contracts outside the regulatory purview of all federal agencies, even the Commodity Futures Trading Commission.

With the new law on the books, the market for credit default swaps exploded from $632 billion outstanding in the first half of 2001, according to the International Swaps and Derivatives Association, to $62 trillion in the second half of 2007.


The reader should take note that Congress has at this point:

Removed the banking industry safeguards put in place following the great depression

Forced banks to make what amounts to bad loans

Forced Fannie Mae and Freddie Mac to lower their credit standards

Forced Fannie and Freddie to buy the bad loans banks and other loan originators were being forced to make under the Community Reinvestment Act

Allowed Fannie and Freddie to securitize and sell to the world AAA rated securitized debt that used bad loans as collateral

Forced (through CRA enforcement policies) the entire banking industry to become politically correct regardless of risk and potential cost

Failed to regulate the banking industry adequately

Placed regulation responsibility of international banks onto states for the insurance like activities of the banks (an impossibility)

Failed to regulate and enforce ERISA law

Failed to ensure pension plans were adequately funded as required by law

Allowed government insured banks to get more and more involved in the riskier banking functions regardless of the risk being transferred to the taxpayer.

In short, Congressional legislation and lack of oversight had at this point put the entire economy on a course to disaster. This disaster could still have been avoided, but people, especially those in Congress, had to listen to the warnings. They didn't.

In 2002 and 2003, with the stage set as described above, Congress failed to listen to the testimony in Congress, on the record, from experts that Fannie Mae and Freddie Mac now represented huge systemic risk to the entire financial system through the "assumed" risk that the GSE's were backed by the government. Keep in mind that at this point in time, the GSE's were, by act of Congress, NOT backed by the federal government. All that was being asked of Congress in this testimony was to simply make that fact clear, that no government guarantee existed.

Instead, Congress (under the leadership of Barney Frank and others) pushed even harder for the GSE's to increase home ownership through purchasing even more risky mortgages with little or no money down and other obviously bad practices. In the process, the balance sheet exposure (risk to the taxpayer) increased from 132 billion of exposure in 1990, to 1.5 trillion in 2005, to 5.2 trillion in 2007. When the housing bubble began to pop in late 2005 or early 2006, Fannie and Freddie immediately fell into desperate financial condition due to the accounting irregularities on their books and their low grade collateral that was being used to back the trillions of dollars of securitized debt.

Now, with the stage completely set for economic catastrophe, that is exactly what America got.

There is only one reasonable reaction at this point in time and that is to Fire Congress. Do not vote for an incumbent ever in the future. Do not re-elect anyone. This, and only this, will remove the power and influence of the PAC's (bad legislation) and curtail the need to write ear marks to benefit special interests in exchange for campaign funds.




We have now reached the point where the Federal Reserve Bank itself is giving IOU's to the Treasury for the Treasury debt it is purchasing. In other words, we are now at the point of selling our debt on credit. This is simply nuts.

ERISA funds are over committed, the FDIC is running low on funds and will need more from the Treasury, the federal highway fund is broke, Social Security is unfunded, Medicare is unfunded, federal retirement is unfunded, and now states are coming forward and asking to be bailed out of their own multi-billion dollar problems.

We will most likely add over five trillion dollars of debt and exposure (guarantees) to our 9 trillion dollar November 2007 national debt before the end of 2011. Our unfunded obligations of Social Security, Medicare, federal retirement, and others now exceed 80 trillion dollars. And what is the government now trying to do? Are they cutting spending? Are they trying to get the financial house in order? No. They are trying to create yet another plan called government provided health care that they will also not be able to fund.

If they want this plan, we should first insist that social security is put on a track of being totally funded first, and the same for Medicare, and the same for government retirement, and the same for the federal highway fund, and the same for PBGC, and the same for FDIC, and the same for FSLIC, and the same for all the others, or kill one or more of these plans if they can not be fully funded. Once all these unfunded obligations are totally funded or killed, then and only then should we proceed with any new entitlements. However, judging from the careless and reckless legislation from the past, and the speeches and promises of today, there is little hope that the new administration and Congress will be this logical.

You have to look back at the government's ability to predict what these plans will cost to see how bad government's planning really is. For example, when social security was first introduced, it was funded with a 1% tax on the first $3000 of wages, or $30 per year. How has that funding mechanism stood the test of time and plan expansion? Well, today, the bite from payroll taxes is 15.3% of the first $102,000 ignoring the taxes applied above that point which are still substantial, but for arguments sake, I am keeping this simple. Plan expansion has resulted in tax expansion to the point that $30 per year has morphed into $15,606 dollars per year for higher compensated workers, yet these plans are still under funded.

It obviously makes no difference how much the government takes in payroll taxes, these plans will never be fully funded because the government has not been able to save one thin dime in our 233 year history. And with the government tax bite growing all the time, the taxpayer due to tax creep is now nearing the position, or is already in the position of not being able to save. This is the quandary we now face. The government won't save and the taxpayer can't save so we borrow the money we need to run our lives from countries around the world and commit yet more tax dollars to debt service making the matter worse. This is ridiculous. What is even more ridiculous is the president wants to add yet another plan...




Tuesday, July 7, 2009

The New Subprime

Morgan House wrote an interesting article that appeared recently on the Motley Fool Website.

The causes are more fundamental than those identified by the author in the following two paragraphs of the article:

1. "In short, many "prime" borrowers might just be subprimers with inflated credit scores. This is also true for people who used the proceeds from home equity loans on one property as a down payment for another. The big down payment made the borrowers look financially fit, but it was all an illusion that didn't reflect their true creditworthiness. They were simply moving debt from one inflated house to another."

2. "In addition, the housing bubble's income distortion also made millions appear more creditworthy than they really were. According to noted economist Mark Zandi, 23% of all new jobs created during the 2003-2006 recovery were housing-related. This includes everyone from mortgage bankers at Citigroup (NYSE: C) to construction workers at KB Home (NYSE: KBH) to (ostensibly) checkers at Home Depot (NYSE: HD). To some degree, the prosperity of all of these jobs was artificially magnified. In a wildly extreme example, Faber's book describes people who went from delivering pizza to working as mortgage brokers making $20,000 a month. (I'd assume they ultimately wound up in the unemployment line). All of this created a stunning short-term illusion of prosperity that allowed armies of borrowers to qualify as "prime" when they were far, far from it."

Due diligence, or should I say Honest Due Diligence, on the part of the lender would not permit granting any high rating to these borrowers. As of last week, the Hudson City Bancorp which is good sized, has six (6) defaults in New Jersey. Yes, six, not six thousand. All of these six are due to second mortgages issued by large "Banks." Hudson City Bancorp (HCBK Quote) Chairman, President and CEO, Ron Hermance, has noted that he realizes a good profit from each of these defaults, because he underwrote, if memory serves me correctly, only a fraction of the current actual value today!!! He and his mortgage writers just did their homework and loaned on value. ALL of the phony reasons cited for lending to people whose property had much lower values were fraudulent.

This was ALL the same scam. The scam is turning in phony information with inadequate documentation. I have bought and sold lots property over the years. In the last twenty years I had to provide proof of everything. That included two years of Federal tax returns!!! That was true when I bought my current house in Tucson in 2000. The need to prove ability to pay went away in the last few years.

Phony credit scores are irrelevant. Where was the due diligence on the part of the issuing lender and on the part of the receiving lender?

There was a lot of fraud because the fees and bonuses for being a conspirator in this large scale conspiracy to commit fraud were so large.

OK, the "Writers" at mortgage companies of the low or no documentation mortgages and the bank officers who purchased them were crooks. We can identify further the appraisers who asked "what number are you looking for"?

Let us not forget the folks at the rating agencies who rated the credit worthiness of these sliced and diced phony "financial instruments" as AAA when it was clear they were intrinsically worthless. If you are lending to those who will not be able to meet the payment in 39 months, then you know there is no one who will be left to buy from them at that time in the future. That means prices will have to fall. That means refinancing at higher prices will no longer be possible. The rating agencies should have flagged that! However, the rating agencies were paid by the lenders, often big banks., The government encouraged the phony ratings so it could say the Gross Domestic Product was rising, as it was actually falling.

Stupidity did play a role, but this had nothing to do with stupidity on the part of all the conspirators I have mentioned.

This appears to be grounds for prosecution under the Rico Act. We just need to find an aggressive and relentless prosecutor who can be guaranteed protection for himself and his or her family by the same folks who guard the President. "POTUS is moving" would then mean Prosecutor Of the Undeserving Sleaze-bags is traveling.

I really am simply pointing out the causes stated in the articles, while interesting, are not the actual root causes, which are the ones I have noted.