The Debt Crisis: Real and Imagined

Memo to Congress: Show Us the M-O-N-E-Y!: Part 2 of 3

by Geraldine Perry / February 19th, 2011

Like the Fed, states and local governments appear to be between a rock and a hard place, and like the Fed’s QE2 program now aimed at Main Street, solutions for state and local governments have been so far less than palatable. One such solution known as “infrastructure privatization” has been rapidly gaining momentum in recent years and involves the sale and/or lease of public assets to private interests. These assets include such things as airports, parking meters and parking garages, public water and utility systems, toll roads and bridges, sea ports, zoos and other outdoor spaces, and more — all originally built by taxpayers and paid for with taxpayer monies.

Metered municipal street and garage parking spaces are among the most popular of recent municipal privatization schemes with one of the first taking place in Chicago “where the city received $1.16 billion in 2008 to allow a consortium led by Morgan Stanley to run more than 36,000 metered parking spaces for 75 years.” Essentially Chicago residents and visitors will, for the foreseeable future, be paying Morgan Stanley and cohorts for the privilege of using parking meters that had already been built and paid for by taxpayers – the income from which heretofore had been used primarily for governmental operating expenses.

This particular parking meter deal, similar to many such “privatization” schemes, immediately translated into higher fees – which not only resulted in a huge public outcry but prompted the inspector general to assert that “the city was short-changed by about $1 billion” based on the new fee structure. Meanwhile alderman, Scott Waguespack, who voted against the lease, noted dryly that “The investors will make their money back in 20 years and we are stuck for 50 more years making zero dollars.” But perhaps the biggest blow to the city came when Fitch Ratings downgraded Chicago’s bond rating to “AA” from “AA-plus” last August, a move which could – happily enough for the banks – raise the city’s borrowing costs. This downgrade, Fitch said, was due in part to Chicago’s “accelerated use of reserves to balance operations.”

Chicago’s experience is not an isolated one but many nevertheless insist that such privatization schemes may now be an essential element of the fiscal pie, one important ingredient of which includes, disconcertingly enough, foreign investors. Overall the results aren’t pretty even when analysts such as Robert Kurtter, a managing director at Moody’s, opine that: “We view these asset sales as 1-shots…that create structural budget imbalances in future years, but that may be necessary actions to bridge the time gap until revenue stabilization or growth returns.”

Not only is this privatization trend “being spurred by a cottage industry of consultants, lawyers and bankers” but even more importantly, it amounts to a fire sale that could help plug budget holes now but worsen their financial woes over the long run.” Some have gone so far as to say, not wholly without justification, that this collective governmental move toward privatization of public assets amounts to little more than corporate fascism – ruled by government proxy through state appointed regulators, rather than citizen votes.

The Debt Crisis, Real and Imagined

Curiously, and at the same time that local governmental entities have been selling off public assets to buyers far and near through “infrastructure privatization,” many have also been actively acquiring a wide variety of assets as investment vehicles and profit centers. These assets, taken together, show that “collective government has controlling interest in all Fortune 500 companies and most other major corporations in and outside of the United States.” Documented evidence of this can be obtained through careful study of at least a portion of some 185,000 governmental entities – everything from school districts to city and county governmental bodies to state government – now using CAFRs, or the Comprehensive Annual Financial Reporting System.

Used by investment rating companies such as Moody’s and Standard and Poors to determine a state’s fiscal integrity and set bond rates, these CAFRs are an accounting tool meant to reflect “a thorough and detailed presentation of the state’s financial condition.” The Institute for Truth in Accounting describes the CAFR mechanism this way (emphasis mine):

While typical state budgets are often created without much regard to sound accounting practices state annual reports are subject to established accounting principles… This collection of “best practices” is known as “Generally Accepted Accounting Principles” or “GAAP”….

In our view, private sector GAAP is more comprehensive and mature than the GAAP established for state and local governments and the GAAP established for the federal government.

Each state budget is its annual blueprint for how the state resources will be spent, while the Comprehensive Annual Financial Report (CAFR) is the document that reports how the resources were employed…

The CAFR is prepared using state and local GAAP established by the GASB. GASB GAAP requires that the CAFR consists of two major sections: introductory and financial…

Included in the financial section are the financial statements for eleven funds which are categorized as governmental, proprietary and fiduciary funds. Every major fund in each of these categories is presented separately. (italics mine)

For all governmental entities using it, the CAFR accounting system in effect functions as a catalog of various types of funds, including institutional funds, enterprise funds or financial holdings, assets and investment funds. These are divided into three main categories, and one additional called “component units.” Pension Trust Funds and Investment Funds are examples of Fiduciary Funds; Unemployment Insurance and University Funds are examples of Proprietary Funds; and the General Fund and Road Fund are examples of Government Funds.

The budget we most often hear about only involves the Government Funds category. It is within this category that we find revenues received – including investment and tax revenue – for the financial period, together with expenditures for specified units of government, including education and social services plus police, fire, park and transportation services. In other words, the most basic functions a governmental entity provides are accounted for here.

Surprisingly, the budget as reported in the CAFR does not always include all of the governmental-type funds within that category — and the funds within the remaining three CAFR categories are never part of the budget. Moreover, and because CAFRs are often published after the next year’s budget is considered and sometimes even after it has been approved, expenditures and unused revenues detailed within that CAFR cannot properly be taken into consideration in the preparation of the next budget. In other words, the budget as we know it covers only a small and somewhat misleading portion of a governmental entity’s financial condition.

According to Lt. Colonel Gerald R. Klatt, who had worked as both an auditor for the US Air Force, and later as a federal accountant with 15 years of CAFR experience:

This is the most deceiving topic that governments, politicians, and the news media have conveyed to the public about governmental financial matters. In reality, a government can simultaneously have a budget shortfall and a financial surplus of the taxpayers’ money.

The now deceased Klatt, whose website is maintained by former Commodities Trader and fellow researcher, Walter Burien, made note of the fact that most of the surpluses in question are located NOT in the Government funds category where the (usually out-dated) operational budget is found, but rather in the other three categories. Mr. Klatt defined surpluses as “funds that are not required or needed for the operation of all government operations, funds, accounts, agencies, etc., directly or indirectly, for the year(s) covered by the budget which is usually one to two years.”

He goes on to say that “what we have found is that most governments have huge amounts of cash and investments on hand at the end of the fiscal year. And somehow these cash and investments are not being recycled back through the budget process the next year, but are being held year-after-year.”

While most Americans assume that local, state and the federal governments are non-profit organizations operating on a “pay-as-you-go” basis, a fair study of the CAFRs shows that this is simply not the case. Klatt maintains that – except for retirement/pension funds – they should be, and further, that reform of the CAFR system properly belongs to experienced accountants and not to lawyers.

According to the Institute for Truth in Accounting — which focuses on the budget portion of the Governmental Funds CAFR category — major operational budgeting problems stem both from the fact that most such budget reports are not released in a timely fashion and also because most state budgets employ two different accounting mechanisms for the CAFR accounting categories. The accrual accounting method is used for the fiduciary and proprietary funds, while the modified accrual method (which is very similar to the cash-based or pay-as-you-go method) is applied to the Governmental Funds category.

While there would be no significant difference between accrual-based and cash-based budgeting for transactions such as grant payments, salaries and other general expenditures, the situation changes when it comes to long-term assets such as infrastructure or commitments such as post-employment health care benefits which are typically handled in the operational budget. In these cases, says the IFTA, “an accrual budget would recognize costs earlier, when the commitment is made, and thus enhance the legislature’s ability to understand and control these costs.” This is because the “accrual system’s major goal is to properly define and match revenues with the actual costs and expenses incurred during the fiscal period.”

Klatt, in apparent partial opposition to certain IFTA positions, maintains that governmental entities should operate on a zero-based budgeting procedure, with little or no cash and investments on hand at the end of each fiscal year. However, and while not specifically addressing accrual accounting, Klatt essentially agrees with IFTA’s relevant points when he writes: “Budgeted expenditures should be last year’s expenditures (as shown in the CAFR) with an adjustment for increase in requirements (costed out) or reductions in requirements.” In other words, revenues should be properly defined and matched with the actual costs and expenses incurred during the fiscal period.

Mr. Klatt’s research sheds important light on the little understood CAFRs by explaining in clear terms the manner in which profit centers are often set up under fund categories that are separate from the reported budget. This is accomplished by applying unrecognized surpluses carried over from previous budgets — and within funds themselves — toward the purchase of a variety of investment vehicles. This situation goes a long way towards explaining charges of government corporatism, oligarchy and even fascism running through the public discourse.

No small degree of credibility is given to theses charges when one understands that — just as increasing numbers of municipalities have been incorporating themselves¹ , ² over the past few decades — so too are increasing numbers of governmental agencies and even pension systems organizing themselves under corporate charters. Most participate in global financial opportunities and some are, themselves, organizing under international guidelines for corporations, apparently in order to gain greater unfettered access to international markets.

For example, on March 18, 1996 the California Public Employee Retirement System adopted an international corporate governance program “designed to increase returns on the System’s international equity portfolio [which could potentially] generate an additional half billion dollars annually.” A few months later, on December 18 Calpers “announced an historic partnership with the prestigious Asian Development Bank (ADB) to make long-term, direct private equity investments in the emerging markets of the Asian-Pacific region.”

Describing itself as “the largest U.S. public pension fund, with assets totaling $201 billion spanning domestic and international markets as of February 28, 2010,” it stated in a 2004 document on its global corporate governance principles that “[a]t Calpers, corporate governance is about making money, not changing the political or social environment.” Proving its point in 2007, Calpers, as “the 13th largest holder of Berkshire Hathaway stock, sided against an investor who want[ed] Berkshire to sell its stake in PetroChina as a statement against violence in Sudan.”

It is important to understand that stock market fluctuations are essential to the long term health of these behemoth funds because they are able to profit from down markets by taking advantage of low asset (fire sale) prices and “cheap” money — and by selling high in up markets. Yet somehow the oftentimes significant financial holdings of these governmental units are both poorly understood and vastly under-reported.

In sharp contrast, the general operational budget is discussed without respite every minute of every day, with short-term, and thus wholly inadequate or inappropriate, solutions haggled over by increasingly divided factions. On its Issues Update page the Illinois Retirement System (a much smaller behemoth than Calpers) explains the “public debate” this way:

In recent months, while reporting on the financial problems faced by Illinois and other states, several news organizations, including the New York Times and Fox News, have focused attention on public pension systems throughout the country as one reason why states are facing multi-million-dollar revenue shortages.

The common thread in these stories is that public pensions are too generous, are mismanaged, make too many risky investments and force states like Illinois to spend billions of dollars every year on retirees instead of state services, and that increases the potential for budget deficits and higher taxes.

TRS has not been immune to these complaints, but in most cases the criticisms have been outright falsehoods. TRS can refute the inaccuracies . . .

Over and above the untold millions spent annually on borrowing costs associated with bond debt, untold millions – even billions – of dollars, are going toward fees and commissions to manage and purchase investments for these various funds. For example, for FY2000 the manager fees for CALSTERS alone was $55 million. Domestic broker commissions totaled $4.8 million, and international brokers commissions totaled $11 million for that same pension fund.

While too few are aware of these assorted fees and commissions, some may nevertheless recall the scandal that arose in August 2005 after federal prosecutors raised concerns about the $4.5 million in fees that had been offered by The Carlyle Group, self-described as a leading defense contractor, to one Robert Kjellander for his help in landing business with the Illinois teachers pension fund.

A spokesman for Carlyle, of course, maintained that Kjellander’s fees weren’t unusual and in any case the average returns on these fund’s investments was at that time 45% per year. The underlying message of this was: who could complain about high fees in the face of such returns, even if the returns, themselves, had the unmistakable taint of blood and corruption written all over them? The same Kjellander had previously raised eyebrows in 2003 when he received an $809,000 consulting fee from Bear, Stearns Inc. after Democratic Governor Rod Blagojevich picked that investment house to handle $10 billion in pension fund bonds. The firm, itself, received $8 million for handling the bond issue.

Over the decades, these various CAFR funds have, when taken together, reportedly accumulated ‘liquid’ investment assets conservatively as of 1999 exceed[ing] 60 trillion dollars and as of 2010 within its continued growth over 100 trillion dollars has been reached.” This according to research done by Walter Burien, mentioned earlier.

The biggest shock per Burien’s research is that two thirds of total government income is now actually coming from non-tax sources, with major revenues coming from the defense industry, big pharma, big banks, agribusiness, big oil and gas, foreign currencies and emerging markets — through the investment activities of these various funds. Moreover, massive profits from these investments have led to equally massive levels of corruption, about which neither the public nor most government officials nor most of those involved in the financial industry have first hand knowledge.

The most recent example of such corruption is coming from SEC efforts to identify fraud in the nearly $3 trillion dollar muni bond market and to crack down on pay-to-play schemes that continue to infect the pension fund arena. While traditional pay-to-play schemes have “involved securities firms providing campaign contributions or other benefits to government officials to obtain underwriting business . . a new wave of pay-to-play has now been uncovered in numerous states, including New York, California, Illinois, New Mexico, and Kentucky, where firms provide kickbacks to individuals at public pension funds in exchange for an agreement to invest capital with the securities firm.”

One example of such pay-to-play schemes came to light as a result of New York Attorney General (now governor-elect) Andrew Cuomo’s investigation against several individuals in the New York State Comptroller’s office, including former Comptroller Alan Hevesi. The investigation was concluded last October when Hevesi pleaded guilty to accepting almost $1 million in kickbacks. In exchange for the kickbacks Hevesi admitted that he had approved $250 million in pension funds investments with a California private equity firm. For its part, “[t]he SEC has filed its own pay-to-play case alleging kickbacks against Hevesi’s former deputy comptroller and a top Hevesi political adviser, which is still pending, and is also reportedly investigating the pay-to-play practices at CalPERS. ”

Such scandals notwithstanding and as Gerald Klatt clearly pointed out, the single biggest problem associated with the manner in which various CAFR fund categories are handled is that the majority of fund-associated investments — including foreign companies and currencies, derivatives, and multi-national corporations — actually draw much needed money away from the community and into the international arena via the financial economy. Profit-making government owned corporations involving the development of community projects such as golf courses and community swimming pools are another part of the mix, but again, the focus is squarely on profit-making rather than broad-based community service. Moreover, and since these community projects are virtually always privately financed, the financial economy again benefits far more than the local community which must pay not only the debt principal and all associated project maintenance and oversight costs, but also all interest and fees associated with the debt as well.

All of which means that the local economy loses while the financial economy wins BIG TIME, effectively diverting Mr. Bernanke’s QE2 “money” spigot away from Main Street and toward Wall Street yet again. Moreover, and given the fact that Mr. Bernancke’s “money” spigot depends on credit creation, it is difficult to imagine how Main Street citizens, whose wealth is being siphoned out of the local economy through government investment accounts and bond debt, can recover enough to benefit. If by some miracle or other QE2 (or 3 or 4) should take hold and trickle down into the real economy, there is that pesky question concerning the debt it creates — which must, of course, ultimately be shouldered by citizens.

Debt, itself, is a dramatic indicator of the depth of Main Street woes. Unimaginably massive as the federal debt may seem and troublesome as state debt appears to be (assorted investment pools aside), all is positively dwarfed by total private debt, particularly that of ordinary individuals whose household debt-to-income ratio reached an all-time high of 133% in 2007 after having doubled over the previous twenty-some year period. This at the same time that personal savings declined.

By late 2009, millions of homeowners who had been using their homes as personal ATM machines were financially shattered by the bursting of the housing bubble. As inflated home prices went into free-fall, households began to deleverage — both unwillingly through default on mortgages and more or less willingly as a result of job uncertainty. The same uncertainty is forcing domestic businesses to deleverage and banks to tighten their lending practices. According to economist, Gary Shilling, and others this deleveraging is likely to last for a decade or more.

Massive deleveraging has led to a shrinking jobs market which, in turn, has increased the demand for student loans. These loans have been adding to household debt at the same time that consumers and households have been paying down credit card debt and otherwise deleveraging. So huge has the student loan market become that, for the first time in history “the total balance of student loans has just surpassed the total balance of credit card debt…..The bad news, of course, is that student loan debt is much more severe than credit card debt, because it can’t be discharged in bankruptcy.” For those who find they can’t manage their loans, the only recourse is default. With defaults averaging 40% and higher for these students, a student loan bubble is emerging.

Ultimately the bursting of this bubble, like the housing bubble, will lead to less, rather than more, lending to individuals, a situation that would further dampen Bernancke’s effort to get the Main Street “money” spigot satisfactorily flowing. Even the banks take a hit in this kind of situation. Whether the student loan bubble bursts or deflates slowly, the collective overload of private debt combined with declining credit scores and a stagnant jobs market means that neither banks nor borrowers will be willing or able, as the case may be, to pull their share of the load in getting the economy back on its feet by taking sufficient advantage of “easy money” Fed policy.

For its part, Congress — whose stimulus projects (with the possible exception of the recent tax cut bill) are being met with the increasing ire of a debt-weary public — likewise appears unlikely to comply with Bernancke’s plea. Similarly, the increasing clamor for austerity does nothing to help open the Main Street money spigot and so mere weeks after the Fed announced QE2 last fall, whispers of additional rounds of easing had already begun to surface. These whispers are particularly noteworthy because QE2, while staunchly defended by Bernancke, had met with a firestorm of criticism from as far away as Brazil, Germany and China as well as here at home.

The problem, as Nobel-prize winning economist and former Chief Economist and Senior Vice President of the World Bank, Joe Stiglitz, explains:

Money isn’t going into the American economy. The lending is actually below what it was in 2007. In a globalized economy, the money is looking for the best place to go. And where is it finding it? In the emerging markets. The irony is that money that was intended to rekindle the American economy is causing havoc all over the world. Those elsewhere in the world say, what the United States is trying to do is the twenty-first century version of ‘beggar thy neighbor’ policies that were part of the Great Depression: you strengthen yourself by hurting the others.

This criticism, whether justified or not, pinpoints a crucial fault line inherent within our current monetary system. This is to say, how can the Federal Reserve, as the nation’s designated monetary authority, balance the internal needs of the world’s largest — and menacingly weak — economy with the inevitable impact that that economy has on the global economy, all through a monetary system precariously built on debt?

Stay tuned for our conclusion.

Read Part 1.

1. The legal status of municipal corporations was first settled by the U.S. Supreme Court, in the 1819 decision Board of Trustees of Dartmouth College v. Woodward. Here the Court “invented a legal distinction between corporations chartered by states. Ruling that a charter granted to private citizens for personal interests is not a conveyance of privilege from the sovereign (which now meant the People and not the king) to the incorporators, but rather a contract between the state and the incorporators, the Court argued that the state could not change, limit or revoke the charter once issued. To do so would be to violate the Contracts Clause (Article 1, Section 10) of the U.S. Constitution, John Marshall’s court argued. Henceforth, private business corporations would have an increasing share in American sovereignty. Business corporations gained legal independence from state legislatures as a result of the Dartmouth College case. But this ruling played-out quite differently in terms of public corporations, like municipalities… Municipal corporations have no incorporators other than the legislature itself, claimed the court. Neither the people living within the jurisdiction of the municipality, nor the local governing officials were recognized as the legal recipients of a charter from the state. In fact, residents living within a municipal jurisdiction were deemed to be mere “tenants” of the municipality. Therefore, although the state legislature could not presume to govern the actions and behavior of a business corporation, once chartered, the state could unilaterally change municipal boundaries, revoke or impose local laws, or even dissolve the municipality unilaterally, according to this long-standing theory of corporate law. It is supported by precedent that has little opportunity to gather dust as it is regularly pulled from the shelves by corporate attorneys and state judges who argue for the sanctity of a legal tradition that denies the fundamental right of people to govern themselves in the places where they live.” (Emphasis mine) [↩]
2. Here is a “list of the 276 most populous incorporated places in the United States. As defined by the United States Census Bureau, an “incorporated place” includes a variety of designations, including a city, town, village, borough, and municipality … PLUS a list of the 7 incorporated municipalities (municipios) of Puerto Rico with a population on July 1, 2009, greater than 100,000 as estimated by the United States Census Bureau, and the rankings they would have if included in the above table.” Note that the preceding is a list of only the “most populous” incorporated places! [↩]

Geraldine Perry is co-author of The Two Faces of Money and creator of its related website which includes recent reviews. This website also has an abundance of related material and links, along with a free, down loadable slide presentation describing the two forms of money creation and the Constitutional solution, which is not the gold-backed dollar as popularly believed. As a means of imparting accurate information on health and nutrition to as broad an audience as possible she developed the web site The Health Advantage. Read other articles by Geraldine, or visit Geraldine's website.

This article was posted on Saturday, February 19th, 2011 at 8:00am and is filed under Finance.

Memo to Congress: Show Us the M-O-N-E-Y!

Part 1 of 3

by Geraldine Perry / February 12th, 2011

Cuba Gooding Jr. became an overnight sensation when his character, pro football player Rod Tidwell, pithily directed his high-minded but needy agent Jerry Macguire, played by Tom Cruise, to “Show me the money!” Tidwell’s terse directive is as practical as it is memorable and luckily for Tidwell, Macguire delivers.

Whether out of extraordinary resolve or sheer desperation, a “show me the money” policy is exactly the course Fed Chair Ben Bernancke is pursuing at full throttle. Faced with the unenviable task of reflating a deflating and uncooperative economy, the Fed opted last fall to take the “easy money” quotient a notch higher by formally initiating a second round of quantitative easing, while tacitly acknowledging the possibility of QE3, QE4, and so on into the undefined future. With Fed Fund rates effectively at or very near zero and a trillion dollars already in reserves, the Fed is in other words doing all it can to get the “credit-as-money” spigot flowing.

While hardly a ringing endorsement of the Fed, the truth is that the Fed has few other “money spigot” tools at its disposal.¹ So it was that – in an op-ed appearing in the November 4 issue of the Washington Post – the beleaguered Bernancke reminded the nation that the Fed cannot, by itself, solve all the problems rippling through the American economy. That process said Bernancke “will take time and the combined effort of many parties including the central bank, Congress, the administration, regulators and the private sector.”

Although the Fed for its part has shown unusual resolve to go the distance, the stimulative activities of the private sector – disconcertingly led as they are by a handful of big banks – are mostly focused on overseas “opportunities” in the emerging markets and not stimulative activities here at home. This combination of “cheap” dollars and cheap emerging market prices has of course enabled the financial sector to do quite well, despite increased risk. Meanwhile even those regulators not previously captured by special interests find themselves increasingly hobbled by a complex matrix of old, new and proposed regulations interlaced with a variety of deregulation schemes which together dilute the likelihood of effective action – and maintains the regulatory environment for “rogue Wall Street firms to kill small American businesses for profit.”

That leaves Congress and the administration. While both are also arguably captured by special interests, they are clearly feeling the intense pressure of a cash-strapped public. Hence the recent tax-cut bill which will add nearly a trillion dollars to the federal debt but do little to stimulate adequate money (as credit) creation where it is needed most – not in the financial economy headquartered on Wall Street but in the real economy, here on Main Street. Now caught between the proverbial rock and a hard place, the Fed, by its own admission and despite its high minded goals, appears every bit as needy as the erstwhile Jerry Macguire.

Main Street’s Woes Belie Wall Street’s Gains

For the moment, the Fed’s “easy money” goal of raising asset prices seems to be working, albeit not necessarily in sectors – such as real estate – where it would do the home economy the most good. Capitalizing on stockpiles of cash, good credit and “cheap money” secured by uber-low interest loans and back-stopped by TARP, the big banks and large corporations – together with a small army of investment funds – have been having a field day speculating in potentially lucrative but nevertheless risky ventures, inflating as they go various commodity prices such as wheat, corn, hogs and similar commoditized foods, as well as health care, precious metals and oil – and raising the possibility of igniting dangerous currency wars through revved up currency speculation.

Surging prices for necessities such as food, oil, and health care send mixed signals to ordinary Americans because inflation in the U.S. economy (after stripping out volatile food and energy prices) is actually at the lowest level it has been since 1957. Clear evidence of this phenomenon appears in the retail sector where for months retailers have been slashing prices on a seemingly endless supply of goods. While bargain hunters and incurable sentimentalists appear to have responded for the holidays at least, one has to wonder how the slimmest of profit margins can sustain not only retailers but their suppliers – and in turn, the myriad of producers and raw materials providers needed for finished goods, even if these are sourced from cheap-labor countries.

Ominously, job growth (with the exception of part-time jobs) is also going mostly nowhere, a fact which – however contra-indicative of an apparent holiday spending spree – does nothing to reverse the troublesome downward spiral in prices and wages. Consensus also has it that higher-than-normal unemployment will be with us for years to come. All of which affirms Bernancke’s preoccupation with stagflation and deflation – and bodes poorly for the Main Street economy inasmuch as “falling prices often also mean falling wages, as businesses respond to declines by cutting output and jobs.”

Wall Street gains make it clear that the banks and investor class are doing very, VERY well, thank you very much. Another portion of the population, perhaps as much as a third overall, is doing reasonably well – or at least well enough to keep up appearances. We have in other words, two Americas which, if understood, helps us make sense of conflicting economic data. The top 20% of Americans are prospering and spending handsomely despite carrying the major share of the tax burden, while the next 20% represents a fragile middle class that has become “mostly a figment of nostalgia and/or political illusion.” In real terms, the bulk of Main Street, including drop-off portions of the shrinking middle class, is bleeding profusely with one of every six Americans unemployed and countless more chronically “underemployed.”

Unfortunately for those most severely affected, the level of suffering is masked by the fact that there are “wide variations of hardship in the 50 largest metropolitan areas” – and official estimates do not always paint accurate pictures. As but one example, Detroit’s mayor and local leaders maintain that Detroit’s unemployment rate actually hovers near 50%, a figure far above official estimates of 30%.

Contributing to the probability of an increase in Main Street woes is the likelihood of a second dip in the housing recession – meaning home prices have yet to hit bottom. This translates into progressively fewer Americans who will be able to tap into home equity as a means of getting themselves through tough times – and it could bring about another tsunami of foreclosures. In turn, local real estate and other tax revenues will continue to decline even as demand for social services increases. This spells additional trouble for state and local governments, with states themselves collectively facing a $140 billion dollar operating budget shortfall next year alone.

Big Trouble Ahead for State and Local Budgets?

Indeed, state and local operational budgetary problems are becoming serious enough to threaten the inviolability of once “super safe” municipal bonds – which heretofore have been considered an attractive investment that comes with the added benefit of providing state and local government with funds for community improvements. Because bonds are essentially loans which the issuer (be it corporate or governmental entity) must pay back with interest, income streams of the issuer must be adequate enough to satisfy the terms of the loan. Unfortunately, low tax revenues and weak economic outlook are now compromising the bond issuer’s (borrower’s) ability to meet the terms of the loan – so much so that municipal bond defaults have been running triple the usual rate.

Economic forecasts that are tepid at best lead anaylsts to “fear that at some point, investors could balk at lending to the weakest states, setting off a crisis that could spread to the stronger ones.” Big name financial analysts such as Meridith Whitney and bond experts such as Marilyn Cohen go so far as to pose the possibility of widespread muni bond defaults.

While not everyone believes state and local budget problems are severe enough to create a ripple effect of bankruptcies, it is nevertheless unsettling to recall that the Great Depression actually began – and was prolonged – as various municipalities, mostly in the South and Midwest, began cutting services and defaulting on bond debt. A re-play of the Great Depression notwithstanding, the one thing most agree on is that states and communities with high levels of debt and poor revenue prospects will at the very least see the cost of borrowing head skyward, as investors head for cover.

Compounding muni market fears is the fact that, while investors of muni bonds may at one time have been lucky enough to have ended up with the equivalent of a piece of Central Park in satisfaction of debt defaults, today many such investors may not fair so well. This is in part because the states themselves are ill-prepared to help themselves much less troubled municipalities, and in part because, in the words of SEC Commissioner Elisse Walter, “investors in municipal securities [have become] in many ways ‘second-class citizens’ who [do] not receive the protections customary in many other sectors of the U.S. capital markets.”

Although states themselves cannot declare bankruptcy and typically look to other ways to satisfy their debt obligations including recasting pension contracts, increasing taxes and slashing programs, they can, at their discretion, help municipalities in trouble. States are, however, much less likely to provide such help when they themselves are in financial trouble. So what happens when a state refuses to rescue a troubled municipality? The municipality can potentially be forced into bankruptcy, leaving bond holders holding the bag.

As fiscal pressures have mounted, states seem to be turning to unorthodox methods in order to remain operational. This is verified by new evidence – emerging as a result of SEC investigations of New Jersey, Florida, California and elsewhere – which suggests that many states may be papering over their fiscal troubles by providing fraudulent information about their finances to muni bond investors. The states do this in a variety of ways, including keeping liabilities under wrap through delayed filings or by burying them in opaque documents. They also may resort to deferring payments of obligations and re-characterizing bond debt as revenues.

In the case of Illinois, for example, heavy borrowing and a history of deferring bill payments has led three major credit-rating agencies to rank Illinois as one of the two riskiest states for bond investors, California being the other. In his final quarterly report, published January 7 (2011), former Illinois Comptroller Dan Hynes warned that “the state could face $7 billion to $10 billion in unpaid bills by the end of the current fiscal year… Any use of bonds to deal with the state’s fiscal condition will continue to impact the state’s cash management practices in the future, as the state must adjust to those higher debt service obligations.”

Despite such warnings, “Illinois plans to borrow more than $3 billion to pay the bills for FY2011 and in June 2010, the legislature permitted the university systems to borrow millions more to make up for the fact that the state has not made the payments it had promised them.” In other words, Illinois is not only borrowing more to pay its own bills (by floating bonds) but it also has begun allowing other entities within its purview the new privilege of borrowing as a means of helping that entity to meet the state’s portion of obligations to it. This according to the non-profit Sunshine Review, which is a collaborative research organization dedicated to state and local government transparency.

The Sunshine Review further reports that: “As of the end of August 2010, Illinois had borrowed $9.6 billion in the prior 12 months.” For Illinois residents this means that as much as $551.3 million extra will have to be shelled out for the state’s borrowing over the last year alone. In addition, “more than half the state’s additional borrowing costs, amounting to approximately $301.2 million, will come due in the next five years.” And adding still more salt to taxpayer wounds, “the cost of insuring five-year Illinois bonds to protect $10 million of debt against default in June 2010 rose to $370,000, a record, from a low of $155,000 in January, 2010. The price fell back to $281,000 at the end of July 2010.”

In addition to the myriad problems associated with borrowing to pay obligations (about which we have only touched upon here), there is another problem connected to the budgetary process – and it lies in current accounting practices which rely on the cash basis method (also referred to as modified accrual basis). This according to the Institute for Truth in Accounting, a professional group of financial and public policy experts dedicated to reform of the GAAP accounting practices now used under the Comprehensive Annual Financial Reports (or CAFRs). For example, “the state of Illinois routinely delays Medicaid payments to healthcare providers. Each year the budget appears balanced on a cash basis even though the state does not provide sufficient funding for the Medicaid program.”

While arguing that “objectively better” accounting systems are universally employed in the private sector, the IFTA said that its research found that the current accounting system “does not give all stakeholders an accurate diagnosis of the financial health of state governments because the accounting principles recommended are biased towards the interests of government officials. The current structure and funding mechanism of the GASB make it difficult for members of this board to not be influenced by constituency groups that represent governmental officials and their staff.”

Thus, says former SEC Chairman Arthur Levitt, “At the core of the [muni] problem are questions about how governments manage pension funds, what investors know, and when they know it. The case against New Jersey revealed that the state has made unfunded pension fund promises to its employees, and compounded the problem by not being forthright with bond investors.”

In ideal circumstances, pension funds are supposed to keep up with benefit promises through a combination of employer and worker contributions, together with market returns from a fund’s investment portfolio. But, says Levitt, those revenue streams have slowed to a trickle as states have cut back on their own contributions, employees have contributed too little, and hoped-for investment gains have shriveled up. If investors discover that the muni market has instead become a way to paper over irresponsible promises, they will flee it, and that could spell disaster.

Investor anxiety has become significant enough that “some analysts have suggested that the Fed could ease muni market worries by purchasing muni debt or lending to struggling borrowers.” But on January 7, Fed Chair Ben Bernancke nixed the idea on legal, political, and practical grounds, saying “that if municipal defaults did become a problem, it would be in Congress’s hands, not his.”

But assuming that Congress will bail out any state in terminal trouble is itself a very risky gamble. Why? Because “[a]nything that the feds do for one state they’d have to do for others, which would turn into a bottomless and politicized spending pit.” With balance sheet problems of its own to contend with, the federal government is hardly in a position to bail out a string of troubled states, this fact being reinforced by growing taxpayer objections.

All of which brings us back to the unchartered waters of quantitative easing. Will QE2 and beyond be able to provide the kind of economic relief so desperately needed by Main Street? This is likely to remain an open question for some time to come because the money spigot used by the Fed can only create money as bank credit – and credit becomes far more expensive, indeed sometimes altogether unobtainable, for those in financial distress. Which of course translates to a “tight” money (as credit) supply – right where it is needed most, here on Main Street.

Should QE2 (or maybe 3 or 4) somehow ultimately work well enough to satisfy squeaky wheels, there’s still that pesky question forever lurking in the background: Can we REALLY keep borrowing our way into prosperity – or is there a better way? ²,³

Stay tuned.

1. While Fed tools may be limited, its options within that framework of tools are less so. In this video presentation prepared for the American Monetary Institute, ex-marine and long time AMI board member Dick Distelhorst explains that the Fed actually has the ability to issue “money,” based on reserves, directly to the American people instead of to the banks as it has been doing, thereby bailing out the people instead of the banks. While this interesting option would still be based on debt (that is to say, creating money at interest based on bonds held in reserves), it does nevertheless raise the important question as to why the Fed chose to support the errant banks instead of the people who are forced to pay for the bailout. Answers to that question may potentially be found in 13 Bankers by Simon Johnson and James Kwak and similar books along with articles such as this, this, and this. But particularly for the purposes of this article, the present author has charitably conjectured that the Fed unwittingly over-looked this option in favor of fractional reserve monetary (that is, credit/debt) expansion – which of course can only be done by the banks, but which could potentially get more money (as credit) into the system. [↩]
2. Monetary expert Will Abrams explains Canada’s experience under two types of monetary systems, one built on debt – the other on the creative and consumptive activities of the people. [↩]
3. For an abbreviated, step-by-step explanation of our current monetary system see “Money Owed and Owned.” Or see this more technical description. [↩]

Geraldine Perry is co-author of The Two Faces of Money and creator of its related website which includes recent reviews. This website also has an abundance of related material and links, along with a free, down loadable slide presentation describing the two forms of money creation and the Constitutional solution, which is not the gold-backed dollar as popularly believed. As a means of imparting accurate information on health and nutrition to as broad an audience as possible she developed the web site The Health Advantage. Read other articles by Geraldine, or visit Geraldine's website.

This article was posted on Saturday, February 12th, 2011 at 8:00am and is filed under Economy/Economics, Finance, Housing, Labor, Social Security.

Public debt and the underground economy

A grey market or gray market also known as parallel market^[1] is the trade of a commodity through distribution channels which, while legal, are unofficial, unauthorized, or unintended by the original manufacturer. The term gray economy, however, refers to workers being paid under the table, without paying income taxes or contributing to such public services as Social Security and Medicare.^[2] It is sometimes referred to as the underground economy or "hidden economy."

A black market is the trade of goods and services that are illegal in themselves and/or distributed through illegal channels, such as the selling of stolen goods, certain drugs or unregistered handguns. The two main types of grey market are imported manufactured goods that would normally be unavailable or more expensive in a certain country and unissued securities that are not yet traded in official markets. Sometimes the term dark market is used to describe secretive, unregulated (though often technically legal) trading in commodity futures, notably crude oil in 2008.^[3] This can be considered a third type of "grey market" since it is legal, yet unregulated, and probably not intended or explicitly authorized by oil producers.

vox

Research-based policy analysis and commentary from leading economists

Public debt and the underground economy

The interaction between the underground economy and government actions is complex and inherently dynamic. The presence of hard-to-manage public debt exacerbates the problem of fighting tax evasion. The stock of debt necessitates fiscal adjustments, but higher tax rates are usually associated with a “quit” option to the underground sector. Further tax increases could set off adverse debt dynamics that undermine future tax bases.

As happened ten years ago in Argentina, a “mass escape” from the regular sector can dramatically worsen the public budget situation. By the same token, lower tax rates may lessen the incentive to evade. But if the evolution of the expenditure side of public budget is out of control, dodgers may anticipate future tax increases and decide to quit now.

Public outlays are also part of the political dilemma. Indeed, apart from their obvious links with the public debt, specific spending items may also have non-trivial effects on the underground sector.

The government is an important employer (sometimes it acts as the employer of last resort, and Europe’s highly indebted countries are certainly not among the exceptions) and hence it influences the conditions of both regular and irregular labour markets. One may well think of policies on some public outlays as a “tax” that directly affects both public debt and tax evasion. A reduction in public wages, which shifts the tax burden from private agents to civil servants, is one example.

Finally, a situation where government revenues are insufficient to offer public services may push citizens to buy these services from underground agents may yield a “bad” equilibrium with both large debt and tax evasion.

A dramatic shift in policy is required

All in all, it is likely that the shift from these bad equilibria to a good steady state requires a dramatic shift in policies. The budget constraint forces the government to choose between paying off public debt and curbing spending or increasing taxation. The “shadow constraint” forces the government to carefully select the better fiscal items to manoeuvre, even considering those with deeper impacts on social consensus. Empirical analyses are paramount in this “Treasury vs dodgers” game.

Unfortunately, a lack of reliable time series data on tax evasion usually hampers the empirical analysis of these feedback effects. Taking advantage of a unique dataset on the Italian underground economy (released by the Italian Institute of Statistics), my coauthor and I have examined a dynamic system of both the hidden sector and fiscal variables (Bovi and Claeys 2008). Figure 1 and 2 show the links between public finance stance and the share of the underground economy in Italy over the last three decades.

Figure 1. Public debt vs shadow economy in Italy (as % of GDP)

Note: Public debt is depicted by the dashed line and corresponds with the right-hand-side axis. The shadow economy is the share of irregular workers compared to total full-time-equivalent units. In 2002 and 2003 there was a mass legalisation of illegal immigrants that reduced by about 200 basis points the irregular share. Italian official GDP includes both regular and irregular activities.

Figure 2. Fiscal revenues and outlays vs shadow economy in Italy (as % of GDP)

Note: Fiscal revenues are depicted by … Outlays depicted by --. Shadow economy and GDP defined as above.

Figure 1 suggests that public debt and the shadow economy go hand in hand. Figure 2 shows the huge increase in tax-to-GDP ratio up to almost 50%, which seems to be the maximum socially sustainable level (the tax burden on honest taxpayers, i.e. on regular GDP, is obviously larger than that reported in Figure 2). Starting from the early 1990s, public outlays decrease, possibly suggesting that they had reached the maximum economically sustainable level. In the last years both revenues and expenditure have maintained their (high) level on GDP.

We have studied the sustainability of public debt through spending and tax rules (e.g. a positive reaction of the surplus to an increase in the public debt) more formally using a dynamic stochastic general equilibrium (DSGE) model.

• Our results show that the underground economy reacts to changes in the tax burden as well as to variations in government spending.
• We also find a positive effect of fiscal surpluses on the black economy. For every 1% increase in the surplus, shadow activities significantly rise by slightly more than 1%.
• The main insight is that higher taxes lead to a shift to the underground sector. Tax increases cause significant substitution into irregular activity. A 1% tax increase implies a more than proportional growth of the underground economy. This shift into the black economy implies a gradual erosion of the tax base.
• At the current level of spending and taxes in Italy (nearly 50% of GDP, see Figure 2), only half of the planned additional revenues actually flow to the Treasury. The other half is foregone due to tax evasion.

Although this additional tax pressure on honest taxpayers turns some into dodgers, at the current level of underground activity there is no danger of unstable revenue dynamics. This does not exclude that increasingly higher tax burdens on less and less honest taxpayers may eventually imply perverse revenue dynamics. On the other hand, being on the increasing part of the Laffer curve implies that tax cuts to combat underground activities would make debt even more of an emergency. It turns out that tackling both fiscal consolidation and tax evasion requires an analysis of the impact of spending on the underground economy.

We have studied wage spending, consumption, investment, subsidies, and interest payments. We find that increased government spending requires future tax rises to keep the budget in balance and therefore has an indirect impact on the underground economy. As before, the magnitude of the response still implies that about half of any additional tax revenue is foregone due to evasion. Hence, the data suggest that a careful two-handed approach is necessary to keep both public debt and the underground economy in check. On the positive side, while some spending variables have a limited direct impact on the underground sector, evidence shows that the government can afford to use some items to face both hidden and financial markets. Specifically, we find that higher public wages reduce underground activities (possibly because higher public wages reduce bribe taking). In contrast, the number of public employees has a strongly positive effect on the level of underground activity. Thus, the government could manoeuvre wage spending either along the intensive margin, i.e. by raising wages, or the extensive margin, i.e. by reducing staff. Although the overall effect of fewer, better paid public workers on total spending could be balanced, such a measure would be complementary to tax cuts in fighting tax evasion.

We are strongly tempted to speculate that targeting unproductive sectors may increase the overall effects on hidden and financial markets. Our findings add support to the current fiscal adjustments implemented in some of Europe’s highly indebted countries and are in line with the call for deep spending cuts outlined by Wyplosz (2009) in his Vox column “Greece: The party is over”.

Disclaimer: The views expressed do not necessarily reflect those of the ISAE. I am indebted with Peter Claeys for his helpful comments.

References

Bovi, Maurizio and Peter Claeys (2008), “Treasury V Dodgers. A Tale of Fiscal Consolidation and Tax Evasion”, ISAE Working Papers 93, Institute for Studies and Economic Analyses.

Cabral, Ricardo (2010), “The PIGS’ external debt problem”, VoxEU.org, 8 May.

Wyplosz, Charles (2009), “Greece: The party is over”, VoxEU.org, 14 December.

This article may be reproduced with appropriate attribution.

Black Market, Black Economy, Grey Market, Gray Market

A black market is one where the buying and selling of products and services take place in an illegal manner. A black economy is a highly organized and vast market where the regular taxation rules and norms of trade are not adhered to. A black market is known by several names, including black economy, underground market, shadow economy, underdog and parallel economy. The variety of goods traded in this market is enormous and the most commonly traded black market items are:

• weapons

• currency

• electronics and watches

• fashion goods (perfumes, jewelry and bags)

• clothes and accessories

• pirated media (CDs and DVDs for music, films and software)

• drugs
• alcohol
• tobacco

Parallel Economy

A black market may also be called a parallel economy because of its disregard for the rules and regulations that ‘white’ businesses follow. Goods sold in the black market can be illegal (such as weapons, drugs or stolen goods). On the other hand, legal goods can be sold illegally (goods sold without proper license and without paying any kind of taxes).

In the black market goods and services are purchased and sold violating all restrictions like rationing or price controls. So, the transactions that take place in this market are “under the table” transactions, which occur outside government-sanctioned channels.

Grey Market

A grey market involves the buying and selling of goods and services that are not illegal, but the channels used in their distribution are either unauthorized or unofficial. A good example is the trading of crude oil by an individual. The grey market includes services that are typically unregistered to evade taxes. Perfectly legitimate occupations, such as domestic help, babysitters, part time beauticians and freelancers, may not be registered. Not only is it difficult to detect such defaulters, the punishment is usually mild.

Factors that Support Black Markets

The stricter the government regulations are in a country, the great the impetus is for a parallel economy. Corruption, shortages and monopolies also act as catalysts for the black market.

Parallel economies are further encouraged by periods of war or any other crisis. During harsh political conditions or natural disasters, scarce goods are rationed by the government. People have the tendency to violate restrictions or rationing laws to secure the products they desire.

Black Market Prices

The price of certain goods sold in a black market could be lower than the legal market price. This is because the good may be stolen. Moreover, black marketers do not pay any taxes and can offer a price advantage to customers. Goods such as pirated DVDs and fashion accessories are sold at a lower price in the black market. On the other hand, the price of certain products sold in the black market can be higher than the normal prices. This is usually the case when there are shortages or there is high risk involved in getting the goods to the customer. Goods such as weapons and illegal drugs are good examples.

Despite the price advantage offered by the black market for certain goods, some people prefer to buy items from the legal market, even at a higher price. The reasons for this could be:

• the black market may not provide proper documents (invoice, licenses, instruction manuals)
• unwillingness to support an unlawful act
• nowhere to turn to if the products do not perform as promised
• brands may be fake
• no after sales support

Black market activities can be reduced by the easing of legal restrictions and by increasing the availability of goods. Making regulations less stringent would encourage buying and selling, exerting downward pressure on prices. This would dissuade people from purchasing the goods from the black market. In cases where a government believes that the sale of certain goods should be restricted (such as ammunition, drugs and human trafficking), stricter law enforcement and awareness spreading can restrict the black market.

CAMPAIGN FOR AMERICA'S FUTURE

Budget Baloney: Why Social Security Isn't a Problem for 26 Years, and the Best Way to Fix It Permanently

By Robert Reich

February 17, 2011 - 1:05pm ET

[Originally posted at RobertReich.org.]

New Jersey Governor Chris Christie, a Republican presidential hopeful, says in order to "save" Social Security the retirement age should be raised. The media are congratulating him for his putative "courage." Deficit hawks are proclaiming Social Security one of the big entitlements that has to be cut in order to reduce the budget deficit.

This is all baloney.

In a former life I was a trustee of the Social Security trust fund. So let me set the record straight.

Social Security isn't responsible for the federal deficit. Just the opposite. Until last year Social Security took in more payroll taxes than it paid out in benefits. It lent the surpluses to the rest of the government.

Now that Social Security has started to pay out more than it takes in, Social Security can simply collect what the rest of the government owes it. This will keep it fully solvent for the next 26 years.

But why should there even be a problem 26 years from now? Back in 1983, Alan Greenspan's Social Security commission was supposed to have fixed the system for good - by gradually increasing payroll taxes and raising the retirement age. (Early boomers like me can start collecting full benefits at age 66; late boomers born after 1960 will have to wait until they're 67.)

Greenspan's commission must have failed to predict something. But what? It fairly accurately predicted how quickly the boomers would age. It had a pretty good idea of how fast the US economy would grow. While it underestimated how many immigrants would be coming into the United States, that's no problem. To the contrary, most new immigrants are young and their payroll-tax contributions will far exceed what they draw from Social Security for decades.

So what did Greenspan's commission fail to see coming?

Inequality.

Remember, the Social Security payroll tax applies only to earnings up to a certain ceiling. (That ceiling is now $106,800.) The ceiling rises every year according to a formula roughly matching inflation.

Back in 1983, the ceiling was set so the Social Security payroll tax would hit 90 percent of all wages covered by Social Security. That 90 percent figure was built into the Greenspan Commission's fixes. The Commission assumed that, as the ceiling rose with inflation, the Social Security payroll tax would continue to hit 90 percent of total income.

Today, though, the Social Security payroll tax hits only about 84 percent of total income.

It went from 90 percent to 84 percent because a larger and larger portion of total income has gone to the top. In 1983, the richest 1 percent of Americans got 11.6 percent of total income. Today the top 1 percent takes in more than 20 percent.

If we want to go back to 90 percent, the ceiling on income subject to the Social Security tax would need to be raised to $180,000.

Presto. Social Security's long-term (beyond 26 years from now) problem would be solved.

So there's no reason even to consider reducing Social Security benefits or raising the age of eligibility. The logical response to the increasing concentration of income at the top is simply to raise the ceiling.

Not incidentally, several months ago the White House considered proposing that the ceiling be lifted to $180,000. Somehow, though, that proposal didn't make it into the President's budget.

---

Robert Reich is the author of Aftershock: The Next Economy and America's Future, now in bookstores. This post originally appeared at RobertReich.org.

Restoring Economic Sovereignty: The Push for State-owned Banks

by Ellen Hodgson Brown / February 17th, 2011

It is time to declare economic sovereignty from the multinational banks that are responsible for much of our current economic crisis. Every year we ship over a billion dollars in Oregon taxpayer dollars to out-of-state and multinational banks in the form of deposits, only to see that money invested elsewhere. It’s time to put our money to work for Oregonians.

— Bill Bradbury, former Oregon Senate President and Secretary of State, quoted in The Nation

Responding to an unfilled need for credit for local government, local businesses and consumers, three states in the last month have introduced bills for state-owned banks — Oregon, Washington and Maryland – joining Illinois, Virginia, Massachusetts and Hawaii to bring the total number to seven.

While Wall Street is reporting record profits, local banks are floundering, credit for small businesses and consumers remains tight, and local governments are teetering on bankruptcy. There is even talk of allowing state governments to file for bankruptcy, something current legislation forbids. The federal government and Federal Reserve have managed to find trillions of dollars to prop up the Wall Street banks that precipitated the credit crisis, but they have not extended this largesse to the taxpayers and local governments that have been forced to pick up the tab.

In January, Federal Reserve Chairman Ben Bernanke announced that the Fed had ruled out a central bank bailout for state and local governments. The collective state budget deficit for 2011 is projected at $140 billion, a mere 1% of the $12.3 trillion the Fed managed to come up with in liquidity, short-term loans, and other financial arrangements to bail out Wall Street. But Chairman Bernanke said the Fed is limited by statute to buying municipal government debt with maturities of six months or less that is directly backed by tax or other assured revenue, a form of debt that makes up less than 2% of the overall muni market. State and municipal governments, it seems, are on their own.

Faced with federal inaction and growing local budget crises, an increasing number of states are exploring the possibility of setting up their own state-owned banks, following the model of North Dakota, the only state that seems to have escaped the credit crisis unscathed. The 92-year-old Bank of North Dakota (BND), currently the only state-owned U.S. bank, has helped North Dakota avoid the looming budgetary disasters of other states. In 2009, North Dakota sported the largest budget surplus it had ever had. The BND helps fund not only local government but local banks and businesses by providing matching funds for loans to commercial banks to support small business lending.

In the last month, three states have introduced bills for state-owned banks, following the North Dakota model. On January 11, a bill to establish a state-owned bank was introduced in the Oregon State legislature; on January 13, a similar bill was introduced in Washington State (discussed in an earlier article here); and on February 4, a bill was introduced in the Maryland legislature for a feasibility study looking into the possibilities. They join Illinois, Virginia, Hawaii, and Massachusetts, which introduced similar bills in 2010.

Broad-based Support

The bills are widely supported by small business owners. The Seattle Times reported on February 3 that 79% of 107 business owners surveyed by the Main Street Alliance of Washington supported the Washington bill. More than half said they had experienced a tightening of business credit, and three-fourths of those said they could create additional jobs if their credit needs were met.

A survey by the Main Street Alliance of Oregon produced similar results. Their survey, which covered 115 businesses in 28 communities, found that two-thirds of small-business owners had delayed or canceled expansions because of credit problems; 41 percent had been turned down for credit; and 42 percent had seen their credit terms deteriorate. Three-quarters of the business owners surveyed supported the Oregon bill.

Also supporting the idea of a state-owned bank is Oregon state treasurer, Ted Wheeler, with this twist: he thinks Oregon can unlock additional lending capacity in partnership with existing institutions by creating a “virtual” bank. The state would not need to build new brick and mortar banks requiring hundreds of new employees to service them. The new tools afforded the state by being a “bank” could be arranged quickly and cheaply through a framework he calls a “virtual economic development bank.” In an OpEd posted on Oregonlive.com on February 9, he wrote:

This new model would consolidate Oregon’s various economic development loan programs in one place, and allow state government to step in as a new lending participant, which will help qualified Oregonians to secure additional financing. We also have strategic investment tools such as the Oregon Growth Account that could be better utilized as part of this framework.

Banks “create” money by leveraging their capital into loans. At an 8% capital requirement, they can leverage capital by a factor of twelve, so long as they can attract sufficient deposits (collected or borrowed) to clear the outgoing checks. States give this leveraging power away when they put their deposits in Wall Street banks and invest their capital there.

State and municipal governments have assets tucked all over the state in separate rainy day funds, which are largely invested in Wall Street banks for a very modest return. At the same time, states are borrowing from Wall Street at much higher interest rates and have to worry about such things as credit ratings, late fees, and interest rate swaps, which have proven to be very good investments for Wall Street and very bad investments for local governments.

By consolidating their assets into their own state-owned banks, state and local governments can leverage their own funds to finance their own operations; and they can do this essentially interest-free, since they will own the bank and will get the interest back. The BND contributed over $300 million to state coffers in the past decade, a notable achievement for a state with a population that is less than one-tenth the size of Los Angeles County.

The growing movement to establish local economic sovereignty through state-owned banks has been a grassroots effort that has grown spontaneously in response to unmet needs for local credit. In Oregon, the push has come from an active volunteer group called Oregonians for a State Bank working with the Working Families Party. In Washington, a major role has been played by the Main Street Alliance, a project of the Alliance for a Just Society (formerly NWFCO). The chief legislative champion in Washington State is Rep. Bob Hasegawa. In Maryland, the campaign was initiated by the Wisconsin-based Center for State Innovation (CSI), working with the Service Employees International Union (SEIU) and the Progressive States Network. Progressive Maryland is a prominent NGO supporter. Detailed analyses of the Washington and Oregon initiatives and their projected benefits have been done by CSI. For grassroots efforts in other states and for petitions that can be signed, see here.

Ellen Brown is an attorney in Los Angeles and the author of 11 books. In Web of Debt: The Shocking Truth About Our Money System and How We Can Break Free, she shows how a private banking cartel has usurped the power to create money from the people themselves, and how we the people can get it back. Read other articles by Ellen, or visit Ellen's website.

This article was posted on Thursday, February 17th, 2011 at 8:00am and is filed under Banks/Banking.

AlterNet.org

ECONOMY

Blog for Our Future / By Dave Johnson

9 Pictures That Expose This Country's Obscene Division of Wealth

Many people don’t understand our country’s problem of concentration of income and wealth because they don’t see it, but a picture is worth 1,000 words.

February 14, 2011 |

Many people don’t understand our country’s problem of concentration of income and wealth because they don’t see it. People just don't understand how much wealth there is at the top now. The wealth at the top is so extreme that it is beyond most people’s ability to comprehend.

If people understood just how concentrated wealth has become in our country and the effect is has on our politics, our democracy and our people, they would demand our politicians do something about it.

How Much Is A Billion?

Some Wall Street types (and others) make over a billion dollars a year – each year. How much is a billion dollars? How can you visualize an amount of money so high? Here is one way to think about it: The median household income in the US is around $29,000, meaning half of us make less and half make more. If you make $29,000 a year, and don’t spend a single penny of it, it will take you 34,482 years to save a billion dollars. . . . (Please come back and read the rest of this after you have recovered.)

What Do People Do With SO Much?

What do people do with all that money? Good question. After you own a stable of politicians who will cut your taxes, there are still a few more things you can buy. Let’s see what $1 billion will buy.

Cars

This is a Maybach. Most people don’t even know there is something called a Maybach. The one in the picture, the Landaulet model, costs $1 million. (Rush Limbaugh, who has 5 homes in Palm Beach, drives a cheaper Maybach 57 S -- but makes up for it by owning 6 of them.)

Your $1 billion will only buy you a thousand Maybach Landaulets.

Here are pics of just some of Ralph Lauren’s collection of cars. This is not a museum, this is one person’s private collection. You don't get to go look at them.

Luxury Hotels

This is the Mardan Palace Hotel in Turkey, Burj Al Arab in Dubai.

Here is a photo gallery of some other expensive hotels, where people pay $20-30,000 per night. Yes, there are people who pay that much. Remember to send me a postcard!

A billion dollars will buy you a $20,000 room every night for 137 years.

Yachts

Le Grand Bleu - $90 million.

Some people spend as much as $200 million or more on yachts.

You can buy ten $100 million yachts with a billion dollars.

Private Jets

Of course, there are private jets. There are approx. 15,000 private jets registered in the US according to NBAA. (Note: See the IPS High-Flyers study.)

This is a Gulfstream G550. You can pick one up for around $40 million, depending. Maybe $60 million top-of-the-line.

Your billion will buy you 25 of these.

Private Islands

If the rabble are getting you down you can always escape to a private island.

This one is going for only $24.5 million – castle included. You can only buy 40 of these with your billion.

Mansions

This modest home (it actually is, for the neighborhood it is in) is offered right now at only about $8 million. I ride my bike past it on my regular exercise route, while I think about how the top tax rate used to be high enough to have good courts, schools & roads and counter the Soviet Union and we didn't even have deficits.

I ride there but that neighborhood is not like my neighborhood at all. While there is one family in that house, I live closer to the nearby soup kitchen that serves hundreds of families. One family in a huge estate and hundreds at a soup kitchen roughly matches the ratio of wealth concentration described below.

Here are a few nearby homes up for sale.

You can buy 125 houses like this one with your billion.

Luxury Items

Here is an article about ten watches that are more expensive than a Ferrari.

The one in this picture costs more than $5 million. You can buy 200 of these with your billion.

Medieval Castles

Just for fun, this is Derneburg Castle. Do you remember the big oil-price runup a few years ago that too the price of a gallon at the pump up towards $5? One speculator who helped make that happen got a huge bonus paid with government bailout money. He owns this castle. He has filled it with rare art. You can’t go in and see any of the rare art.

Click here to see the layout in an aerial view. That’s as close as you're going to get, peasant.

Let's Go Shopping

So you say to yourself, "I want me some of that. I’d like to place the following order, please."

• One Maybach Landaulet for $1 million to drive around in. (Actually to be driven around in.)
• One $100 million yacht for when I want to get seasick.
• One Gulfstream G550 private jet for $40 million.
• One private island for $24.5 million (castle included) for when I want to escape the masses.
• One $8 million estate for when I have to go ashore and mingle with the masses (but not too close.)
• One $5 million watch so I can have one.
• Total: $178.5 million.

My change after paying with a billion-dollar bill is a meager $821.5 million left over. I might be hard up for cash after my spending spree, but I can still stay in a $20,000 room every night for 112 and 1/2 years.

So, as you see, $1 billion is more than enough to really live it up. People today are amassing multiples of billions, paying very little in taxes and using it in ways that harm the rest of us.

How Extreme Is The Concentration?

Now you have a way to visualize just how much money is concentrated at the very top. And the concentration is increasing. The top 1% took in 23.5% of all of the country’s income in 2007. In 1979 they only took in 8.9%.

It is concentrating at the expense of the rest of us. Between 1979 and 2008, the top 5% of American families saw their real incomes increase 73%, according to Census data. Over the same period, the lowest-income fifth (20% of us) saw adecrease in real income of 4.1%. The rest were just stagnant or saw very little increase. This is why people are borrowing more and more, falling further and further behind. (From the Working Group on Extreme Inequality)

Income VS Wealth

There are a few people who make hundreds of millions of income in a single year. Some people make more than $1 billion in a year But that is in a single year. If you make vast sums every year, after a while it starts to add up. (And then there is the story of inherited wealth, passed down and growing for generation after generation...)

Top 1% owns more than 90% of us combined. "In 2007, the latest year for which figures are available from the Federal Reserve Board, the richest 1% of U.S. households owned 33.8% of the nation’s private wealth. That’s more than the combined wealth of the bottom 90 percent." (Also from the Working Group on Extreme Inequality)

400 people have as much wealth as half of our population. The combined net worth of the Forbes 400 wealthiest Americans in 2007: $1.5 trillion. The combined net worth of the poorest 50% of American households: $1.6 trillion.

Corporate wealth is also personal wealth. When you hear about corporations doing well, think about this chart:

The top 1% also own 50.9% of all stocks, bonds, and mutual fund assets. The top 10% own 90.3%.

Worse Than Egypt

In fact our country's concentration of wealth is worse than Egypt. Richard Eskow writes,

Imagine: A government run by and for the rich and powerful. Leaders who lecture others about "sacrifice" and deficits while cutting taxes for corporations and the wealthy. A system so corrupt that rich executives can break the law without fear of being punished. Increasing poverty and hardship even as the stock market rises. And now, a nation caught between a broken political system and a populist movement that could be hijacked by religious extremists at any moment.

Here's the reality: Income inequality is actually greater in the United States than it is in Egypt. Politicians here have close financial ties to big corporations, both personally and through their campaigns. Corporate lawbreakers often do go unpunished. Poverty and unemployment statistics for US minorities are surprisingly similar to Egypt's.

The Harmful Effect on The Rest Of Us

This concentration is having a harmful effect on the rest of us, and even on the wealthy. When income becomes so concentrated people who would otherwise think they are well off look up the ladder, see vastly more wealth accumulating, and think they are not doing all that well after all. This leads to dissatisfaction and risk-taking, in an effort to get even more. And this risk-taking is what leads to financial collapse.

Aside from the resultant risk of financial collapse, the effect of so much in the hands of so few is also bad psychologically. People need to feel they earned that they have earned what they have, and develop theories about why they have so much when others do not. Bizzare and cruel explanations like Ayn Rand's psychopathic theories about "producers" and "parasites" take hold. Regular people become little more than commodities, blamed for their misery ("personal responsibility") as they become ever poorer.

Teddy Roosevelt, speaking to the educators about "False Standards Resulting From Swollen Fortunes," warned that while teachers believe their ideals to be worth sacrifice and so do non-renumerative work for the good of others, seeing great wealth makes people think that obtaining wealth is itself a lofty ideal,

The chief harm done by men of swollen fortune to the community is not the harm that the demagogue is apt to depict as springing from their actions, but the effect that their success sets up a false standard, and serves as a bad example to the rest of us. If we do not ourselves attach an exaggerated importance to the rich man who is distinguished only by his riches, this rich man would have a most insignificant influence over us.

Societies that are more equal do better. In the book The Spirit Level: Why More Equal Societies Almost Always Do Better, Richard G. Wilkinson and Kate Pickett make the case that great inequality harms us physically as well as spiritually, and the these harmful effects show up across society. The book examines social relations, mental health, drug use, physical health, life expectancy, violence, social mobility and other effects and show how inequality worsens each.

Influence Buying

There is a problem of the effect on our democracy from the influence that extreme, concentrated wealth buys. In the book Winner-Take-All Politics: How Washington Made the Rich Richer--and Turned Its Back on the Middle Class, Jacob Hacker and Paul Pierson make the case that the anti-democracy changes we have seen in America since the late 1970s that led to intense concentration of wealth and income are the intentional result of an organized campaign by the wealthy and businesses to use their wealth to, well, buy even more wealth.

The secretive Koch brothers are said to have a net worth of $21.5 billion each and are particularly influential. They financed the Tea Party movement and along with big corporations and other billionaires they financed the massive assault of TV ads in the midterm elections that helped change the makeup of the Congress. And now Congress is paying them back,

Nine of the 12 new Republicans on the panel signed a pledge distributed by a Koch-founded advocacy group — Americans for Prosperity — to oppose the Obama administration's proposal to regulate greenhouse gases. Of the six GOP freshman lawmakers on the panel, five benefited from the group's separate advertising and grassroots activity during the 2010 campaign.

... Republicans on the committee have launched an agenda of the sort long backed by the Koch brothers. A top early goal: restricting the reach of the Environmental Protection Agency, which oversees the Kochs' core energy businesses.

We Must Address This

We owe it to ourselves to come to grips with this problem. We owe it to democracy to begin taxing high incomes and inheritance again. We owe it to future generations to use a temporary wealth tax to pay off the debt.

Resources

The Working Group on Extreme Inequality explains why inequality matters in many more ways, and is well worth clicking through to study. They also have a page of resources for study with links to other organizations. Also, spend some time at Too Much, A commentary on excess and inequality because it is "Dedicated to the notion that our world would be considerably more caring, prosperous, and democratic if we narrowed the vast gap that divides our wealthy from everyone else." The Center on Budget and Policy Priorities has a Poverty and Income area of research with good resources. The Center for Economic and Policy Research has a research section on Inequality and Poverty.

Dave Johnson blogs at Seeing the Forest and is a fellow at the Commonweal Institute.