WHAT goes around comes around. Sometimes it happens sooner than you’d think.
That round wheel turned on JPMorgan Chase last week, which disclosed that it had suffered a $2 billion trading loss in credit derivatives. That such a hit had befallen the mightiest of banks was perhaps more stunning than the size of the loss.
So where does the karma come in? The loss, and the embarrassment it held for Jamie Dimon [ http://topics.nytimes.com/top/reference/timestopics/people/d/james_dimon/index.html ], the bank’s imperious chief executive, came just one month after a private dinner party in Dallas at which he assailed two respected public figures who have pushed for policies that would make banks like JPMorgan smaller and less risky.
The party, sponsored by JPMorgan for a group of its wealthy private clients, took place at the sumptuous Mansion on Turtle Creek hotel. Mr. Dimon was on hand to thank the guests for their patronage and their trust.
During the party, Mr. Dimon took questions from the crowd, according to an attendee who spoke on condition of anonymity for fear of alienating the bank. One guest asked about the problem of too-big-to-fail banks and the arguments made by Mr. Volcker and Mr. Fisher.
Mr. Dimon responded that he had just two words to describe them: “infantile” and “nonfactual.” He went on to lambaste Mr. Fisher further, according to the attendee. Some in the room were taken aback by the comments.
Neither Mr. Fisher nor Mr. Volcker would comment on the remarks. But it appears to have been a classic performance from Mr. Dimon. In-your-face. Pugnacious. My way or the highway.
Mr. Dimon declined to comment.
AS overseer of the bank that emerged in the best shape from the credit crisis, Mr. Dimon has gained in stature in recent years. Hailed for his management skill, he has also become the financial industry’s point man in the war against tighter regulation of derivatives and proprietary trading. Almost since the financial crisis began, JPMorgan Chase and its legion of lobbyists have swarmed lawmakers and regulators in an effort to beat back efforts to bring transparency to derivatives and to separate risk-taking activities like proprietary trading from commercial lending units.
JPMorgan has not been alone in these efforts. But it has had more clout because of its position as the grown-up in the financial industry’s playground.
The industry’s efforts to curtail or derail both derivatives transparency and the Volcker Rule — which would eliminate proprietary trading at commercial banks — have had significant effects. In the case of the Volcker Rule, lobbying has made the proposed regulation vastly more complex. Mr. Volcker himself told lawmakers at a Congressional hearing last week that “I could give you stories all day about lobbyists making things more complicated.”
The financial industry’s opposition has delayed the effective dates of regulatory changes. Had those delays not occurred, it’s possible that JPMorgan would not have incurred its big and jarring loss.
Mr. Dimon does not agree with this assessment, judging from his comments in a conference call last Thursday. But it’s an argument made persuasively by Michael Greenberger, a law professor at the University of Maryland and an authority on derivatives. He said that if two still-pending aspects of the Dodd-Frank legislation had been in effect, JPMorgan’s trading position probably wouldn’t have been allowed to grow as large as it did. Even better, the trades might not have been made by the bank at all.
“If the trades at issue were proprietary trading, as now appears to be the case, they would be banned by the Volcker Rule,” Mr. Greenberger said. “And if derivatives rules under Dodd-Frank had been in effect, these trades would almost certainly have been required to be cleared and transparently executed. The losing nature of the trades, therefore, would have been obvious to market observers and regulators for quite some time and the losses would not have piled up opaquely.”
Mr. Greenberger is talking about Title VII, the section of the Dodd-Frank law dealing with over-the-counter derivatives, which were at the heart of the JPMorgan trades. It would require clearing on an exchange and transparent execution of these derivatives. Under these rules, when trades go against an institution, additional capital would have to be supplied. “A Title VII clearing facility would have priced this trade regularly, and if it kept moving away, the facility would have been asking for margin,” Mr. Greenberger said. “That kind of discipline tends to head people off from these positions.”
The hypocrisy is that our nation’s big financial institutions, protected by implied taxpayer guarantees, oppose regulation on the grounds that it would increase their costs and reduce their profit. Such rules are unfair, they contend. But in discussing fairness, they never talk about how fair it is to require taxpayers to bail out reckless institutions when their trades imperil them. That’s a question for another day.
AND the fact that large institutions arguing against transparency in derivatives trading won’t acknowledge that such rules could also save them from themselves is quite the paradox.
“These regulations are not just protecting the United States taxpayer,” Mr. Greenberger said. “They protect the banks themselves. The best friend of these banks would be laws that prevent them from shooting themselves in the foot. The fact is, they can’t do it themselves.”
More than a year ago, we published this piece from the Stanford finance expert Anat Admati in which she presciently warned of the dangers of continuing to tolerate high levels of leverage in the banking system. She specifically challenged the notion advanced by Jamie Dimon, chief executive of J.P. Morgan Chase, that huge banks are beneficial to society, because they bring economies of scale. Admati's warning about the pitfalls of huge, highly leveraged behemoths dominating finance has only become more relevant in the wake of disclosures that Dimon's J.P. Morgan Chase has lost at least $2 billion trading credit derivatives -- the same sorts of investments that played a leading role in the 2008 financial crisis. Amid reports that the losses could yet increase, and given the scarcity of reliable information about the status of J.P. Morgan's trading positions and the potential for trouble spilling into the broader financial system, Admati's piece is well worth a fresh look. Here it is again. Far from fading, the debate over the potential dangers of "too big to fail" financial instituions is only intensifying.
The debate is raging about banks and their size, financial regulation, and the international capital standards known as "Basel". Jamie Dimon of JP Morgan Chase, in his New York Times magazine profile [ http://www.nytimes.com/2010/12/05/magazine/05Dimon-t.html ], expresses admiration for the Basel committee and says,
"… they are asking the questions that, in theory, bankers ask of themselves: how much capital do banks need to withstand the inevitable downturn, and what is an acceptable level of risk?"
There is one problem, however. Basel may have asked the right question, but it did not come up with the right answers, mainly because it allows banks to remain dangerously leveraged, setting equity requirements way too low. This fact is not understood because the debate on capital regulation has been mired with a cloud of confusion, and filled with un-substantiated assertions by bankers and others. As a result, the issues appear much more mysterious and complicated than they actually are.
After a massive and incredibly costly financial crisis, we seem to have a financial system that is a more consolidated, more powerful, more profitable and, yes, as fragile and dangerous as we had before the crisis. How did this happen and what can we do?
Here are some questions on which the confusion is staggering.
(i) Is "too big" the same as "too big to fail?"
(ii) Do capital requirements force banks to "set capital aside for a rainy day" and not use it to help the economy grow?
(iii) Are banks different than non-banks in that high leverage is essential to banks' ability to function?
(iv) Would terrible things happen if capital requirements were to increase dramatically?
The first order of business is to clear the fog and focus on the right things. I will try to explain. With the basics in place, answers will begin to emerge, or at least the right questions to ask.
By the way, I answer an emphatic NO to each of the above questions.
Let's start with balance sheets
Take a bank; indeed take any firm. The balance sheet is a snapshot of assets and liabilities. It has two sides, often shown piled on top of one another in financial statements or online data.
On the left hand side, or the top, of the balance sheet are the firm's assets, what the firm owns. The numbers come either in the oxymoron called "book value" that accountants produce based on historical costs, or in the more meaningful "market value," which for illiquid assets might not be readily available, and which can change frequently. More typically, some assets appear at cost and some are "marked to market."
On the right hand side, or the bottom, of a balance sheet are the liabilities and "shareholder equity," a summary of the claims that are held by various parties "against" the assets. There are two basic types of claims here: one called broadly "debt" (or "liabilities") and the other is "equity."
There is a huge variety of debt claims. One that we all provide to banks is called "demand deposits." Depositors can demand that this debt is paid back at any time. Other debt claims are distinguished by the length of the commitment, the interest rate, the collateral and the "seniority" (the place in the creditors' queue in a bankruptcy) and other provisions. Depositors are the most senior creditors of a bank; junior, unsecured debt-holders, or holders of certain "hybrid" securities, are the last in this priority line. If a bankruptcy occurs, however, it can take years to sort all these different debt claims out.
One feature of corporate debt is that the tax code allows interest paid on debt to be called a business expense and it is deductible before corporate taxes are calculated. This is similar to the deductibility of mortgage interest payments for homeowners.
But the main feature of debt that distinguishes all debt claims from equity, is that debt is a hard claim, an "I Owe You." Creditors have rights to take legal action if they are not paid what they are owed. They can cause a financial failure or bankruptcy. This process can be a terrible thing or not so terrible. Airlines "fail" routinely and they renegotiate some contracts, re-organize, and emerge out of bankruptcy. No stigma is attached, and operations often continue, although of course it is bad news. And debt contracts work well when the bank finances individuals and businesses. Things are different, and much more problematic, when banks use a lot of debt to fund themselves. More on this later.
The final part of the balance sheet is the category of "equity." Bankers like to call it "capital," but let's stick to the standard terminology of equity. (Using a different lingo than for other types of firms is part of the mystique of banking and helps in creating confusion.)
There are a few distinctions within equity too, mostly between "preferred" and "common" equity. Preferred equity, like debt, specifies how much the holder of the preferred will be paid. The lowest-class equity, called "common equity" cannot be paid at all until the preferred equity is paid what it was "promised." The key difference with debt, however, is that the firm does not "fail" if it does not pay its equity holders, even if they are "preferred."
Why does anyone buy this bottom-feeding equity? Because equity gets the upside, the profits of the firm, and if the firm is successful –and banks make a lot of money most of the time — this can be a very good deal. For banks, in fact, the return on equity is very high, often in the order of 25%. This is not something "abnormal." It is likely the "appropriate" return, because this "leveraged" equity is also quite risky. In financial markets, the higher the risk, the higher the average or required return.
Leverage and funding costs: the basics
Financial leverage is about how much debt relative to equity a firm has. The more debt relative to equity, the higher is the leverage. Does it matter to overall funding costs how much debt vs equity a firm uses? There was a great deal of confusion about this way back in the first half of the 20th century. In 1958, two economists, Franco Modigliani and Merton Miller (who separately won Nobel prizes, partly for this work) considered this issue and showed that, while leverage does typically affect overall funding costs, this is not due to the reasons people were giving at the time, which were based mostly on the fact that equity has a higher required return than debt.
The so-called MM result from 1958 builds on a basic "conservation of value" principle. As leverage changes, so does the riskiness of equity (and sometimes that of debt as well), and thus its required return. If there were no other factors, such as third parties (think governments) taking or injecting cash in taxes or subsidies, and if the funding method did not affect the investment decisions of the firm that determine what is on the assets' side of the balance sheet, then it would be irrelevant how much debt vs. equity is on the balance sheet. Of course, none of these "ifs" are true in reality, particularly for banks, so capital structure does matter, sometimes a lot.
MM is a basic "physical law," taught in every basic corporate finance course, and the starting point of any intelligent discussion of financing decisions. Yet, quite astonishingly, bankers and others, with a straight face, routinely and to this date, make the outrageous claim that "Modigliani and Miller does not apply to banks." As if banking is so different from the rest of the world that it is exempt from natural laws. This is akin to saying that one can ignore the force of gravity because of air friction.
If there are frictions, we must consider their impact. Do air frictions work against gravity or in the same direction? Do frictions associated with funding favor debt or equity, in the sense that — in their presence — funding costs or the total value that can be created on both sides of the balance sheet favors a particular mix of funding means? And, importantly in the context of banks, because the funding decisions of any bank may have broader implications, if a bank chooses a certain way to fund itself, does it follow that society is best off under this structure?
Key observations on the effects of leverage
It turns out that the biggest friction in bank funding is not one that is "inherent" in the banking system or in funding more generally, something unavoidable and found "in nature," like the wind. The main friction is the result of government policies. That would not be so bad if these policies worked to our collective benefits. Unfortunately, these policies go exactly in the wrong direction, favoring leverage that inflicts systemic fragility and extraordinary costs during crisis, precisely because they give bankers strong reasons to choose high leverage.
The fact is that, because of government policies, the funding costs of banks are lower the more debt they have relative to equity, i.e., the higher is their leverage.
Even worse, these same policies, and the resulting excessive leverage, distort the investment decisions of banks. They give incentives for excessive risk taking, which means that banks may overinvest in risky loans (something we witnessed quite clearly in the housing market leading up to the crisis). And it can interfere sometimes with banks' ability to provide credit and fund valuable investments, because, with a lot of prior debt commitments hanging over them, it may be harder for highly leveraged firms to raise new funds. This so-called "debt overhang" problem contributed to the credit crunch that we experienced in the crisis.
Clearly, the consequences to society of highly leveraged banks are exceedingly negative. Yet, we have a system where we subsidize leverage!
If this sounds crazy to you, this is because it is crazy. The analog would be a government policy that subsidized pollutants, such that the more they pollute, the larger the subsidy. If pollution is bad for health and for the environment, and you required pollutants to limit emissions, they would obviously complain that their cost of production would increase, and this might be true because they lose subsidies. Does this mean we must subsidize pollution? Clearly not, especially if there is an alternative!
Continuing with the analogy, what if there was another process by which to produce the same product, which would actually not increase the cost of production but which is not chosen because of the subsidies given to the polluting technologies? This analogy is key to understanding the battle over bank funding. The way in which subsidies are given to banks makes no sense. If we believe that banks provide important services, and if we want to subsidize them, we must find other ways to do so which do not lead to this perverse situation. We should not effectively penalize equity as a form of financing.
Leverage in banking and elsewhere
The tax code gives an advantage to debt financing not just for banks, of course. (Whether this makes sense is highly debatable. Many economists, including Michael Boskin, advocate abolishing the corporate tax code in part because of this effect.) But despite the tax incentives, many highly productive firms hardly use any debt at all, and no one chooses to fund themselves with anywhere near as much debt as banks. (The following, for example, are funded virtually only by equity: Apple, Google, Gap, Yahoo, eBay, Bed, Bath and Beyond, Broadcom, and Citrix.) This is because there are other forces that work against leverage, such as constraints lenders put on firms, and the distortions in investment decisions that are due to conflict of interest between equity and debt. An "all equity" firm is the gold standard for making good investment decisions, as it takes into account properly the upside and the downside of its decisions.
Everything is different for banks. Banks love high leverage. Whenever they make money, which is most of the time, they pay much of it out (to managers and shareholders), and they keep rolling over their huge debt, continuing to borrow more as they pay off what they owe. Equity is always a relatively small fraction of the total balance sheet. High leverage creates fragility because even a small change in the asset value can wipe out the equity and cause insolvency and financial "failure."
Bankers tell us that they must be allowed to maintain high leverage because this is part of the business of banking. They assert that economies will suffer if they are made to fund more of their investments with equity, there will be credit crunches, terrible things will happen. We clearly must examine these statements carefully before agreeing.
Why banks choose high leverage, and why this has awful consequences
The "safety net" that was created to make sure banks' operations are not disrupted by economic shocks, i.e., the fact that the FDIC, the Treasury, or the Fed, often stand ready and are expected to back up the banks' liabilities, plays havoc on banks' incentives to manage their risk and their leverage prudently and create a gap between what the banks find optimal and what is good for society. This is a very unhealthy situation.
The reason banks strongly prefer debt over equity is because their creditors or debt holders feel reasonably safe about being paid and thus do not require much in average return from the bank. Such creditors don't have to put restrictions and conditions on banks' activities. As long as they are confident they will be paid, creditors don't care what the bank does with its money. When they become nervous, it's often too late and the system freezes.
Why have we established this safety net for banks? Experience and research has shown that bank runs are very inefficient and disruptive. To prevent inefficient runs, deposit insurance was introduced. The safety net was expanded because the distress or failure of a bank has certain "contagion" effects and can thus be very disruptive and costly to the financial system and to the economy.
Even the suspicion of possible insolvency for a bank can lead creditors to withhold further funding. Banks then may need to engage in massive "fire sale" of their assets to pay their debts, and even that might not be sufficient if they are truly insolvent. This can lead the entire system of credit and payment to freeze. Does this sound familiar?
Allowing the legal process of bank "failure" to work itself out is extraordinarily costly and disruptive, particularly for global banks subject to different legal systems. There are no great options here. The Lehman bankruptcy process, which is still going on for more than two years, has consumed many billions of dollars in direct and indirect costs. And we are still dealing with its fallouts.
So when Jamie Dimon says that he favors resolution authorities and that JP Morgan "should file for bankruptcy" if the situation arises, we must ask ourselves the following: first, do we believe that the government will actually let JP Morgan go into bankruptcy, and if they did, would this be the right thing? Second, is there an alternative? Can we prevent more of these costly and disruptive failures and the need for bankruptcy and resolution procedures? And if so, how?
Is high leverage necessary for banks?
Here is the good news, and the simple and powerful answer. NO! Quite simply, high leverage is not necessary for banks! We can significantly lower the fragility and the likelihood of needing resolution and bankruptcy in banking by insisting that they use a lot more equity and less debt to fund themselves. And, for society, this will only have positive side effect, despite what the bankers say. Focusing on more equity funding is the simplest and most effective approach to the "too big to fail" problem, because it directly works to reduce the likelihood of "failure." It does not rely on costly resolution or "bail-in" mechanisms that we are not sure would work or on bankruptcy courts. And it forces banks to "own up" to their investment decisions and alleviates many distortions associated with high leverage.
The business of banking does mean that banks cannot be funded completely with equity as Apple or Gap, because demand deposits and even money market funds and certificates of deposit are part of their business of financial intermediation. Thus, a certain amount of debt is built into banks' balance sheet. But this does not imply that banks' leverage must be as high as it is or as they would like it to be or even as high as Basel III would allow.
There is simply nothing that prevents banks from doing everything valuable for society at dramatically lower leverage, say 30% of total balance sheet. (In an interview on CNBC in May [ http://www.cnbc.com/id/15840232?video=1506628338&play=1 ], Gene Fama suggested 40% or 50% in equity for banks would be a good thing.) Some of the banks' debt is not part of their business model and just serves to provide funding. And issuing more equity to support the liability on their own would not increase their funding cost in a way that represents any social cost. (If they lose some subsidies, we save on providing these subsidies!)
Not only would we have a safer system if equity levels were dramatically higher, it is hard to think of any negatives, from society's perspective, of doing so. Back to the pollution analogy, the alternative, clean technology of funding turns out to be cheaper than the polluting one once subsidies are removed!
The fact that so much fog was created to prevent the above from being recognized by decision makers in Basel and in many governments, including US, is maddening.
There are other claims made in this debate, but the bottom line holds up upon closer examination: there does not seem to be any compelling reason that banks must be as highly leveraged as Basel III would allow. Those who say otherwise, and bank executives such as Vikram Pandit of Citi have complained that Basel III is too harsh on banks cannot justify their claims coherently. The only interpretation is that they are motivated by self interest.
In a paper I wrote with Stanford colleagues Peter DeMarzo and Paul Pfledierer and with Martin Hellwig from Bonn, we discuss in some detail every argument we are aware of regarding the mantra that "equity (or, as bankers call it, "capital") is expensive." We also discuss contingent capital and bailout funds, arguing that the equity-based solution dominates them. The paper is available here [ http://www.gsb.stanford.edu/cgrp/cgwire/documents/BankEquityisNotExpensive.pdf ].
The case for much more equity funding for large banks (and possibly other financial institutions) is overwhelming. The main challenges are to define the "regulatory umbrella" appropriately, to understand the "shadow banking" system, and to find effective ways to monitor the true risk and leverage of financial institutions on and off the balance sheets. These challenges can be met if energy is focused appropriately.
Sensible capital regulation does not necessarily involve a hard and fixed "number" for the equity ratio, but rather a flexible system of buffers and adjustments where the balance sheet of the banks is managed with the objective of allowing them to operate without overly endangering themselves and the system. Supervising the payouts and the funding methods of banks so as to keep the system healthy and functional is eminently possible if we take up the challenge.
First, however, we should remove the fog of confusion. Then we must find the political will to insist on prudent regulation before another crisis hits.
Comments on Hoenig, Dimon and banks being "too big"
Many argue that banks that are "too big to fail" are simply "too big." In an excellent op ed in the New York Times [ http://www.nytimes.com/2010/12/02/opinion/02hoenig.html ] this week, Kansas Fed president Thomas Hoenig identifies the key problems of "too big to fail" banks and argues that we should strive to create smaller banks, none too big to fail. Related proposals were made by Andy Haldane from the Bank of England (see this link [ http://www.bankofengland.co.uk/publications/speeches/2010/speech433.pdf ]), and by Simon Johnson and James Kwak, authors of the important book "13 Bankers [ http://13bankers.com/ ]." These proposals, and the so-called Volcker Rule, focus on the total size of the bank and more generally on the "asset" side of the balance sheet. How does this relate to leverage?
If managed properly, breaking up the banks would likely be a step in the right direction. But we cannot ignore leverage. Many small but interconnected banks would still be fragile and subject to systemic risk and possible crises if each of them was highly leveraged. A small drop in the asset value of a leveraged bank leads to distress and possible insolvency, and this can be contagious in such a system. So fragility in the banking system invariably relates to the degree of leverage.
Jamie Dimon of JP Morgan says large banks are useful and efficient. He wants to be the Walmart of banking. Presumably, he wants to have the size of Walmart but he is not planning to have the type of capital structure that Walmart and firms like it have, with more than twice as much equity as debt on the balance sheet (at least by market value).
Mr. Dimon, how about you start helping the world of banking and the economy by pushing for banks to be much less leveraged, relying more on equity funding than Basel III allows, and for regulators to make sure they are? If you do that, your growth aspirations might seem a bit less scary.
This regrettable news from JPMorgan Chase obviously goes counter to the bank's narrative blaming excessive regulation for the woes of financial institutions. Interestingly, in the Economist's long attack on the financial reform bill, one of their leading examples of the harm the bill is doing was JPMorgan Chase's assertion that complying with the new rules will cost $400 to $600 million at the outset (a number which will obviously go down as compliance processes are set in place). In other words, JP Morgan Chase, entirely without any help from the government has lost, in this one set of transactions, five times the amount they claim financial regulation is costing them.
Jamie Dimon, JPMorgan Chase's boss, reckons the direct costs to his bank, America's largest, will be $400m-600m annually. "Additional regulations resulting from the Dodd-Frank act may materially adversely affect BB&T's business, financial condition or results of operations," said one regional bank in its recent annual filing to the SEC. Other institutions are said to be in the process of drafting similar statements, or, at the least, planning to acknowledge the costs in the conference calls that surround quarterly earnings.
When Mayor Rahm Emanuel introduced a “new and innovative” financing tool last month to help Chicago renovate failing infrastructure without precipitating another budget crisis, many in the city were understandably critical.
Chicagoans have already endured the notorious 75-year lease of their parking meters to a consortium headed by Morgan Stanley. That sale promulgated a system wherein the public is held hostage by private finance, due largely to the inclusion of arcane legal stipulations like “non-compete clauses” and “compensation events” in the language of the contract.
Ellen Danin, writing in the Northwestern Journal of Law and Social Policy relates that: “Chicagoans learned about compensation events when CBS reported that the city’s parking meter contract required reimbursement for events like repairing streets. Public records showed that in the first quarter of 2009, the city was liable to the parking meter contractor for more than $106,000 in lost income during the slow months for street repair and street closings for festivals, parades, and holidays, as well as repairs and maintenance. At that rate, it is not unreasonable to predict that Chicago will owe roughly $500,000 a year to the private contractor.”
The city essentially acts as an insurer for the meter merchants, with the return being a one-time injection of roughly a billion dollars that the previous mayor, Daley the Second, haphazardly exhausted on closing budget deficits in the waning years of his two-decade tour at the helm.
With the current infrastructure deal, Emanuel has repeatedly claimed that this is not privatization: This is not like the parking meter deal. Can the public believe him?
Here is how the “infrastructure trust” works: the city pays for upgrades to its roads, rail or schools with dollars pooled by Emanuel’s friends from the banking and investment world. Meanwhile, the city retains “ownership” of the infrastructure, though this comes at the cost of having to ensure a revenue stream for the fund. Emanuel’s favorite example is his $225 million pet project [ http://www.theatlanticcities.com/politics/2012/04/chicago-approves-its-infrastructure-bank-cities-across-country-watch-and-wait/1848/ ] to green-retrofit some of the city’s older buildings. The savings on energy usage stemming from the renovations are then extracted and used to pay off investors. Of course, the city could also sell municipal bonds to raise necessary funds, and then use the savings in energy costs to pay the loan back at a much lower cost to taxpayers. But then Emanuel’s friends (and campaign donors) would not be the richer for it.
While the mayor bills his plan as “bold” and “innovative,” the reality could not be further from the truth. Public-private partnerships (PPPs) have been around for decades in various forms and their track record is replete with delays, cost overruns and prolonged legal battles. What’s more, the beneficiaries of these investment mechanisms are the same rapacious Morgan Stanleys and Goldman Sachs that gave us the mortgage-backed securities scandal and the ensuing recession. Using the economic malaise they created as cause, they have ratcheted up their advocacy of PPPs as a means of helping cash-starved public entities finance capital-intensive projects.
The upshot is that they are holding us hostage all over again. They are using infrastructure built over decades with public monies as collateral to extract profit off of the back of taxpayers. A cursory look at some past projects of this nature demonstrates that PPPs are often inefficient, overly costly and inherently unjust.
The London Tube Nightmare
The granddaddy of all PPP debacles is the London Underground. Metronet PPP is the brainchild of former Prime Minister Gordon Brown. The contract design kept London Underground in public hands while privatizing the renovation and renewal elements to the system [ http://www.guardian.co.uk/commentisfree/2009/dec/18/tube-ppp-upgrade-london-underground ]. As with the Chicago parking meter deal, the contract was replete with virtually unintelligible legalese designed to give the private partners an advantage in court, while also rendering public scrutiny of the contract exceedingly difficult. Bureaucratic costs related to drawing up contracts with external bidders ultimately surpassed 500 million pounds.
In the Guardian, Christian Wolmar notes that “the idea that the PPP would keep costs down has also proved fanciful. It is a recipe for disputes, which often end up in the hands of expensive lawyers. During the first contract, there is a mega dispute brewing over Tube Lines' failure to complete the resignalling of the Jubilee Line which should have been finished this month and is now set to take until the autumn, with numerous extra weekend closures. In addition, the arbiter's report says that claims involving a staggering £727m have been laid by Tube Lines, £500m of which are still outstanding.”
As bloated contractual costs and project overruns spun out of control, Metronet ultimately collapsed in 2008. A year later, the entire PPP went down with it after an arbiter refused to allow funds for the other private partner, Tube Lines, to do further renovations. The final cost to taxpayers is estimated at somewhere between 170 million and 410 million pounds, which does not account for the inconvenience of relentless service stoppages and construction delays. Former London Mayor Ken Livingstone complained at the time: “We are being asked to write a blank cheque in order to prop up failing Tube Lines. In other countries this would be called looting, here it is called the PPP.”
Orange County’s Privatized HOV Lane
Almost equal in disrepute to the London Tube fiasco was the privatization of one high-occupancy vehicle (HOV) lane on California’s SR-91. In the early '90s, the Orange County Transportation Authority (OCTA) proved incapable of procuring necessary funding for implementation of the new HOV using traditional revenue streams, so instead developed a private partnership to construct and manage the project, which opened December 27, 1995.
This contract included “non-compete” clauses that prevented the public from providing necessary maintenance to the adjacent free lanes. The California Department of Transportation hoped to add new lanes between SR-91 and another recently completed public toll road. These improvements would have violated the non-compete terms of the contract, though CalTrans argued there were overriding safety concerns that permitted them to proceed with the construction.
The ensuing public row served to turn opinion against the private toll lane. Ultimately, the outcry led to passage of Assembly Bill 1010, which authorized OCTA to acquire the lane for $207.5 million in 2003. California’s earliest experiment with private financing of a publicly controlled entity, like the London Tube, came crashing to a premature halt on the heels of widespread public outrage.
What is most telling is that popular frustration centered on a principal term of the contract, which was publicly available for viewing prior to approval. Once again, a common ploy of instigators of these contracts is rendering the terms so confusing as to limit public scrutiny. Meanwhile, the mainstream press tends to focus on the bottom line and avoid the esoteric legal mumbo jumbo, much to the detriment of an enlightened public.
The SDX
California, ever the epicenter of political innovation, was also the site of another one of the most significant PPP boondoggles. In this case, Australian investment group Macquerie led an assortment of banks that invested in a new expressway from San Diego to the Mexican border, beginning with the project’s commencement in 2000 and lasting until the contract expiry in 2042.
However, faced with the challenges of the housing crisis and wider economic slump, the project faced persistent toll revenue shortfalls and ultimately filed for bankruptcy last year. Meanwhile, the cost of the project jumped from $360 million to $843 million, while being delayed for over a year. In the bankruptcy proceeding [ http://www.huffingtonpost.com/2011/12/27/transportation-department-south-bay-expressway_n_1171842.html ], the South Bay Expressway LLC was created to administer the road and ultimately purchased by the San Diego Association of Governments (SANDAG) for $344.5 million.
This project received an initial $140 million boost from funds provided by the Transportation Infrastructure Finance and Innovation Act (TIFIA). TIFIA is designed as a tool to provide federal investment in PPPs. Interestingly, Rahm Emanuel cited the program as an example of a financing tool that his Infrastructure Trust is based on. However, this is a bit misleading, as TIFIA is composed entirely of federal funds used to augment existing finances for capitol projects. Meanwhile, Emanuel’s trust is composed of $1.7 billion in funds raised from private banks leveraged against a $200 million investment by the city.
Nonetheless, the two shortcomings of this project are particularly instructive. Its primary problem was the failure to meet the initial high-shooting projections initially set out. Traffic patterns are extremely difficult to accurately anticipate: a situation not helped by the backdrop of the worldwide recession and the location of this road in a region that was particularly burdened by the foreclosure crisis. The intrinsic uncertainty of usage of public infrastructure renders it a poor focal point for private, profit-driven investment. The reality is that parks, roadways and bridges require periodic capital investment irrespective of profitability. Public entities are far more well-equipped to finance these unreliable projects for the very reason that government is not motivated by profit.
The second problem this project faced by this PPP, like so many others, was its predilection to legal wrangles. SBX was involved in legal proceedings with InTrans, the toll system provider, and a number of construction related contractors. One source speaking with TollRoadNews called the governing contract a “sue-me contract” that was “made for litigation.” Given the immense costs seen by the London Tube PPP, this should come as no surprise. These projects seem to invite costly litigation just from their sheer complexity.
Toward Sustainable Investment in Infrastructure
PPPs are purported to make additional resources available for public expenditure on capital-intensive infrastructure projects. However, the opposite tends to be the case. A report published by the Public Services International Research Unit notes: “The great majority of PPP’s rely on a stream of income from payments by government – i.e. public spending...In a context where there are political demands to cut public spending, the existence of PPP’s creates greater threats to other spending on public services. This is because PPP’s create long-term contractual rights to streams of income, and so governments are legally constrained from reducing payments to PPPs.”
Even the International Monetary Fund warns that public investment in PPPs should be subject to strict scrutiny in a July 2009 publication: “Intervention measures should be consistent with the wider fiscal policy stance, be contingent on specific circumstances, and be adequately costed and budgeted.” The IMF also argues that PPPs related to weathering the economic crisis should include a “turn off” mechanism. A green paper published by the Commission of the European Communities in April 2004 even went further, recommending against PPPs as a tool to close any budget deficits. They argue that the mechanism should be employed primarily when the private entity is providing a specific field of expertise.
After all, why should anyone trust the same racketeers who precipitated the global economic crisis to make acute investment decisions on behalf of the people? All levels of government face serious fiscal constraints stemming from a range of causes, including the ongoing recession and regressive tax policy across the board. When financiers so generously offer to open up the purse strings to invest in pet infrastructure projects, the public response ought be: “No, thank you. Instead, we are going to raise the top marginal tax rate.” That would be a far more efficient and prudent way of beginning to tackle the fiscal crises in government.
Matt Reichel is a writer living in New Orleans. Email him at mereichel@gmail.com or follow him on Twitter at: https://twitter.com/#!/mattreichel.
Mitt Romney: Bank Of America Protesters Too Young 'To Really Understand' Economy 05/12/2012 Mitt Romney said the protesters rallying against Bank of America in Charlotte this week are too young "to really understand how the economy works." “Unfortunately, a lot of young folks haven’t had the opportunity to really understand how the economy works, and what it takes to put people to work in real jobs, and why we have banks, and what banks do," Romney told WBTV in Charlotte, according to National Journal. "It's a very understandable sentiment if you don't find a job, and you can’t see rising incomes. You're going to be angry and looking at someone to blame." Romney said the protesters' blame should be targeted at "the president and the old school liberals that have not gotten this economy turned around." He made a not-so-subtle 2012 push, insisting he's the one who "understands how to get the economy going again." [...] http://www.huffingtonpost.com/2012/05/12/mitt-romney-bank-of-america-protests_n_1511868.html [with comments]
Survey for health, poverty benefits threatened in Congress
The survey provides data about who has health insurance so services can be directed toward specific people and places.
By Elizabeth Landau, CNN updated 8:14 AM EDT, Tue May 15, 2012
(CNN) -- Americans needing health insurance or disability services could be overlooked by their local governments if a bill now being considered by the Senate passes. It would eliminate a survey that some call a vital source of information about health indicators of millions of Americans, but which House Republicans say is too expensive and raises privacy concerns.
It's called the American Community Survey. The Census Bureau surveys about a quarter of a million Americans every month. Community officials, academics and businesses rely on this information to understand the markets they operate in and the needs of individual localities. The House last week passed a Republican-backed bill that would cut the survey altogether, citing costs and privacy issues.
The survey program, which reaches more than 3 million people annually, could cost taxpayers upwards of $2.4 billion over the next 10 years. Survey supporters say that isn't much money in the grand scheme of government, but opponents say the survey is needless and unconstitutional.
"Given the intrusive nature of some of these questions, which are mandatory for Americans to answer under penalty of law, it would seem that these questions hardly fit the scope of what was intended or required by the Constitution," Rep. Daniel Webster, R-Florida, told Congress last week.
But the American Community Survey is vital to state legislators, mayors, city councils and city planners, said Robert Moffitt, professor of economics at Johns Hopkins University in Baltimore. These officials need to know information such as how many families don't have health insurance, how many people are living in poverty, and how many individuals are disabled, so that services can be directed toward the appropriate number of people in particular places, he said.
Academics who rely on the data for research have been particularly concerned about maintaining the survey, whose data is used in a wide variety of analyses.
"If you're opposed to the survey, you're opposed to understanding what's going on in America," said MIT economist Jonathan Gruber, director of the Program on Health Care Research at the National Bureau of Economic Research.
The poverty question is particularly important because in areas where poor families are concentrated, problems multiply, and community officials should know where those areas are, Moffitt said. High crime, health conditions and underperforming public schools are all consequences of poverty clusters, according to the Brookings Institution.
And with health insurance, as communities devise health insurance programs for those who are not covered, it's useful to know exactly where the uninsured live and other facts about them, such as whether they are also unemployed, Moffitt said.
Gruber says the survey is probably the best source of data on health insurance coverage currently available. Health insurance markets are quite different across areas. The survey additionally allows researchers and policy-makers to look for trends among minorities. "If you want to do any local estimates, you need big samples, and that's what the ACS gets you," he said.
The Affordable Care Act, whose constitutionality will be decided by the Supreme Court, would require that everyone have health insurance. But irrespective of that, any state doing health care exchanges needs to know about the markets it's operating in, he said.
In 2008 the American Community Survey began including questions about marriage -- for instance, how many times people have been married, and whether they have been married, divorced or widowed in the previous 12 months. This could be used to zoom in on needs surrounding child care and child support for single-parent households, as well as to create and evaluate policies and initiatives relating to the institution of marriage.
The survey is also important to businesses. Joan Naymark, director of market analytics and planning at Target Corporation, said in a video on the Census website that her company uses Census Bureau data to see the characteristics of potential customers who live in communities throughout the United States. Target's director of guest insight, Kate Whittingon, said in the video that Target looks at the American Community Survey for information about family structure and household size.
Educational attainment and workforce age are two statistics from the survey that are valuable to the Greater Houston Partnership, a nonprofit geared toward building economic prosperity in Houston.
As examples of the intrusiveness of the survey, Webster cited questions that ask if respondents have difficulty dressing, concentrating and making decisions, how long it takes them to get home from work, and what their emotional condition is. He also said that failure to answer the survey can result in a $5,000 fine.
But Martin Gaynor, professor of economics and public policy at Carnegie Mellon University, called concerns about privacy "very foolish." "People volunteer all kinds of far more intimate, sensitive information online without a thought about who is watching," he said.
And there's a harsher penalty for Census Bureau employees who identify individuals filling out the surveys: five years in prison or $250,000 in fines, or both, according to the Census website. All employees take an oath of nondisclosure, and the information is kept private.
The American Community Survey has been administered since 2005. Before that, there was a long-form questionnaire that accompanied the general U.S. Census, which is given out every 10 years. "There was a general sense in the statistical community that there was a burden and people objected to it," said Margo Anderson, professor of history at the University of Wisconsin-Milwaukee.
Supporters of the cost-cutting bill won the vote to kill the survey 232-190 in the House. But it's far from being a law -- the Senate hasn't voted on it yet, and White House has suggested it would veto such a bill.
"I think the issue really is: The Republican House right now is looking for ways to cut the federal budget," Anderson said.
"What's likely to happen is: There's now going to be a much more robust public debate about whether (cutting it) is prudent or not."
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howdy .. Kabuki, episode 1 was on tv some hours ago .. after returning i just finished watching this .. it was just as good if not more peaceful in silence ..
yup, while no negative of the music at all it was very nice to watch it in SILENCE .. beautiful in fact .. good day all .. :)
Rep. Broun: Evolution, Embryology, Big Bang Theory Are "Lies Straight From The Pit Of Hell"
Uploaded by BridgeProject21 on Oct 5, 2012
From Rep. Paul Broun's (R-GA) remarks at the Liberty Baptist Church Sportsman's Banquet on September 27, 2012, in Hartwell, Georgia:
BROUN: God's word is true. I've come to understand that. All that stuff I was taught about evolution and embryology and the Big Bang Theory, all that is lies straight from the pit of Hell. And it's lies to try to keep me and all the folks who were taught that from understanding that they need a savior. You see, there are a lot of scientific data that I've found out as a scientist that actually show that this is really a young Earth. I don't believe that the Earth's but about 9,000 years old. I believe it was created in six days as we know them. That's what the Bible says.
And what I've come to learn is that it's the manufacturer's handbook, is what I call it. It teaches us how to run our lives individually, how to run our families, how to run our churches. But it teaches us how to run all of public policy and everything in society. And that's the reason as your congressman I hold the Holy Bible as being the major directions to me of how I vote in Washington, D.C., and I'll continue to do that.
People like this have the power to impose their anti-scientific ideas on the rest of us through legislation. If you aren't registered to vote, the deadline is THIS WEEKEND in several states. Please take 20 seconds to register here: http://www.rockthevote.com/rtv_voter_registration.html
The first clip is from the U.S. House Subcommittee on Energy and Environment - March 25th 2009. Congressman John Shimkus (R-Il.) puts all of our minds at ease about climate change. We don't need to worry about it. Why? Because God said he wouldn't flood the world again in Genesis.
Clip #2 is U.S. Congressman Paul Broun (R-GA) speaking yesterday to an audience in Georgia, expressing his disagreement with the unifying scientific consensus in astronomy and biology. Since his arrival in Congress, he has been appointed to the House Committee on Natural Resources, and currently serves as Chairman of the Investigations and Oversight Subcommittee for the House Science, Space, and Technology Committee.
The ideas that these men hold can lead to real harm, especially to future generations who fail to get a quality science education.
If you aren't registered to vote, please take a few seconds to do so, and help get rid of anti-science assholes like these.
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