G.Nelson

In their article, “Cartographies of Race and Class: Mapping the Class-Monopoly Rents of American Subprime Mortgage Capital,” Elvin Wyly, Markus Moos, Daniel Hammel, and Emanuel Kabahizi illustrate that in order to understand the subprime housing crisis of twenty-ought, one needs to understand the structural inequalities of class-monopoly rent. The understanding of class-monopoly rent has not gone away, but has shifted from a local landlord to an international landlord that regulates the renter upon the predatory practices of subprime lending. Variable rates, expensive fees, and asymmetrical information controls the tenants, like that of the 1960s land-installment contracts.

The group quickly illustrates the process of creating and packaging subprime loans. A bank or mortgage company to a borrower draws up a mortgage; that loan is quickly sold off to a Government Sponsored Enterprise (GSE); in return, the bank or mortgage company receives cash to make more loans. The original loan is, then, pooled into Collateralized Debt Obligations (CDOs) and Mortgage Backed Securities (MBS) –which are backed by Wall Street Investment Banks—and are sold around the world to various public and private institutions. The group highlights that at the time of rising home prices, the risk of a default is limited and the financial impact on the bond (MBSs and CDOs) is relatively mute. The bank could force a new mortgage, and the equity that was in the home would go to generate more income for the bank or, essentially, drop the homeowner and force them to become a renter.

In 1995, the Subprime markets accounted for $65 billion, but by 2006, the markets mushroomed to $625 billion. In 2007 a rush of delinquencies, defaults, and foreclosures, along with decreasing home values, created a credit crunch in the economy and chipped away at the confidence of the investors of MBSs and CDOs. This left the U.S. government vulnerable in which the Federal Reserve took dramatic action to buy up MBSs and of unknown values and government bonds to free up banks’ balance sheets.

Instead of taking blame within the financial markets, industry-defenders blamed the imperfect markets, the consumers for taking out more than they could manage, and the attempt by institutions to help more individuals then the markets could handle. The group illustrates, however, that institutionalized racial inequality because of credit-worthiness and lending practices are to blame for the systemic credit crunch of the twenty-ought.

Risk-based pricing --a theory that determines that an individuals ability to borrow and at what rate—has been the basis philosophy of financial markets of the last twenty years. However, the group illustrates how the philosophy has come under attack recently, and provides anything but the rosey picture that it once promised. The theory only deters moneylenders from lending to minorities and low-income individuals by providing a justification of denial to entry.

A social problem of the lack of access to homeownerships for the “underserved” (minorities and low-income individuals) gradually brought about State and Federal regulations and programs to assist homeownership for the underserved. Within the 1960s, for minorities to build up credit worthiness and equity for a bank to justify a mortgage --even if the minority already had the sufficient income to justify a mortgage—the minority would utilize a land-installment contract. This path towards homeownership often carried higher premiums. Within the 1980s, a series of laws made specific types of loans and lenders exempt from regulatory practices (337). Through the 1990s, federal and state regulators maintained the effort of providing traditional mortgages to the underserved, but at the turn of the century, small lending firms, which were backed by Wall Street, began to provide loans that were not restricted by state and federal regulations. Asymmetrical information, lack of knowledge by the consumers, led many to believe that this is the only way for them to own a home. These small lending firms were bought up by national banks and accounted them as subsidiaries, which allowed the bank to carry the exempt status in its subsidiary firm and continue the predatory practices, but now at this time, in a much grander scale. The loan restriction of the 1960s –which stems from racism-- has only transformed itself back to loan restrictions of today because of the predatory lending that is justified by the risk-based pricing theory.

I am illustrating the foresaid points of the article in my annotation to emphasize the foundation of racial-lending practices that span decades within the U.S. financial system. This will be imperative to tie into the financial credit crisis of 2008, and how municipalities suffered from this sort of practice.<br> G.Nelson

G.Nelson

In her article, “Government Budgets as the Hunger Games: The Brutal Competition for State and Local Government Resources Given Municipal Securities Debt, Pension and OBEP Obligations, and Taxpayer Needs,” Professor Christine Chung provides an eye opening and thorough analysis of Detroit’s economic woes. She summarizes the latest statistical findings, which illustrates the severe loss in residents, property blight, crime rates, the maximum statutory limit of taxation reached, citizen flight, and the loss of jobs. Moreover, she illustrates the budgetary debt constraints that have ballooned to more than $18 billion, which helped prompt Detroit to file for bankruptcy; the debt to revenue ratio will only increase over the next few years; bondholders are expected to lose a substantial amount of their investment from the bankruptcy. Chung illustrates that the City’s collapse preceded by an incremental decrease in jobs. From 1970 to 2012 the number of jobs declined from 735,104 to 346,545 (Chung 666).

She illustrates that Detroit is not an exceptional case, but there are numerous municipalities that are struggling to pay debt and other obligations, e.g. pensions. Currently, out of the participating states and localities, only $2.35 trillion has been set aside to pay pensions, health care, and OPEB promised to public sector employees; however, the actual estimated cost is around $3.5 trillion: more than $1 trillion in unfunded obligations (Chung 669).

Because of Detroit’s financial instruments used to manage their budgetary obligations, they took a high stake wager on interest rates, and when the rates declined, “Detroit lost catastrophically on the swaps bet” (Chung 670). Some municipalities have used derivatives to win, but others, e.g. Orange County, California and Jefferson County, Alabama, have lost or struggled with the financial instruments.

Chung posits that the Dodd-Frank Wall Street Reform and Consumer Protection Act does not go far enough to protect stakeholders or prevent from imprudent financial-decisions-makers from erring in how they utilize risky financial instruments. She finalizes her article with the following regulatory recommendations, which should provide a clearer picture of a City’s budget, obligations and revenues: "(i) requiring compliance with uniform accounting standards, so that stakeholders can get a better sense of the state of state and local government budgets; (ii) creating a data collection resource and oversight body to help identify and manage risks associated with complex instruments, (iii) creating a data collection resources and oversight body to help identify and management risks associated with public employee compensation (particularly pensions and OPEB), and (iv) expanding the reach of the fiduciary standard to a broader range of stakeholders involved in local government financial decision-making, including public officials, underwriters, and derivatives counterparties.” (Chung 671)

Honest politicians, clear and transparent accounting, and realistic demands on the City’s and State’s resources are needed, even at the cost of upsetting some constituents. A norm can be redeveloped that can help Cities create stability and longevity.

G.Nelson

G.Nelson

In their article, “Detroit’s Bankruptcy Settlement will not solve the city’s problems,” Gary Sands, Laura A. Reese, and Mark Skidmore depict core problems associated with the budgetary woes of Detroit, and list four possible scenarios that can happen to Detroit. The group provides a brief descriptive-statistical overview of the decline of Detroit. Since the 1950s, Detroit has lost more than 90% of the manufacturing jobs, and since 2000, employment in downtown has fallen 30%. Real estate has lost an average of 48% since the high in 2006. The number of residents has decreased by more than 60 percent since 1950s.

The Group illustrates that the shrinking tax base, extremely underfunded pension liabilities, and shrinking public services, coupled with a racial divide and poor public leadership sets Detroit apart from other municipalities that are suffering similar financial stresses. Detroit is usually noted for being the “most racially segregated US metropolitan area” (Sands 2).

Detroit has functioned as a “vendor regime,” where subsidies are issued to private businesses for urban renewal and redevelopment efforts. The private businesses are seen to benefit more than public interests, however, and this has led to “instances of mismanagement and public corruption.”

The overall goal of the bankruptcy is to bring about a financial viability and recovery; however, the group believes that latter is unlikely, but the bankruptcy will focus on how bondholders, pensioners, and other liabilities will be paid out and by how much.

The Group predicts four likely scenarios for Detroit: i) “Municipal operations could be reduced to the barest essentials, including only the services that could be supported by a realistic budget that ensures the City is able to maintain fiscal balance. ii) Many, even all, public sector functions of the residual Detroit could be taken over by other governmental entities, including newly-created local or regional authorities or by the county or state. iii) Detroit could be dissolved as a municipal corporation with the more viable areas incorporating as smaller municipalities (The State of Michigan has recently used this approach to dissolve two small, insolvent public school districts). In some instances, the more viable areas might be annexed by adjacent suburban municipalities. The balance of the Detroit territory would revert to Wayne county control. iv) The city becomes a de facto colony, with its resources exploited primarily for the benefit of others. This scenario has considerable currency among Detroiters, but it may be the least likely of the potential outcomes. In reality, for most suburbanites, Detroit offers little of value.” (Sands 3)

The group posits that the city will definitely be different in the future, but the hope and dream of an imminent recovery is unlikely. Racism, mistrust, and antipathy will be issues that need to be overcome.

G.Nelson

G.Nelson

I am utilizing this weeks article review to assist us and expand upon Meagan Jordan’s article, “Punctuations and Agendas: A New Look at Local Government Budget Expenditure.” Also, I’d like to link her analysis of intergovernmental aid and developmental expenditures together, and illustrate how a Community Development Block Grant (CDBG) grant can have an influence on the local budget, via political and economic influence upon the decision-makers and, thus, the agenda.

A Community Development Block Grant (CDBG) is a grant from the Federal government to assist in the funding of certain projects with stipulated mandates, and the state, then, awards a part of the grant to a local municipality or government to aid in economic growth and, or a revitalization project. This can have an impact of local budgets.

The City of Royal Oak, a suburb of Detroit, provides a “Guide To Compliance with Section 3 Requirements: Employment Opportunities For Low Income Residents of Royal Oak.” The purpose of this guide is to provide the Federal mandated requirements and information associated with HUD-funded project, specifically CNBGs, to the civilian contractor. Within Section 3, employment preference is mandated to first seek and hire low-income residents or businesses within the Metropolitan Detroit area. This mandate will cover any contractor that receives more than $100,000 from the City of Royal Oak.

To identify the individual or business to be preferred under this mandate, Section 3 list the following factors: The individual is a recipient of public housing or a housing choice voucher, and lives in the Metropolitan Detroit area with an income less than 80% of the area median income (AMI); the business is 51% owned by a Section 3 individual, 30% of the employees are Section 3 individuals, and 25% of subcontractors under the contract are Section 3 businesses.

Strict penalties are enforced upon the individual or business if found non-compliant and neglects to remedy the non-compliant issue. The individual or business may have their contract cancelled, face legal and equitable remedies for a contract default, and be suspended from future HUD contracts.

I will investigate further into how CDBGs dictate and change the local budget and politics of Detroit, specifically, after the 2013 bankruptcy.

G.Nelson

G.Nelson

In Matt Egan’s article, “Dr. Doom: This ‘Time Bomb’ Will Trigger Next Financial Collapse,” illustrates how the man, Nouriel Roubini, who predicted the 2008-09 financial crisis is predicting the next financial crisis. The next financial crisis will be a “liquidity time bomb.” After the 2008-09 financial crisis, the Federal Reserve created liquidity in the markets by buying up illiquid assets through quantitative easing. Quantitative easing is a policy were the Federal Reserve buys up troubled assets through the creation of dollars, i.e. debt creation. An illiquid asset is something, like a bond, that is not easily tradable, especially in a time of crisis.

Egan illustrates that in 2010 and 2013 the financial markets were shocked by illiquidity. Even with the mentioning of the Federal Reserve’s intent to someday cut back or cease their Quantitative Easing program, the markets reeled and temporarily crashed.

Paradoxically, the Federal Reserve’s policy of providing liquidity in illiquid market situations has only exasperated the liquidity problem by magnifying the situation from the dollars created to buy up illiquid financial instruments.

Egan illustrates three reasons for illiquid markets: Herding behavior, bonds are not stocks, and banks are missing in action.

Roubini is depicted as stating, “ironically,” the federal reserves policy of money creation, has created financial bubbles, and has ballooned asset prices in valuation higher than where they should be. As more investors rush into illiquid investments, such as bonds, the likelihood of a crash becomes more palpable, and the carnage that will come from such a collapse, will reverberate throughout the world. This is where the article ends, and I illustrate the bigger impacts and depths of the liquidity crisis

The liquidity crisis illustrates a small underlying problem associated with the 2008-09 financial crisis: the Federal Reserves policy of bubble creation and destruction since the 1930s. A Keynesian philosophy of economics originated in the 1930s, and is finally illustrating the cogitative fallacy associated with growth via a debt-based fiat-monetary system. This has big implication for the availability and strength of the US Dollar in the near future, and impacts everyone and everything around the world from mom and pop in the US, municipal bonds, corporate financial systems, to the factory workers in China. I am focusing on the broader macro picture, so you two can illuminate the direct impact of the financial problems that arise therein.

G.Nelson

G.Nelson

Blanchard, Dave. “Manufacturers’ Big Squeeze Puts Pressure on Supplierss.” Industry Week/IW 262.5 (2013): 40-41. Academic Search Complete. Web. 10 Oct. 2015

In light of the recession, Dave Blanchard explains in his article, “Manufacturers’ Big Squeeze Puts Pressure on Suppliers,” manufacturers are looking for ways to shore up cash flow. Large companies are looking to expand their payment arrangements to their suppliers for services and, or products rendered from 45 to 70 days. For the small to mid-sized suppliers of larger companies, this can greatly affect the smaller company’s cash flow and profits. Smaller companies may go to commercial lending companies, banks, and request a “factoring” service. Factoring is when a bank or lending institution looks at the accounts receivable and lends the company 70% to 90% of the value therein. The bank or lending institution will, then, usually charge 1.5% to 5.5% of the “total face value of the invoice.”

Blanchard illustrates how one company in the plastic industry utilized this banking technique of factoring to expand the growth of the company domestically and internationally. I find some issues with this technique of factoring, though. If any company is relying on credit markets and tools to grow or finance the company, the company is instantly losing 1.5% to 5.5% of potential profit to banking fees. Since the big companies are rearranging their finances due to the recession, is a small to mid-sized company trying to grow when the headwinds of a recession is attempting to push them back? A couple of questions that are not directly being answered in this article: since the big companies are expanding their payment arrangements to shore up cash flow, will this drive the big company to expand business? Will this expansion help the suppliers? Or is the factoring by small and mid-sized just a domino effect of the debt crisis of 2008-09?

Even though this article is short, the article illustrates the creativity that is within the financial markets, but also illustrates the potential risks of easy debt through creative financial mechanisms. Part of the issue that caused the 2008-09 crisis was debt, specifically derivatives. Even though factoring is --assuming-- to be limited to 45 to 70 days, commercial or investment banks my be able to bundle an amalgamation of factorings by multiple companies to sell to investors of debt, and if one company, or more, defaults on the factoring because a larger company defaults on their payment to suppliers, the underlying value of the amalgamated-bundle of factorings would default and result in a domino effect; thus, a 2008-09 crisis would once again rise up to smack the GDP down.

Does the Dodd-Frank Act account for this? My next article will be Dodd-Frank specific.

G.Nelson

G.Nelson

Rugy, Veronique de. "The Municipal Debt Bubble." Reason 42.8 (2011): 20-21. Academic Search Complete. Web. 5 Oct. 2015.

In Veronique Rugy’s article, “The Municipal Debt Bubble,” she posits that the municipal bond markets are heading for a “housing-like crisis,” and with federal-incentive policies and private investors looking for a safe heaven from current market turmoil, the municipal bond market will be turning into an unsustainable financial-bubble, like that of the 2006 housing bubble.

Since the 2008 financial crisis, she states, the demand for a safe haven has pushed investors into the municipal bond markets. Municipal bond markets are relatively safe and attractive in a time of financial uncertainty: “[T]he default rate for municipal bonds has average .o1 percent annually” (Rugy). This was the perceived notion on U.S. housing mortgages before the housing crisis of 2006. Rugy illustrates that if a state or local government wants to increase spending, they must issue bonds. Bonds have been utilized to fund projects ranging from stadiums, schools, bridges, to museums. Since 2009, however, they have increased by 800% and have recently been utilized to cover “basic operational expenses” (Rugy).

In 2009, the federal government created “The Build America Bonds program, part of the American Recovery and Reinvestment Act of 2009” (Rugy). Rugy illustrates that this program was utilized to subsidize local and state infrastructure programs. Through this act, the federal government directly paid part of the interest on the municipal bond, and with private investors seeking a safe heaven from corporate bonds, and tax incentives of investing in muni-bonds, the supply of municipal bonds where quickly bought up by private investors. Private investors, along with state and local officials, believe that if the banks were “too big to fail” then surely the municipal bonds would be “too big to fail.” Rugy illustrates that this assumption has lead to risky municipal bonds being issued to localities that are near bankruptcy, like Detroit and Los Angeles. This sort of risky loans operation is what fueled the housing crisis of 2006.

Like the 2006 housing crisis, investors have started to hedge, protect themselves, from a muni-bond crisis. Investors can purchase Credit Derivative Swaps (CDS) as an insurance against failing bonds. The price of CDS can be indicative of the underlying assumptions that investors have toward bonds, and recently, the prices have been increasing, just like what happened before and during the 2008 financial crisis on corporate bonds.

Rugy believes that there will be a muni-bond crisis in the near future. Since her article, Detroit has been in an annual bankruptcy process that has written off muni-bonds, costing taxpayers billions. Similarly, Puerto Rico has had muni-bond problems, which is tied in with US muni-bonds. If enough muni-bonds fail, a domino-like effect will overwhelm not just the U.S. economy, the global economy, as well, like that of the 2008 crisis. This time, however, the Fed is more limited in resources and jurisdiction to limit the financial fallout.

G.Nelson

G.Nelson

[http://www.financialsense.com/contributors/matthew-kerkhoff/fed-s-dilemma]

Kerkhoff, Matthew. "The Fed's Dilemma." The Fed's Dilemma. Financial Sense, 11 Sept. 2015. Web. 28 Sept. 2015.

In Matthew Kerkhoff’s article, “The Fed’s Dilemma,” he examines what the Federal Reserve will do, in regards to interest rates (leave put or raise rates), when they release their FOMC Statement at the end of September 2015. Kerkhoff utilize market indicators, such as the GDP quarterly reports, jobless claims and job growth, corporate profits, tax revenue collected, personal income levels, consumer spending, consumer sentiment and confidence, yield curves, to illustrate to the reader that the U.S. economy is in a relatively strong position, and this should be a positive indicator for the Fed to start to raise rates.

Kerkhoff illustrates that the Fed has two components in which they primarily utilize as indicators to move rates or keep rates constant: “Maximum employment and price stability --defined as 2% inflation” (Kerkhoff). In regards to maximum employment, Kerkhoff utilizes the U-6 rate, “a broader measure of unemployment that includes discouraged and underemployed workers,” is relatively high (Kerkhoff). Moreover, wage growth, an individuals salary, is less than ideal, and is not showing significant growth. The Fed is, also, missing the second mandated component to raise rates: Inflation. Kerkoff depicts that domestic inflation is relatively stagnant, hasn’t moved much since 2012, and the deflationary pressures from around are working to keep domestic inflation down. Furthermore, the IMF and World Bank requested the Fed to withhold from raising rates, stating that it could have adverse affects to the many countries and markets that are currently struggling.

If the Fed were to raise rates, Kerkhoff hits on a key point about the ramifications that could ensue. A higher rate means a stronger U.S. dollar, which means the products manufactured within the U.S. are more expensive to foreign consumers. This, in turn, would lower future growth, and also, create stronger deflationary pressures, but this time from within the U.S. Kerkhoff only brushes slightly on the issue of currency wars, however, by stating that other countries are working to devalue their own currencies in order to drive growth” (Kerkoff). This move by other countries to devalue their dollars acts as a catalyst for other nations, investors, individuals, and groups to flood into the U.S. dollar to protect themselves from devaluation, thus, causing more deflationary pressure upon the U.S. economy.

At the end of September, Kerkoff sees that the Fed could go either way in how they deal with interest rates --leave put or raise rates. In the past, Kerkoff illustrates, the Fed has worked to raise rates to control a growing economy, but this time they are simply trying to maintain a “’normative’ interest rate policy” (Kerkoff). It is unusual to have rates near zero when the economy looks so “robust.” Kerkoff believes it’s best for the Fed to raise rates because of the strength of the U.S. economy, and the mandated components do not involve global growth.

G.Nelson

G.Nelson

Swagel, Phillip. "Legal, Political, and Institutional Constraints on the Financial Crisis Policy Response †." Journal of Economic Perspectives 29.2 (2015): 107-22. Web.

Phillip Swagel, former Assistant Secretary for Economic Policy at the US Department of Treasury, discusses in his essay, “Legal, Political, and Institutional Constraints on the Financial Crisis Policy Response,” that the US policymakers response to the 2007 and 2008 financial crisis was shaped by the limited legal authority and tools available to the US Department of Treasury and the Federal Reserve at that time, and how new tools and authority –access to public money and greater jurisdiction-- were made available because of the financial crisis’ “’unusual and exigent’” stresses upon the broader US economy (Swagel 107). The new tools and authority of the Treasury Department and the Federal Reserve were not imminent, but required the crisis to unfold more seriously, so that the policymakers could realize the economic emergency as more of a pressing issue and pass legislation that would grant the Fed and Treasury Department more tools.

The Treasury Department and the Federal reserve had the following tools at the ready, pre 2007 and 2008 crisis: Discount window was available for banks in need, discount in the federal funds interest rate, FDIC backing, and encouragement for investors not to fire sale their assets and to avoid foreclosure on properties. However, a majority of tools were not available for the investment or insurance institutions that held a substantial amount of subprime loans and derivatives. Swagel illustrates that the Federal Reserve’s and Treasury Department’s tools were not just underwhelming in their initial attempt at remedying the crisis, but they, also, initially underestimated the seriousness and complexity of the crisis, as did the policymakers.

At the collapse of Bear Stearns, the Treasury Department and Federal Reserve realized that more investment firms would soon collapse if new tools and authorities were not granted. Swagel illustrates that the Fed turned to its only ace in the hole: “emergency authority…[to] lend to ‘any individual, partnership, or corporation’” if a loss is not expected (Swagel 110-1). Even with the Fed’s ability to loan a limited amount of assistance, this legal authority did not give the Fed or Treasury Department direct access to public money, however. After Bear Stearns’ negotiated bailout with the Fed, it took nearly 6 more months, October 2008, to enact the “Emergency Economic Stabilization Act that created the Troubled Asset Relief Program [(TARP)]” (Swagel 111). Beforehand, the Treasury Department understood that even attempting to approach congress without a real-time economic crisis of illiquid assets and credit market seizures, congress would “loath” the idea of providing public funds to investment banks for bailouts.

Under the same tools of restraint and provisions that granted the Fed the option to bailout Bear Stearns, Swagel illustrates that it was the decision of the Fed not to bail out Lehman Brothers that led to an even tighter constraint on market liquidity and seizures within the credit market. With limited options from the Fed and Treasury Department, the unforeseen consequences of letting Lehman Brothers collapse exasperated the crisis further and put a constraint on debt markets, which affected normal government operations of securing debt. Two days after refusing to bailout Lehman Brothers, however, the Fed provided loan assistance to AIG, American International Group, an insurance company, because the Fed believed AIG to be more financially sound and important to the US economy. The deal between AIG and the Fed was not clean or clear, however, and the two are currently in litigation, today, from the deal struck in 2008. The same week of the AIG and Fed deal, TARP was proposed --which passed a few weeks later in October 2008-- and two more banks failed, WAMU and Wachovia (Swagel 117). With TARP, the Treasury Department would be able to provide financial support to the markets of $700 billion. Swagel illustrates that if the Fed and Treasury Department had the tools earlier and the foresight, the crisis could have been more contained, but the policymakers would not have been able to justify the $700 billion cost of TARP without such a monumental crisis.

Swagel contends that if another financial crisis happens relatively soon, the Fed and Treasury Department will be limited in how they can intervene because of the 2010 Dodd-Frank financial reform bill and the expenditure of an already lowered interest rate by the Fed. Politicians stumped on the promise of not bailing out businesses that were “too big to fail,” so the likelihood of congress approving another direct infusion of funds, such as TARP, would be improbable, but with the Dodd-Frank act, governments may be able to seize businesses directly to control operations and direct the losses onto the bond holders and investors, which will limit the loss to the taxpayer because of new FDIC provisions. Swagel states that by studying what happened from the 2007 and 2008 collapse, a more effective response may be garnered in a future crisis.

G.Nelson