Posts tagged ‘Financial Times’

Risks of QE

So far, I have mainly been concerned about inflationary risks from quantitative easing, which is effectively a fancy term for substituting printed money for government debt (I know there are folks out there that swear up and down that QE does not involve printing (electronically of course) money, but it simply has to.  Operation Twist, the more recent Fed action, is different, and does not involve printing money but essentially involves the Fed taking on longer-term debt in exchange for putting more shorter term debt on the market.

Scott Minder in the Financial Times highlights another potential problem:

In 2008, just before the first of two rounds of quantitative easing, the Federal Reserve had $41bn in capital and roughly $872bn in liabilities, resulting in a debt to equity ratio of roughly 21-to-one. The Federal Reserve’s portfolio had $480bn in Treasury securities with an asset duration of about 2.5 years. Therefore, a 100 basis point increase in interest rates would have caused the value of its portfolio to fall by 2.5 per cent, or $12bn. A loss of that magnitude would have been severe but not devastating.

By 2011, the Fed’s portfolio consisted of more than $2.6tn in Treasury and agency securities, mortgage bonds and other fixed income assets, and its debt-to-equity ratio had dramatically increased to 51-to-one. Under Operation Twist, the Fed swapped its short-term securities holdings for longer-term ones, thereby extending the duration of its portfolio to more than eight years. Now, a 100 basis point increase in interest rates would cause the market value of the Federal Reserve’s assets to fall by about 8 per cent, or $200bn, leaving it insolvent, with a capital deficit of about $150bn. Hypothetically, a 5 per cent rise in interest rates could cause a trillion dollar decline in the value of the Federal Reserve’s assets.

As the economy continues to expand, the Federal Reserve will eventually seek to normalise monetary policy, resulting in higher interest rates. In this scenario, the central bank could find that the market value of its portfolio has declined to the point where it no longer has enough sellable assets to adequately reduce the money supply and maintain the purchasing power of the dollar. Given US dependence on foreign capital flows, if the stability of the dollar is drawn into question, the ability of the US to finance its deficits may falter. The Federal Reserve could then find itself the buyer of last resort for Treasury securities. In doing so, the government would become hostage to its printing press, and a currency crisis or runaway inflation could take hold.

George Dorgan observes, on the pages of Zero Hedge, that European countries are taking even large balance sheet risks.  The most surprising is the Swiss.

"Green Jobs" Are Starting To Sound a Lot Like Those Jobs At The Museum of Science and Trucking on the Sopranos

Via Christopher Horner:

Spain's Dr. Gabriel Calzada "” the author of a damning study concluding that Spain's "green jobs" energy program has been a catastrophic economic failure "” was mailed a dismantled bomb on Tuesday by solar energy company Thermotechnic.

Says Calzada:

Before opening it, I called [Thermotechnic] to know what was inside "¦ they answered, it was their answer to my energy pieces.

Dr. Calzada contacted a terrorism expert to handle the package. The expert first performed a scan of the package, then opened it in front of a journalist, Dr. Calzada, and a private security expert.

The terrorism consultant said he had seen this before:

This time you receive unconnected pieces. Next time it can explode in your hands.

Dr. Calzada added:

[The terrorism expert] told me that this was a warning.

The bomb threat is just the latest intimidation Dr. Calzada has faced since releasing his report and following up with articles in Expansion (a Spanish paper similar to the Financial Times). A minister from Spain's Socialist government called the rector of King Juan Carlos University "” Dr. Calzada's employer "” seeking Calzada's ouster. Calzada was not fired, but he was stripped of half of his classes at the university. The school then dropped its accreditation of a summer university program with which Calzada's think tank "” Instituto Juan de Mariana "” was associated.

Additionally, the head of Spain's renewable energy association and the head of its communist trade union wrote opinion pieces in top Spanish newspapers accusing Calzada of being "unpatriotic" "” they did not charge him with being incorrect, but of undermining Spain by daring to write the report.

Ugh! $2 Trillion

Not good, but not really a surprise:

The estimate by Orin Kramer will fuel investors' concerns over the deteriorating financial health of US states after the recession. "State and local governments are correctly perceived to be in serious difficulty," Mr Kramer told the Financial Times.

"If you factor in the reality of these unfunded promises, their deficits will rise exponentially."

Estimates of aggregate funding requirement of the US pension system have ranged between $400bn and $500bn, but Mr Kramer's analysis concluded that public funds would need to find more than $2,000bn to meet future pension obligations.

Kenneth Anderson asks:

Two trillion dollars?  One question about these obligations is whether taxpayers will stick around to pay them, or instead will vote with their feet.  ("Vote with their feet" is something that has been discussed in various ways at VC "” as an aspect of a federal system and states with their own laws.)  Many of these pension obligations have been incurred by municipalities and others by states, and in some cases the obligations are intertwined.  But what happens if voters-taxpayers move out?

The assumption has long been that taxpayers are stuck, on account of jobs and other circumstance.  But query whether that is necessarily true as the baby boom generation retires.  In that case, it might find itself far more mobile, in circumstances where rising taxes at every level make relocation a more valuable decision at the margin.  For that matter, if otherwise desirable locales manage to tax their businesses away, will the baby boomers' kids and grandkids have reason ever to locate in places that lack jobs?  They might have been raised there "” but would they go back?

Would people leave California? They are leaving now, true, but would they leave in the future specifically for this reason or generally on account of the tax burden, particularly as retirees?  Or New Jersey?  What about the city of Oakland?  Or even smaller cities, such as the towns in California "” not large at all, small towns, that have already declared bankruptcy over pension obligations?  It's easy to move out of those towns.

My guess is that the Feds are going to pick up a lot of these state and local obligations, making it effectively impossible for taxpayers to escape them short of leaving the country (and creating the mother of all moral hazards, by the way).  After all, if the current administration will bail out Wall Street banks with whom they have little ideological sympathy, they certainly will do so to keep SEIU-represented government employees in jobs.

Accounting for Offsets

Anybody who has been a part of a productive business (e.g. so this excludes almost all politicians and academics) will probably have experience with some type of profit improvement program.  Usually you are doing about a hundred things simultaneously to reduce costs.  When costs actually go down, you find yourself scratching you head - what actually made the difference.  Everyone will claim that their program or initiatives saved the company X amount of money, but when you add up all the X's, you get a number four or five times the actual improvement. 

Well, apparently the same dynamic occurs in carbon offsets:

An investigation by the Financial Times
suggests that many carbon offsets are illusory, and that there is
little assurance that purchasing carbon offsets does much of anything
to reduce carbon dioxide emissions. Specifically, the report found:

-
Widespread instances of people and organisations buying worthless
credits that do not yield any reductions in carbon emissions.

- Industrial companies profiting from doing very little "“ or from
gaining carbon credits on the basis of efficiency gains from which they
have already benefited substantially.

- Brokers providing services of questionable or no value.

- A shortage of verification, making it difficult for buyers to assess the true value of carbon credits.

Who in the world would have every predicted this?  Well, it turns out a lot of people did, including me.  For example, I suggested that companies like Terrapass are probably selling their CO2 offsets at least three times:

  1. Their energy projects produce electricity, which they sell to
    consumers.  Since the
    electricity is often expensive, they sell it as "CO2-free"
    electricity.  This is possible in some sates -- for example in Texas,
    where Whole Foods made headlines by buying only CO2-free power.  So the
    carbon offset is in the bundle that they sell to
    electricity customers.  That is sale number one. 
  2. The company most assuredly seeks out and gets
    government subsidies.  These subsidies are based on the power being
    "CO2-free".  This is sale number two, in exchange for subsidies. 
  3. They still have to finance the initial construction of the plant, though.  Regular heartless
    investors require a, you know, return on capital.  So Terrapass
    finances their projects in part by selling these little certificates that you
    saw at the Oscars.  This is a way of financing their plants from people
    to whom they don't have to pay dividends or interest "”just the feel-good
    sense of abatement.  This is the third sale of the carbon credits.

I also suggested that there is an incredible opportunity for outright fraud:

This type of thing is incredibly amenable to fraud.  If you sell more
than 100% of an investment, eventually the day of reckoning will come
when you can't pay everyone their shares (a la the Producers).  But if
people are investing in CO2 abatement -- you can sell the same ton over
and over and no one will ever know.

Finally I argued that many of the abatement numbers make no sense:

Something smells here, and it is not the cow-poop methane.  This 100,000 pound [CO2 Offset] coupon retails for $399.75 (5x79.95) on the TerraPass web site.
First, this rate implies that all 300 million Americans could offset
their CO2 emissions for about $100 billion a year, a ridiculously low
figure that would be great news if true. 

Lets look at solar, something I know because I live in Arizona and have looked at it a few times.  Here is the smallest, cheapest installation
I can find.  It produces 295 CO2-free Kw-hours in a month if you live
in Phoenix, less everywhere else.  That is enough to run one PC 24
hours a day -- and nothing else.  Or, it is enough to run about 10
75-watt light bulbs 12 hours a day -- and nothing else.  In other
words, it is way, way, way short of powering up a star's Beverly Hills
mansion, not to mention their car and private jet.  It would not run
one of the air conditioning units on my house.  And it costs $12,000!
Even with a 20 year life and a 0% discount rate, that still is more
than $399.75 a year.  For TerraPass's offset claim to be correct, they
have to have a technology that is one and probably two orders of
magnitude more efficient than solar in Arizona.

[update:  Al Gore's house 221,000 kwH last year.  Call it 18,400KwH
per month, that would require about 62 of these solar installations for
$744,000.  I don't think $399.75 is really offsetting it]

The Feds May Have to Come Clean

From Marginal Revolution:

The FASAB has asked
that the United States government start including future Medicare and
Social Security liabilities in current budget deficit figures:

Monday,
the Federal Accounting Standards Advisory Board released a proposal in
which the government would have to account for the cost of future
Social Security payments year by year as people build up entitlements.

Seen in advance of its release by the Financial Times, the switch in
accounting practices would be an international accounting anomaly, as
most other governments treat social insurance as a political commitment
to pay future benefits rather than a financial liability, the newspaper
said.

The FASAB is made up of six independent members who support the
proposal and three opposing members from the U.S. Treasury, the White
House Office of Management and Budget and the Government Accountability
Office.

I support this change despite the fact it may result in what I consider bad outcomes (e.g. big tax increases) as the magnitude of future liabilities become clear.  Tyler Cowen also argues it may make these programs harder to scale back, since it shifts the future payments from a political promise to a financial commitment.  But just like free speech, one has to be consistent in one's support for transparency.

If this all seems arcane to you, let me give you some perspective.  Today, Jeff Skilling was given over 30 years in jail for various accounting-related frauds, supposedly hiding losses and liabilities from shareholders's view.  But what Skilling was convicted of doing were minor, subtle accounting tricks involving penny-ante sums of money compared to the egregious games Congress plays with accounting for the federal government's future liabilities.  Skilling was accused, for example, of booking future liabilities in certain joint ventures where they were hard to find; the feds, in contrast, do not book future liabilities at all.