Kevin Drum - May 2010

Sanctions on Iran

| Tue May 18, 2010 10:34 AM EDT

Apparently Hillary Clinton has brokered an agreement for yet more sanctions on Iran:

The Obama administration announced Tuesday morning that it has struck a deal with other major powers, including Russia and China, to impose new sanctions on Iran, a sharp repudiation of the deal Tehran offered just a day before to ship its nuclear fuel out of the country. “We have reached agreement on a strong draft with the cooperation of both Russia and China,” Secretary of State Hillary Rodham Clinton told a Senate committee. “We plan to circulate that draft resolution to the entire Security Council today.”

There isn't much to say about this until we see the text, but I have to say that I have my doubts that China would have agreed to any proposal that's genuinely stringent. If it is, and they do, that will represent something of a sea change in their external relations. Should be an interesting afternoon.

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Tight Money in the Eurozone

| Tue May 18, 2010 12:48 AM EDT

As part of its rescue plan for the euro, the European Central Bank has started buying Greek and Portuguese debt. But at least so far, they're plainly unwilling to mount a serious operation: the value of their purchases is small (about €16.5 billion) and they're making sure to "sterilize" their new holdings by selling off other bonds to make up for it, thus keeping the money supply steady. The Telegraph is unimpressed:

The ECB’s strategy of draining liquidity to offset the stimulus from the bond purchases risks making matters worse. "They are using one-week deposits for sterilisation and the effects of this to make short-term funding more expensive. This will force banks to sell assets to shrink their balance sheet and risks causing a credit crunch," said [Hans Redeker, currency chief at BNP Paribas].

Mr Redeker said the ECB is pursuing a contractionary policy to assuage concerns in Germany that Club Med bond purchases will stoke inflation. "They have read the German press and it made their hair stand up on their necks. The reality is that a deflationary cycle is developing in Euroland and the ECB will eventually have to start quantitative easing," he said.

Ewald Nowotny, Austria’s central bank chief, called the German concern over inflation "hysteria." But hysteria or not, it seems to be in control of Europe's destiny. That means a non-expansionary monetary policy and fiscal austerity are going to be their answer to a massive recession. Maybe Europe doesn't have any choice at this point. I don't know. But it sure doesn't bode well for their near-term economic growth prospects.

UPDATE: On the other hand, perhaps the ECB's sterilization efforts are mainly symbolic, designed to appease German public opinion while not having any actual contractionary effect. Tracy Alloway rounds up the arguments at FT Alphaville.

News Flash: Toxic Waste Still Toxic

| Mon May 17, 2010 8:48 PM EDT

Last year I linked to a Wall Street Journal piece about "re-remics." In a nutshell, banks were taking the sliced-and-diced AAA securities that blew up in the great crash of 2008, reslicing them using only the remaining good bits, and creating a whole new bundle of AAA securities. My comment at the time:

Shiny new AAA securities! Hooray! And there's more! Ratings for re-remics come from the same ratings agencies that bollixed up the original ratings. And investment banks pocket fat fees for performing the financial alchemy. What could possibly go wrong?

So cynical, Kevin! Surely banks had learned their lessons. And ratings agencies too. Except, um, apparently not: "Standard & Poor’s cut to junk the ratings on certain securities, backed by U.S. mortgage bonds, that it granted AAA grades when they were created last year....The reductions were among downgrades to 308 classes of so-called re-remics, or re-securitizations, created from 2005 through 2009."

Created last year! After the great ratings fiasco of the previous decade. Felix Salmon comments:

I consider myself pretty cynical when it comes to structured finance, but this comes as a shock even to me. S&P knew, when it was rating these re-remics, exactly where it had gone wrong in the first round of structured-credit ratings, yet somehow was unable or unwilling to fix the problems in that group.

Tracy Alloway quotes S&P citing significant deterioration” in the performance of the underlying mortgages as the reason for the downgrade — but the whole point of a triple-A-rated mortgage-backed security is that it's robust to such deterioration. If it isn't, then it should never have been rated triple-A in the first place.

If we needed one more reason to strip all official recognition from credit ratings, this is it. S&P and Moody's are clearly completely incompetent, and no one should base any investment decisions on the random series of letters they apply to bonds. If the CDO fiasco wasn't enough to make them change their ways, then nothing will be.

This is the kind of thing that leaves you speechless. But maybe Felix is right: maybe it's time to tear down the whole lot of them, sow the ruins with salt, and figure out some way to start all over again. The whole episode just boggles the mind.

Chart of the Day: Corporate Earnings

| Mon May 17, 2010 4:17 PM EDT

Via Paul Kedrosky, here's a McKinsey chart comparing projections of corporate earnings by Wall Street analyst with the actual results. As you can see, the analysts relentlessly overestimate earnings.

Actually, what I find most interesting about this chart isn't the overestimation — though that's fascinating — but the remarkable steadiness of their earnings projections. For 25 years, with the exception of a few years starting in the late 90s, through good times and bad, consensus earnings for the S&P 500 have been right around 12-13%. No matter what's going on in the broader economy, Wall Street always thinks earning will be at least 12% or higher. Coincidentally, I'm sure, this is also the direction of error most likely to get their clients to churn stocks.

Anyway, it's nice work if you can get it. If any Wall Street firm wants to hire me, I'll be happy to project 13% earnings forever and then make up good stories to justify it. I think I'd be good at it. And my services probably come cheaper than the analysts they're using now. Any takers?

You May Be More Public Than You Think

| Mon May 17, 2010 3:59 PM EDT

Via Kieran Healy, this is perhaps the most graphic illustration ever of Facebook's privacy problems. Making use of a public programming interface that Facebook released a few weeks ago, three programmers in San Francisco wrote Openbook, a website that searches Facebook profiles for — well, for anything you want. Because I'm basically a nice guy, I've illustrated this with a relatively innocuous search for "rectal exam" and then blurred out the results. But other popular searches include "playing hooky," "boss is an asshole," and so forth. You get the idea.

So what's the point of this? Here's what the authors say:

Our goal is to get Facebook to restore the privacy of this information, so that this website and others like it no longer work....This website is a parody, and has no relationship to Facebook.

All the charts and graphs and blog posts in the world don't bring home just how public your Facebook information is the way this does. So show it to your friends! And if you want to make sure that your random musings aren't available to, say, your boss or your teachers, here's a tool that checks your Facebook privacy settings and lets you know if you should think about changing them.

Throwing Away the Key

| Mon May 17, 2010 1:59 PM EDT

Among other things, the Adam Walsh Child Protection and Safety Act authorizes the federal government to keep "sexually dangerous" persons in prison even after their sentences have been completed. The Supreme Court ruled today that this is perfectly constitutional:

Solicitor General Elena Kagan successfully argued the government's case in front of the Supreme Court. Kagan has now been nominated to replace the retiring Justice John Paul Stevens.

Kagan in January compared the government's power to commit sexual predators to its power to quarantine federal inmates whose sentences have expired but have a highly contagious and deadly disease.

"Would anybody say that the federal government would not have Article I power to effect that kind of public safety measure? And the exact same thing is true here. This is exactly what Congress is doing here," she said.

Civil commitment is already common at the state level, but I can't say I'm thrilled about it there either. Kagan's logic, after all, applies to other kinds of criminal behavior too. If federal or state authorities can keep "sexually dangerous" prisoners behind bars forever on the grounds that they're mentally impaired and need to be quarantined, why not "economically dangerous" or "physically dangerous" prisoners too? As near as I can tell, special consideration for sex offenders is largely an effort to use an emotionally charged topic to justify the real heart of these statutes: lowering the standard for civil confinement from "mentally ill" to "mentally impaired." But once that's in place and well accepted, what's left to stop that same standard from being used elsewhere?

POSTSCRIPT: I had a particular point I wanted to make here, so I didn't get into the technical question at issue in this case. It wasn't a question of due process, since previous Supreme Court decisions have already held that civil commitment doesn't violate due process protections. That's why lots of states already have laws like this one. Rather, it was a question of whether the federal government also has the authority to mandate civil commitment, and this turns on an interpretation of the "necessary and proper" clause of the constitution. On narrow grounds, I think I probably support the majority's decision on this. But I'm not sure I support the court's previous decisions on the more fundamental issue of due process.

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Obama Takes On the Pentagon

| Mon May 17, 2010 12:36 PM EDT

Having given up on Wolf Hall (spoiler alert: Anne marries Henry, gets head chopped off, etc.) I've now picked up The Promise, Jonathan Alter's take on President Obama's first year in office. One of the most fascinating sections, about Obama's drawn-out planning process for the Afghanistan war and the Pentagon's PR counteroffensive for more troops, has now been excerpted in Newsweek:

The AfPak sessions led to an explosion of unauthorized disclosures, spin, and cutthroat bureaucratic gamesmanship, including the leak of the McChrystal Report to Bob Woodward of The Washington Post....The military, practiced in the ways of Washington, now ran PR circles around the neophytes in the Obama White House, leaking something to the Pentagon reporters nearly every day. The motive for all the leaks seemed clear to the White House: to box the president into the policy that McChrystal had recommended, at least another 80,000 troops and an open-ended commitment lasting 10 years or more.

....It was important to remind the brass who was in charge. Inside the National Security Council, advisers considered what happened next historic, a presidential dressing-down unlike any in the United States in more than half a century. In the first week of October, Gates and Mullen were summoned to the Oval Office, where the president told them that he was "exceedingly unhappy" with the Pentagon's conduct. He said the leaks and positioning in advance of a decision were "disrespectful of the process" and "damaging to the men and women in uniform and to the country." In a cold fury Obama said he wanted to know "here and now" if the Pentagon would be on board with any presidential decision and could faithfully implement it.

"This was a cold and bracing meeting," said an official in the room. Lyndon Johnson had never talked to Gen. William Westmoreland that way, or George H.W. Bush to Gen. Norman Schwarzkopf. Presidents Kennedy, Carter, and Clinton had all been played by the Pentagon at various points but hadn't fought back as directly. Now Obama was sending an unmistakable message: don't toy with me. Just because he was young, new, a Democrat, and had never been in uniform didn't mean he was going to get backed into a corner.

There is, of course, no telling who Alter's sources are for this or what axe they have to grind. So take it with a grain of salt. But there's also this conversation after Obama has agreed to the troop escalation the Pentagon wanted:

Inside the Oval Office, Obama asked Petraeus, "David, tell me now. I want you to be honest with me. You can do this in 18 months?"

"Sir, I'm confident we can train and hand over to the ANA [Afghan National Army] in that time frame," Petraeus replied.

"Good. No problem," the president said. "If you can't do the things you say you can in 18 months, then no one is going to suggest we stay, right?"

"Yes, sir, in agreement," Petraeus said.

I'm not a fan of Obama's escalation in Afghanistan, but this conversation makes me feel a little bit better about it. Only a little bit, though. Promise or not, I'll bet that next year, when the drawdown is supposed to start, Petraeus tells us we need to stay.

Can Federal Debt Rise Forever?

| Mon May 17, 2010 11:58 AM EDT

A few days ago Ezra Klein interviewed lefty economist James Galbraith (John Kenneth's son) and asked him whether the long-term growth of the federal deficit was a problem. He said no:

EK: Why?

JG: What is the nature of the danger? The only possible answer is that this larger deficit would cause a rise in the interest rate. Well, if the markets thought that was a serious risk, the rate on 20-year treasury bonds wouldn't be 4 percent and change now. If the markets thought that the interest rate would be forced up by funding difficulties 10 year from now, it would show up in the 20-year rate. That rate has actually been coming down in the wake of the European crisis.

This is a common argument, but I've never been much impressed by it. After all, for about a decade "the markets" thought that housing prices would rise forever and subprime CDOs were a great investment. Then they changed their minds practically overnight starting in 2007 and touched off a global financial panic. Those same markets may now think that U.S. interest rates are going to stay low forever, but they can change their minds about that just as quickly if they suddenly decide to get scared about the size of our deficit. That may or may not happen, but the fact that we're witnessing a flight to safety in the middle of a global slump isn't very good evidence that it never will.

But that's the less interesting of the two things he said in the interview. Here's the more interesting one:

EK: But putting inflation aside, the gap between spending and revenues won't have other ill effects?

JG: Is there any terrible consequence because we haven't prefunded the defense budget? No. There's only one budget and one borrowing authority and all that matters is what that authority pays. Say I'm the federal government and I wish to pay you, Ezra Klein, a billion dollars to build an aircraft carrier. I put money in your bank account for that. Did the Federal Reserve look into that? Did the IRS sign off on it? Government does not need money to spend just as a bowling alley does not run out of points.

What people worry about is that the federal government won't be able to sell bonds. But there can never be a problem for the federal government selling bonds. It goes the other way. The government's spending creates the bank's demand for bonds, because they want a higher return on the money that the government is putting into the economy. My father said this process is so simple that the mind recoils from it. [Italics mine.]

This strikes me as wrong. I don't know when Galbraith Sr. made that (typically witty) comment, but I imagine it was in the 50s or 60s, when inflation was restrained, the deficit was low and federal debt was shrinking, global capital flows were more regulated, and government bonds were mostly sold domestically. But that's no longer the case. Domestic banks have lots of things they can do with their money besides stashing it in treasurys, and they do. What's more, treasury bonds these days are held in large part by overseas investors and central banks, and they could lose their appetite for funding both our federal deficit and our current account deficit any time. There's no simple law that says there has to be a market for as much debt as the United States cares to run up.

Countries usually get into trouble when their debt levels get too high. It generally leads to default, high interest rates, high inflation rates, a currency crash, or a combination of all four. Now, the United States has the singular advantage of having its external debt denominated in dollars, but that doesn't make us invulnerable. It's true that we're not in any trouble right now (in fact, just the opposite since the rest of the world looks even shakier than we do) and there's no reason we should be cutting back on spending during a massive recession. But surely the long-term picture is less rosy than Galbraith makes it out to be?

But I'm no economist. Maybe I just don't get it. However, I've waited a few days to post about this, and I still haven't seen any real economists comment on this. Anybody want to take a crack at it?

Europe's Financial Woes

| Mon May 17, 2010 10:23 AM EDT

Yesterday the New York Times reported that Europe's financial woes are hurting their economy more than expected:

After a brief respite following the announcement last week of a nearly $1 trillion bailout plan for Europe, fear in the financial markets is building again, this time over worries that the Continent’s biggest banks face strains that will hobble European economies....Bourses and bank shares in Europe plunged on Friday because of these fears, with Wall Street following suit. Shares were also down in Tokyo and Australia in early trading on Monday.

Today they report that Europe's financial woes are hurting China more than expected:

The pain of the European debt crisis is spreading, with the plummeting euro making Chinese companies less competitive in Europe, their largest market, and complicating any move to break the Chinese currency’s peg to the dollar.

....Some economists warn that there may be much worse to come. The biggest reason Chinese exports plunged early last year was not weakening demand in industrialized countries but a sudden, temporary disappearance of trade finance. The availability of trade finance could easily become a serious problem again soon, said Dong Tao, the chief Asia economist at Credit Suisse....The Shanghai stock market plunged Monday, with the composite index falling 5.1 percent on worries about global demand as well as concerns about possible further moves in China to limit a steep rise in real estate prices this spring.

If Europe and China both go down, the United States is going down too. So we'd all better pray that the political and central banking leaders in Europe and China get a handle on this. Ours may have made plenty of mistakes back in 2007-08, but in the end they did the right things. They're not in charge this time around, though, and there are, it turns out, worse things than bailing out a bunch of fat cat bankers. For example, not bailing out a bunch of fat cat bankers. Buckle your seat belts.

Israel's Demographic Challenge

| Mon May 17, 2010 1:00 AM EDT

Peter Beinart writes that demographic and political trends are turning Israel inexorably more reactionary:

Israeli governments come and go, but the Netanyahu coalition is the product of frightening, long-term trends in Israeli society: an ultra-Orthodox population that is increasing dramatically, a settler movement that is growing more radical and more entrenched in the Israeli bureaucracy and army, and a Russian immigrant community that is particularly prone to anti-Arab racism. In 2009, a poll by the Israel Democracy Institute found that 53 percent of Jewish Israelis (and 77 percent of recent immigrants from the former USSR) support encouraging Arabs to leave the country. Attitudes are worst among Israel’s young....This March, a poll found that 56 percent of Jewish Israeli high school students — and more than 80 percent of religious Jewish high school students — would deny Israeli Arabs the right to be elected to the Knesset. An education ministry official called the survey “a huge warning signal in light of the strengthening trends of extremist views among the youth.”

And these same trends are visible in America, splitting the younger half of the Jewish community into one group that increasingly doesn't feel any attachment at all to Israel and a smaller — but growing — group that identifies with the Israeli hard right:

Because they marry earlier, intermarry less, and have more children, Orthodox Jews are growing rapidly as a share of the American Jewish population. According to a 2006 American Jewish Committee (AJC) survey, while Orthodox Jews make up only 12 percent of American Jewry over the age of sixty, they constitute 34 percent between the ages of eighteen and twenty-four. For America’s Zionist organizations, these Orthodox youngsters are a potential bonanza. In their yeshivas they learn devotion to Israel from an early age; they generally spend a year of religious study there after high school, and often know friends or relatives who have immigrated to Israel. The same AJC study found that while only 16 percent of non-Orthodox adult Jews under the age of forty feel “very close to Israel,” among the Orthodox the figure is 79 percent. As secular Jews drift away from America’s Zionist institutions, their Orthodox counterparts will likely step into the breach. The Orthodox “are still interested in parochial Jewish concerns,” explains Samuel Heilman, a sociologist at the City University of New York. “They are among the last ones who stayed in the Jewish house, so they now control the lights.”

These trends have been apparent for many years, and it's hard to see how they can be turned aside. It's also hard to see how they turn out well. Beinart's essay must have been hard to write, but because of that it's worth reading.