Outside the Box: Big Banks Shift to Lower Gear


Posted on 1st August 2014 by Administrator in Economy |Politics |Social Issues

Outside the Box: Big Banks Shift to Lower Gear

By John Mauldin


For today’s Outside the Box, good friend Gary Shilling has sent along a very interesting analysis of the big banks. Gary knows a lot about what went down with the big banks during and after the Great Recession, and he tells the story well.

After the bailout of banks during the financial crisis, many wanted too-big-to-fail institutions to be broken up. Big banks resisted and pointed to their rebuilt capital, but regulators are responding with restraints that strip them of proprietary trading and other lucrative activities and push them towards spread lending and other traditional commercial banking businesses. The fiasco at Citigroup, JP Morgan’s London Whale, and BNP Paribas’s sanctions violations have spurred regulators as well.

Regulators are pressured to impose big fines and get guilty pleas for infractions. Meanwhile, big bank deleveraging proceeds. In this new climate, big banks are still profitable but at reduced levels and are moving toward utility and away from growth-stock status. The end of mortgage refinancing and weak security trading are also drags.

Banks are reacting by taking more risks, but regulators are concerned as long as depositors’ money is at risk. Still, regulators want to keep big banks financially sound and profitable enough to serve financial needs.

Gary’s analysis is extensive and thorough, but it’s only one part of his monthly Insight report. If you subscribe to Insight for $335 via email, you’ll receive a free copy of Gary Shilling’s full report on large banks, excerpted here, plus 13 monthly issues of Insight (for the price of 12), starting with their August 2014 report.

To subscribe, call them at 1-888-346-7444 or 973-467-0070 between 10 AM and 4 PM Eastern time or email [email protected]. Be sure to mention Outside the Box to get your free report on the big banks. (This offer is for new subscribers only.)

I am back from Whistler, British Columbia, where I spent the weekend at Louis Gave’s 40th birthday party. I went to Louis’s new home on the mountain, where you can ski down and take the gondola back up when you want to go home. Sunday afternoon Louis and I sat and talked for a few hours about the state of the world, interrupted now and again by the excitement of the children when a mother bear and cub walked through the yard. Later we saw another mother with two cubs.

The conversation drifted to the state of the investment industry in which we both work. It echoed similar conversations I have had over the world with other market participants. There is a growing feeling (admit it, you probably feel it too) that significant changes in the investment business are coming at us rather swiftly. Everywhere I go people are trying to figure out what those changes will entail. I’m not talking about just another bear market. In the same way, much of the music industry was sitting fat and happy in 2000 – they had little idea that Napster was just around the corner. And while Napster came and went, the way that people consume music today is significantly different than it was 10 or 15 years ago.

I have the feeling that the investment industry is getting ready to be hit by its equivalent of Napster. I’m not quite sure what that ultimately means, other than in 10 years (or maybe less) clients will be consuming their investment research and advice in a different manner. Old dogs are going to have to learn new tricks or be retired to the porch. And I am not ready to retire, so I will need to master a few new tricks, I guess. Of course, I would like to avoid Napster and go straight to Spotify. Then again, wouldn’t we all?

As Louis drove us back to the hotel – past more bears – he remarked that one does have to be careful around them. “Not really,” I said. “I have run with more than a few bears in my life and been OK.” He looked at me rather strangely, and I added. “Yeah, like Marc Faber, Gary Shilling, Rosie in his former life. Those were REAL bears. These are just cute animals.” He smiled and kept driving.

I will write my next note from Maine, where my son Trey and I will be going to fish for the 8th year in a row at what has become known as Camp Kotok. And though they tell me they are all around us there, the only bears I have seen are some of my fellow campers.

Your ready to lose the fishing contest again,

John Mauldin, Editor
Outside the Box
[email protected]

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Big Banks Shift to Lower Gear

(Excerpted from the July 2014 edition of A. Gary Shilling’s INSIGHT)

In February 2007, the subprime mortgage bubble broke (Chart 1). Big British bank HSBC was forced to take a $1.8 billion writedown on its U.S. Household subprime lending unit’s bad loans, at the time an unprecedented amount, and subprime mortgage lender New Century reported disappointing fourth quarter results.

Quick Spreading

At the time, many housing bulls tried to convince us that the problem was limited to subprime loans that were made to people they, luckily, would never have to meet. But it spread to Wall Street. Bear Stearns was laden with subprime-related securities and when market lenders refused to finance the firm, the New York Fed provided $30 billion in short-term financing. On March 16, 2008, the firm merged with JP Morgan Chase bank in a stock swap worth $2 per share, only 7% of its value two days earlier and 1% of the $172 a share price for Bear Stearns in January 2007. Morgan bank paid $1 billion and the New York Fed was stuck with $29 billion.

Lehman Brothers was next. But this time, the Fed and the Bush Administration refused to bail out that firm and it filed for bankruptcy on September 15, 2008 when outside financing of its hugely leveraged portfolio disappeared and its net worth was a negative $129 billion.

With a meltdown of major Wall Street firms in prospect that probably would have spread worldwide, the Fed and the Administration twisted Congress’ arms into passing the Troubled Asset Relief Program. TARP originally authorized $700 billion to finance troubled assets but it soon morphed into a bailout fund for banks and other troubled financial institutions and took equity positions in 707 banks. The objective was to stabilize their balance sheets and encourage them to lend.

Some $475 billion of TARP money was disbursed and all but $40 billion has been repaid. That $40 billion went to automakers GM and Chrysler as well as insurer AIG – two of them non-banks. But that didn’t stop Washington from placing most of the blame for the financial crisis on the big banks and their CEOs. After all, when a lot of people lose a lot of money, there is a cosmic need for scapegoats, and the big banks have served themselves up for this role.

Too Big To Fail

Much of Wall Street is financed by very short-term loans, often only overnight. So if one firm gets in trouble, funding woes can spread quickly to other firms in the same business, regardless of their individual size, as lending dries up. This is the systemic risk problem. Nevertheless, Congress addressed the situation with such measures as “living wills,” plans prepared by banks to liquidate themselves quickly in the event of future troubles. But if a specific bank were in deep difficulty, would others remain untouched? Can you “keep your head when all about are losing theirs and blaming it on you?”

Then there is the Volcker Rule, proposed by former Fed Chairman Paul Volcker and part of the 2010 Dodd-Frank financial reform law. It strips banks of proprietary trading for their own accounts even though proprietary trading was not a problem for any troubled firms during the financial crisis.

Most significant is the Too-Big-To-Fail concept, the belief that big banks need to be broken up so they can fail individually without endangering the entire financial system. Proponents apparently dismiss the systemic risk reality and forget that bank runs took down many small banks in the early 1930s as well as large ones. We recall a story of people queued up to withdraw their money from a bank in a line that stretched past another bank. So they made a run on that second bank while waiting!

The too-big-to-fail concept originated
in the 1980s when Continental Illinois
had to be rescued. That bank wasn’t
involved in exotic financial activities but rather straightforward commercial banking, taking deposits and making loans. Unfortunately, it made too many bad loans, as have failed predecessors over the centuries.

Bank Concentration

The too-big-to-fail concept is also fueled by the increasing concentration of bank assets. Sure, the number of banks continues to fall (Chart 2), largely due to mergers. The FDIC now insures 6,730 institutions, down from an earlier peak of 18,000 in 1985. But most of the decline of 10,000 banks in the 1984-2011 years was among small banks with less than $100 million in assets due to mergers, consolidations and failures, with 17% of banks collapsing. Increasing costs of regulations since 2008 has also speeded the demise of small banks. At the same time, the number of banks with $100 million to $1 billion in assets has risen since 1985. More regulation in response to earlier collapse in the residential mortgage market, and economies of scale, are encouraging mergers of medium-sized banks into larger units.

Many observers believe banks with less than $1 billion in assets are too small to cope with increased regulation. Last year, in 204 bank mergers, the target bank had assets under that level, about the same as the 206 in 2012 but up hugely from 102 in 2009 before the pressure to merge was fully felt. Not only Dodd-Frank regulations, but also the new “qualified mortgage” rules by the Consumer Finance Protection Bureau that insures borrowers can afford mortgages, are very costly for small banks.

Also, the number of bank branches continues to drop, in part due to mobile and electronic banking. Last year, 2,563 branches disappeared and reduced the total to 96,339 in mid-2013 (Chart 3). This is a far cry from the situation in the early 1960s when I was working on my Ph.D at Stanford and a girlfriend from the Chicago area was visiting me in the summer. She had a letter of introduction from Continental Illinois so she could cash checks at Bank of America, then entirely located in California. While filling out the Bank of America forms in San Francisco, she was stymied by the blank that called for the branch of her bank. Illinois at the time had only unit banking, one location per bank. The Bank of America officer in turn couldn’t understand her problem because of that bank’s statewide branch network.

Big Banks Balloon

Nevertheless, the largest banks’ share of assets continues to leap. It was propelled in the 1990s by the progressive relaxation and final elimination in 1999 of the Depression- era Glass-Steagall law that kept commercial banks out of investment banking. Then with the 2008 financial crisis, stronger big banks bought weaker competitors – with government encouragement, we might add. JP Morgan Chase took over failed Washington Mutual as well as Bear Stearns, Bank of America acquired mortgage lender Countrywide and Merrill Lynch, and Wells Fargo purchased Wachovia. At the end of 2013, the five largest institutions controlled 44.2% of total bank assets, up from 38.4% in 2007. As of March 31, 2014, those 107 institutions with over $10 billion in assets were only 1.7% of the total number but held 80.8% of all bank assets (Chart 4).

In addition, critics of big banks note that buyers of bank debt are more lax in their due diligence of a bank that’s too big to fail because they anticipate a government bailout if needed. This allows the leaders of these banks to borrow cheaply and take bigger risks in a self-feeding cycle of more leverage and more risks.

A recent New York Fed study found that big banks pay 0.31 percentage points less than smaller banks when issuing high-quality bonds, and an even bigger advantage in comparison with nonfinancial corporations where the spread is 0.5 percentage points. Similarly, the IMF reports a borrowing advantage of 0.6 percentage points for too-big-to-fail banks in Japan and the U.K. and 0.9 in the eurozone.

Furthermore, bank CEO pay is much more linked to size than performance. A recent study revealed that the eight U.S. “Systemically Important Banks” – Wells Fargo, JP Morgan Chase, Goldman Sachs, State Street, Bank of New York Mellon, Morgan Stanley, Citigroup and Bank of America – had a median stockholder total return (stock appreciation plus dividends) of 38% since 2009 while the return for smaller banks like US Bancorp, PNC and Sun Trust exceeded 100%. But the median total pay, including cash and stock awards of the large banks between 2010 and 2013, was $57 million compared with $35 million for the second tier. Sure, larger firms are more complex and harder to manage but they can make bigger mistakes, as shown by JP Morgan’s $6.2 billion loss with the London Whale, as we’ll discuss later. No wonder big bank CEOs resist dismemberment and want to grow even bigger!

Break-Up Proponents

Among those now advocating the breaking up of big banks is Sanford Weill, who, ironically, earlier led the charge to end Glass-Steagall so he could merge insurer Travellers, which he headed, with Citigroup. In fact, the Gramm-Leach-Bliley Act that killed Glass-Steagall was dubbed the “Citigroup Authorization Act.” In announcing his reversal in opinion in July 2013, Weill said, “I think the earlier model was right for that time. I think the world changed with the collapse of the real estate market and the housing bubble and what that did because ofleverage ofcertain institutions. So I don’t think it’s right anymore.” He also said, “I am suggesting that they be broken up so that the taxpayer will never be at risk, the depositors won’t be at risk.” And he admitted, “Mistakes were made.”

Others advocating the break-up of big banks include Philip Purcell, the former CEO of Morgan Stanley, Sheila Bair, the former head of the FDIC, John Reed, who ran Citigroup before it was merged with Travellers, Thomas Hoenig, former Kansas City Fed President and Dallas Fed President Richard Fisher. A number in Congress are also on board including Sen. Ron Johnson from Wisconsin.

Like unscrambling an egg, it’s hard to envision how big banks with many, many activities could be split up. But, of course, one of the arguments for doing so is they’re too big and too complicated for one CEO to manage. Still, there is the example of the U.K., which plans to separate deposit-taking business from riskier investment banking activities – in effect, recreating Glass-Steagall.

In any event, among others, Phil Purcell believes that “from a shareholder point ofview, it’s crystal clear these enterprises are worth more broken up than they are together.” This argument is supported by the reality that Citigroup, Bank of America and Morgan Stanley stocks are all selling below their book value (Chart 5). In contrast, most regional banks sell well above book value.

Push Back

Not surprising, current leaders of major banks have pushed back against proposals to break them up. They maintain that at smaller sizes, they would not be able to provide needed financial services. Also, they state, that would put them at a competitive disadvantage to foreign banks that would move onto their turf.

The basic reality, however, is that the CEOs of big banks don’t want to manage commercial spread lenders that take deposits and make loans and also engage in other traditional banking activities like asset management. They want to run growth companies that use leverage as their route to success. Hence, their zeal for off-balance sheet vehicles, proprietary trading, derivative origination and trading, etc. That’s where the big 20% to 30% returns lie – compared to 10% to 15% for spread lending – but so too do the big risks.

Capital Restoration

The strategy of big bank CEOs seems to be to fight break- up proposals tooth and nail in the hope that as memories of the 2008-2009 bailouts fade, so too will interest in reducing their size. Furthermore, the vast majority of banks, big and small, have restored their capital. Most banks are comfortably above impending capital requirements. At the end of the first quarter, 98.2% of all FDIC-insured institutions representing 99.8% of industry assets (and therefore all the big banks) met or exceeded the requirements of the higher regulatory capital category.

Nevertheless, the FDIC and Federal Reserve are planning a new “leverage ratio” schedule that would require the eight largest “Systemically Important Banks” to maintain loss-absorbing capital equal to at least 5% of their assets and their FDIC-insured bank subdivisions would have to keep a minimum leverage ratio of 6%. This compares with 3% under the international Basel III schedule. Six of these eight largest banks would need to tie up more capital. Also, regulators may impose additional capital requirements for these “Systemically Important Banks” and more for banks involved in volatile markets for short-term borrowing and lending. The Fed also wants the stricter capital requirements to be met by 2017, two years earlier than the international agreement deadline.

The number of institutions on the FDIC’s “Problem List” fell to 411 and the assets of those banks dropped to $126.1 billion in the first quarter. Bank failure numbers have yet to return to pre-crisis levels, but have dropped considerably since the 157 peak in 2010 (Chart 6). Similarly, the percentage of institutions with quarterly losses continues to fall
while the percentage with quarterly earnings increases exceeds the pre-crisis
level (Chart 7).

More Regulation

Despite the improving financial status
of banks, especially larger institutions,
their push back against being dismembered has been met with more regulation. The unvoiced strategy in Washington seems to be, if the big banks
don’t agree to be broken up, they’ll be regulated to the point that they wish they
were, or at least to the degree that individual failures are much less likely
and far less damaging if they do occur.
Slowly but surely, they’re being busted back toward spread lending and other traditional commercial banking businesses and bereaved of many risky but highly-profitable activities – highly-profitable until adjusted for risks. Consider the higher Basel III capital requirements, the pressures to orient executive compensation toward long- run risk-adjusted profitability and away from short-run speculation, the divestiture of non-core bank assets, the Volcker Rule, the selling ofbranches and subsidiary banks, etc.

Late last year, the FDIC prepared a plan to unwind large banks on the edge of collapse without taxpayer bailouts. The FDIC would keep parts of the bank open, prioritize payments to creditors and recapitalize the firm. “Unsecured creditors and shareholders must bear the losses of the financial company without imposing a cost on U.S. taxpayers,” said FDIC Chairman Martin Greenberg.

All of these new regulation proposals strike us as fighting the last war. With all the Dodd-Frank and other regulations now in place and the losses, chastisements and embarrassments of bankers, mortgage lenders, homeowners, etc., it’s unlikely that a repeat of the 2008 financial crisis and the speculation that spawned it will occur any time soon. That doesn’t mean that financial bubbles are extinct, but that the next one will occur in a different area that is outside the scope of the regulatory reaction to the last crisis. Besides, all those super bright, million-dollar per year guys and gals on Wall Street can figure out how to beat most $100,000 regulators any day!

Fed Proposals

Meanwhile, the Fed and the Office of the Controller of the Currency, another bank regulator, in March 2013 told banks to avoid funding takeover deals that would leave companies with high debts. But since then, “judging from aggressive market data, it appears that many banks have not fully implemented standards set forth” in March 2013, said a senior Fed official recently. In March of this year, the OCC said there would be “no exceptions” to the guidance for newly-issued loans. These junk “leveraged” loans have seen a rapid reduction in investor-protecting covenants that moves them back to previous day’s levels that proved disastrous when the 2008 financial meltdown hit.

In a similar vein, the Fed’s point man on regulations, Gov. Daniel Tarullo, said recently that after reading accounts of the role that money market and other short-term markets played in the financial crisis, a “broadly applicable” minimum margin requirement makes sense. Fed Chairwoman Janet Yellen also backs new rules for short-term funding to mitigate risks to the financial system.

The final version of the Volcker Rule has been delayed by haggling over the difference between genuine hedging of customer assets and proprietary trading with bank assets. The Volcker Rule isn’t expected to be implemented until 2015 and promises to be very specific as to what is and what isn’t a hedge. Meanwhile, Wall Street houses such as Goldman Sachs have exited their in-house trading.

More Examiners

Regulators are adjusting their staffs to better understand and control financial institutions’ activities. The New York Fed roughly doubled its supervision staff since the crisis and has between 15 and 40 overseeing each of the largest bank holding companies. The OCC, which regulates banks with national branch networks like JP Morgan and Wells Fargo, has upped its staff examining large banks by 20% since 2007, with up to 60 at the largest institutions. These examiners have access to computer systems and can attend internal strategy meetings and readily meet with bank executives and board members.

At the same time, the heat is on banks to beef up their compliance. Regulators are concerned that banks don’t comprehend their own operations, including measuring risks and planning for future crises. The OCC recently said that only two of 19 banks have met the standards it laid out after the crisis. Among other things, it wants two independent directors on boards of national banks and independent officers to track and monitor all business lines.

Large banks are hyping their compliance staffs. JP Morgan plans to add over 13,000 people and the industrywide hiring effort is creating a war for talent with escalating pay levels. Similarly, bank risk officers are multiplying like fruit flies as the OCC warns that “credit risk is now building after a period of improving credit quality and problem loan cleanup.” At major banks, their numbers are rising over 15% annually.

Wells Fargo now has 2,300 in its risk management department, up from 1,700 two years ago and the department’s budget has doubled to $500 million. In contrast, the bank’s total workforce has remained flat. Goldman Sachs put its chief risk officer on the 34-person management committee for the first time in the firm’s 145-year history. Senior risk officer pay is up as much as 40% from a few years ago and equal to the compensation of chief financial officers and general counsels. Earlier, they were paid a third less.

Large banks are being pushed by regulators to specify in writing which risks and how much they’re willing to take to meet financial goals. Risk officers are being urged to examine big losses or big profits for signs of undue risks.

The efforts of regulators and risk officers may be having significant effects. At the end of 2013, the five largest banks had $793 billion in equity capital to protect against losses, up 19% from $667 billion in 2009. At the same time, their value at risk, in effect their exposure to losses on any given trading day, fell 64% from $1.05 billion to $381 million

Who’s The Toughest?

Then there is the war among regulators to be the toughest. They’re chastised in and out of Washington for leveling billion-dollar fines that are still just a cost of doing business for major banks, for letting them off with mere “we neither admit nor deny” statements and for not sending individual bankers to jail. The relatively new SEC Chairwoman Mary Jo White promises to be a lot tougher, but the results are yet to be seen. The OCC recently detailed risk management standards for banks with over $50 billion in assets, which puts the monkeys on the bank board members’ backs and requires banks to have independent audit and risk management offices that can take their concerns directly to the board.

Then there’s the game of one
regulator trying to deflect
pressure by saying that other
regulators are lax. The SEC
has criticized the Financial
Industry Regulatory Authority, which it oversees, for being
too lenient in its sanctions. In
the five years since the financial
crisis, FINRA did not
discipline any Wall Street
executives and imposed fines
of $1 million or more 55 times
compared with 259 times for
the SEC. FINRA regulated
4,100 brokerage firms and over 600,000 brokers and collected just $74.5 million in fines last year compared to $3.9 billion for the SEC. Note, however, that the SEC, not FINRA, takes the most serious fraud cases while FINRA concentrates on lesser infractions such as operations breakdowns where penalties are smaller.


Dodd-Frank has bereaved banks of much of their origination in trading in futures, options and other derivatives. Derivative trading is largely being transferred to exchanges that guarantee fulfillment of the contracts as opposed to the highly-profitable over-the-counter derivatives that banks trade but with which investors or speculators have to look to counterparties to be good for losses. This is the “counterparty risk” problem. Still, the seven largest banks still accounted for 98% of the $215 trillion notional value of derivative contracts as of March 31 (Chart 8), 85% of which were interest rate contracts (Chart 9).

Still, regulators are concerned with derivatives. Those from 10 European and North American countries recently released a report that said many large banks and their regulators are still not ready to deal with difficulties in the huge derivatives market. They lack the information to consistently and accurately know who their counterparties are. Officials estimate that banks are up to three years away from having the necessary systems in place.

Dark Pools And High-Speed Trading

Another area of concern to regulators is dark pools, private trading venues that don’t disclose their activities publicly and account for 14% of all stock trading. Another 23% occurs in other off-exchange locales. The purpose of dark pools is to facilitate large institutional trading without exposure to high-frequency traders. Barclays bank runs Barclays LX, the country’s second largest dark pool, which is marketed with the motto, “Protecting clients in the dark.” But the New York Attorney General has charged that Barclays offered access to Barclays LX to high-speed traders. The bank is also accused of using other trading venues that benefit Barclays rather than its customers.

Under pressure from their institutional investor clients, many large brokers are routing trades away from Barclays LX and other dark pools. The SEC is investigating dark pools to determine whether they accurately disclose how they operate and whether they treat all investors fairly. Chairwoman White said in June that the size of off-exchange trading “risks seriously undermining” the quality of the U.S. stock market. Goldman Sachs recently agreed to pay an $800,000 fine for mispricing 400,000 trades in dark pool Sigma X in 2011. The firm already reimbursed clients with $1.67 million.

Citigroup Charades

One big bank that remains squarely in regulators’ gun sights is Citigroup, and for good reason. The present firm resulted from the merger of Citicorp and Travellers in 1998. Vikram Pandit left Morgan Stanley in 2005 after being passed over for CEO and, with two colleagues, started a hedge fund, Old Line. It was sold to Citigroup in 2007, right at the top of the financial bubble, for $800 million. Even though that hedge fund was not very successful and eventually closed, Pandit rose to be CEO of the firm in December 2007.

On his watch, the company’s stock continued its collapse from what would have been $564 per
share in December 2006, except for the
10-to-1 reverse split in May 2011 to avoid the embarrassment of its selling at penny stock prices (Chart 10). The swoon to the trough in March 2009 was 98.2%.

Pandit’s relations with regulators were poor and he didn’t help matters by letting the bank consider completing the purchase of a private jet after receiving $45 billion in TARP bailout money. Despite his announcement to the Citigroup directors that all was well with regulators, the bank failed the Fed’s stress test in 2012. So it was not allowed to increase its quarterly dividend from one-cent per share to five cents and it requested but could not buy back up to $6.4 billion in stock. Shareholders were not amused and Pandit was shown the door in October.

Pandit told Congress in February 2009 that “my salary should be $1 per year with no bonus until we return to profitability.” After some improvement in the bank’s finances, he was awarded a $23.2 million retention package in 2011, close to the top of CEO compensation. Nevertheless, in April 2012, 55% of shareholders voted against increasing his pay to $15 million, the first nonbinding rejection of a compensation plan by a major bank.

History Repeats

In a repeat of history, last March the Fed again said Citigroup flunked its stress test, only the second bank along with Ally Financial to fail twice. So it can’t raise its quarterly dividend from one-cent to five cents per share.

It wasn’t the quantitative part of the test that tripped up Citigroup. Its Tier 1 capital ratio would only fall to 7% under very adverse conditions, still well above the fed’s 5% minimum. That adverse scenario, specified by the Fed, includes a deep recession with leaping unemployment, a steep decline in house prices and a 50% plummet in equity prices. Also, in the third annual stress test, the Fed made its own projection of the bank’s balance sheet, assuming the assets rise during tough times rather than fall as banks had assumed, so more bank capital would be necessary. In addition, the Fed forced eight big banks to assume the default of their largest counterparty.

The Fed this year flunked Citigroup on the quantitative side of the stress test. It cited deficiencies in Citi’s capital-planning process and risk assessments. The Fed had earlier warned the bank about these problems, but received an inadequate response. In effect, the Fed is questioning whether Citigroup is too big and too complex to manage without posing systemic risk.

The London Whale

In failing Citigroup in its stress test, the Fed has yet to bring up the bank’s risks controls in Mexico and the Banamex loss. But the Fed and other regulators have been clear over JP Morgan Chase’s lack of controls that led to the London Whale disaster in 2012.

Banks normally invest funds they’re not using for loans in Treasurys, but with low interest rates, JP Morgan became aggressive. As an example, at the end of 2006, it held $600 million in riskier corporate debt, or about 1% of total investments, but jumped those holdings to $10 billion, or 5% of all security holdings, two years later, and $62 billion, or 17% of the total, at the end of 2008 after the Fed initiated its zero interest rate policy. Similarly, non-U.S. residential mortgage security holdings jumped from $2 billion at the end of 2008 to $75 billion in early 2012. At the time, CEO Jamie Dimon disputed the idea that the bank was taking on more risk. “I wouldn’t call it more aggressive. I would call it better,” he said.

Meanwhile, the bank’s culture of risk-taking – and we believe the tone in any organization is set at the top – was rampant in London. A JP Morgan bank trader, Bruno Iksil, was making huge bets totaling $82 billion, with insurance-like derivatives called credit default swaps so big that he became known as the London Whale. That attracted hedge funds to take the other side of his trades, figuring he’d have to unwind them sooner or later. Meanwhile, his boss was urging him to put even higher values on his positions. When asked about this trading on April 13, 2012, Dimon said concerns were “a complete tempest in a teapot.”

Then came revelations of losses of at least $2 billion and Dimon began to realize the extent of the problem. “There’s blood in the water – hedge funds are going to come after us and make it worse,” he was told by a colleague. And they did, with the loss leaping to $6.2 billion by July. Dimon tried to get ahead of the bad public relations by stating that the trades were “flawed, poorly executed, poorly reviewed and badly monitored.”

The Chief Investment Office in which these trades took place was supposed to manage and hedge the firm’s fixed- income assets. But it has become clear that the CIO was taking directional bets and speculating in contradiction of the impending Volcker Rule. In 2011, risk-control caps that had required traders to exit positions when their losses exceeded $20 million were dropped. Subsequently, Dimon admitted as much, saying, “What this hedge morphed into violates our own principles.” Also, he was slow to fire Ina Drew, who was responsible for the CIO, and he dithered about clawing back the $14.7 million in stock awards she received.

Bones And Joints

Furthermore, Dimon, the bank and Wall Street faced huge fallout from this mess. He has led the charge against the Volcker Rule and other new bank regulations and had considerable credibility in Washington and on Wall Street because his bank largely avoided the near-financial meltdown.

Dimon was known as the smart, hands-on operator who says he knows all the “bones and the joints” of the bank. Is his being shocked! shocked! to discover the $6.2 billion loss proving what many regulators and legislators believe: that big banks are too complicated to manage and should be broken up? If they’re too big to fail, it’s ironic that when asked, in hindsight, what he should have paid more attention to, Dimon quipped, “Newspapers,” no doubt referring to the April 6, 2012 front page Wall Street Journal story about the London Whale.

Furthermore, the London Whale fiasco has not hindered Dimon’s compensation, although he suffered a pay cut at the time. In January 2014, the JP Morgan board raised his pay 74% to $20 million for 2013, a year in which the bank agreed to more than $20 billion in fines and other legal payouts and suffered its first quarterly loss in nine years. In making that award, which included $18.5 million in stock, the board cited “the regulatory issues the company has faced and the steps the company has taken to resolve those issues.”

Well, in contrast to Citigroup, JP Morgan’s stock fell “only” 70% during the financial crisis. Since then, it has rallied 260% to now exceed the May 2007 peak by 8%. And investors didn’t have lasting concerns over the 2012 London Whale losses and lack of controls. Regulators, however, may have the last word.


That lack of investor worry comes despite the huge fines and other penalties being paid by JP Morgan and other big banks over bad mortgages, manipulation of currency, interest rate and commodity markets, and illegally helping Americans to avoid taxes.

The CFTC and JP Morgan settled for $100 million in the London Whale case after the regulator charged the bank with reckless use of manipulative devices. The bank also acknowledged wrongdoing as part of the $970 million settlement with the SEC, OCC, the Fed and U.K. regulators in September 2013 in the same case.

The SEC got $200 million of that total and admissions by JP Morgan that it misstated its first quarter 2012 financial results, failed to properly oversee its traders and didn’t keep its board of directors informed about the trading problems. This is only the second time, after the settlement with hedge fund company SAC, that the SEC obtained admission of wrongdoing and it is in line with Chairwoman White’s promise to get tough and get more admissions. Earlier, U.S. District Court Judge Jed S. Rakoff rejected a $285 million settlement the SEC negotiated with Citigroup, in part because Citi did not admit liability.


Big foreign banks with U.S. operations are not beyond the reach of American regulators. France’s largest bank, BNP Paribas, has finally agreed to pay $9 billion in penalties and plead guilty to criminal charges over concealing about $30 billion in oil and other transactions with countries that are sanctioned by the U.S. including Iran, Cuba and Sudan. Also, as demanded by New York State regulators, 30 people will leave the bank. Starting in January, the bank will lose its permission to clear certain dollar transactions for a year. The alternative to accepting these harsh sanctions was being banned from done business in lucrative U.S. financial markets.

Since French banks dominate trade financing and these transactions between the Americas and Asia are carried out in U.S. dollars, this last penalty is especially meaningful for BNP, although the bank has six months to arrange a transition to other firms that will handle this business during BNP’s absence. French President Francois Hollande called the demands by U.S. regulators “unfair and disproportionate,” but with classic French face-saving, Finance Minister Michel Sapin took credit for the limited scope of the dollar ban. “In line with the demands of the French authorities, this agreement sanctions the activities of the past and protects the future,” he said.

Prosecutors in the Justice Department and Manhattan District Attorney’s office were especially irked by BNP’s slow and incomplete response to their requests for documents and interviews in 2009 concerning transactions that took place between 2002 and 2009. U.S. authorities believe that BNP employees took deliberate steps over several years to hide their dollar transactions with U.S.-sanctioned countries. Transactions were run through intermediate banks to avoid detection, in schemes that resemble money-laundering. BNP apparently did not expect this big of a fine since it reserved only about $1.1 billion. It plans to maintain its dividend and its stock rose 3.6% on the news, although it had dropped 18% since February when the bank announced the provision for possible U.S. fines….


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Important Disclosures



Posted on 31st July 2014 by Administrator in Economy |Politics |Social Issues


Below are the first two articles I ever wrote in 2008. Back then Nolan Chart was my other main outlet. Here is a link to all my old articles from the early years.




I love America. That is why I am so disillusioned by what our “leaders” have done to our great Country. I use the term “leaders” loosely. Dr. Howard Gardner defines a leader as, “an individual (or, rarely, a set of individuals) who significantly affects the thoughts, feelings, and/or behaviors of a significant number of individuals”. The reason we are in our current predicament is because, “We the people” have elected politicians rather than leaders. Merriam-Websters dictionary defines a politician as “a person primarily interested in political office for selfish or other narrow usually short-sighted reasons”. The people we have elected to Congress and the Presidency are politicians who are more concerned with their own re-election, maintaining power, and enrichment of their financial backers than they are about our great country. Our great leaders included: George Washington, Benjamin Franklin, Abraham Lincoln, Franklin D. Roosevelt, John F. Kennedy, and Ronald Reagan. A true leader tells the American people what we need to hear and is able to convince us to change our behavior. Our current cast of politicians, tell us what we want to hear based on polls that tell them how to best get re-elected. They spend our children’s future by dishing out election year rebate bribes and foreclosure bailout schemes for votes. The only two people that I have seen on the political scene today who show the characteristics of true leadership are Ron Paul and David Walker.

Ron Paul has been a Congressman from Texas for 20 years. He has been running for President as a Republican. The Republican establishment despises him because he has been against the Iraq invasion from the beginning. The Conservative media have tried to trivialize and demean his positions. It is these conservatives who have sold out. Ron Paul is a true social and fiscal conservative. His consistent principles and moral backbone should be an example to all conservatives. I am a registered Republican and consider myself a fiscal conservative and social conservative. After 8 years of Republican control of the Presidency and 6 years controlling Congress, I’ll provide a scorecard of the results most important to the average American as of today:


                                             2008         2000          % Change

Gasoline (per gallon)                      $4.00           $1.36                   194%

Natural gas (per ccf)                       $1.30           $0.71                    83%

Electricity (per kwh)                        $.116            $.084                   38%

Milk (per gallon)                              $3.87            $2.78                   39%

Bread (per lb)                                   $1.28            $0.91                   41%

Eggs (per dozen)                               $2.18            $0.98                 122%

Orange Juice (per gal.)                      $2.54            $1.82                  40%

Ground Beef (per lb.)                        $2.33            $1.48                  57%


                                              2008           2000            Change

National Debt                                 $9.4 trillion     $5.5 trillion           71%

Annual Budget surplus/(deficit)   ($400) bil      $150 bil         ($550) bil

Median S&P 500 CEO pay             $8 million       $6 million              33%

Median household income            $49,000          $42,000                17%

Consumer Price Index (per BLS)      211.1              168.8                   25%

Consumer credit                            $2.52 trillion     $1.54 trillion         64%

Median Home value                      $168,000          $120,000              40%

Euro vs. Dollar                                  $1.57               $0.85                   -87%


                                                            2008 to date       2000

American soldiers killed in Iraq                               4,094                    0

American soldiers wounded in Iraq                      29,978                    0

American soldiers killed in Afghanistan                    517                     0

American soldiers wounded in Afghanistan          1,868                    0

Iraqi deaths (est. since 2005)                               49,000                     0

Cost of Iraq & Afghan wars (per CBO)                $600 billion           $0

You have to admit, this is quite a success story. I doubt that President Bush will be considered in the list of our greatest leaders. He is more likely to be lumped with such distinguished Presidents as Herbert Hoover and James Buchanan. He has single-handedly destroyed our fiscal situation by spending like a drunken sailor. The difference is that drunken sailors spent their own money. George Bush spent our money and borrowed the rest from the Chinese to pay for his wars. His spending and Alan Greenspan’s mismanagement of interest rates have led to our current situation. With the current bunch of imbecile politicians running this country, a Depression is a distinct possibility. If they start putting up barriers to free trade, we could relive the 1930′s.

In the data above, you may have noticed that the CPI has only increased by 25% in eight years. How could this be when energy costs are up over 100% and food is up over 50%? It is because the government manipulates the CPI in order to make it lower. Again, we have Alan Greenspan to thank. He is a very smart manipulative man. He realized that Social Security obligations will bankrupt the country. Social Security payments are increased by CPI every year. By artificially reducing the CPI, he has reduced the government debt by billions.

If the CPI was calculated the same way it was when Paul Volker was the Federal Reserve Chairman, then we currently have 12% inflation, versus the 4% reported by our government. Which rate seems right to you? While the average American is struggling to educate their children, save for retirement, take care of their aging parents, and generally get ahead, the Treasury Secretary and Federal Reserve Chairman have been busy propping up bankrupt financial institutions who made billions in the last 8 years while paying their “Masters of the Universe” leaders hundreds of millions in salary and bonuses. Guess what they are using to prop up these bankrupt institutions? That’s right, our money. My money, your money, your children’s money, and your grandchildren’s money.

Of course, this is small potatoes compared to the current and future costs of Bush’s wars and the unfunded liabilities created by our politicians over the years in order to win re-election. According to Paul Craig Roberts, former Assistant Secretary of the Treasury under Ronald Reagan, the cost of the Iraq war has been north of $500 billion and does not include the replacement cost of the destroyed equipment, the future costs of care for veterans, and the cost of interest paid to the Chinese to finance the war. Joseph Stiglitz, Nobel Prize winning Princeton economist, estimates that the war will cost $5 trillion by 2017, including $800 billion of interest paid on the money borrowed to finance the war. If I recall correctly, Dick Cheney and Donald Rumsfeld told the country that the war would cost $50 billion and that the future Iraq oil revenues would be used to pay us back. Were they being dishonest or could they have miscalculated by such an enormous margin. Larry Lindsey, a Bush economic advisor who suggested that the total cost of the war could be $100 billion in 2002, was fired shortly thereafter.

The human cost of the Iraq war is the most tragic, in my opinion. President Bush chose to put our troops in harm’s way and more than 4,000 souls have sacrificed their lives, while almost 30,000 have been wounded. The tragedy is that no one needed to die or be wounded. There were no weapons of mass destruction, no links to 9/11, no relationship with Al Qaeda. Dick Cheney and Donald Rumsfeld decided in September 2001 that we would go to war with Iraq. The neo-cons were looking for any excuse to attack Iraq. Therefore, they trumped up the intelligence reports to support their case. How many lives have been ruined (mothers losing their sons, wives losing their husbands, children losing their fathers) for the sake of a political agenda. I hope Bush, Cheney and Rumsfeld sleep well at night with all of that blood on their hands.

Representative from Texas, Dr. Ron Paul, was the only Republican to vote against the Iraq War. He was ridiculed for this during the Republican Presidential debates. But, who is ridiculous. John McCain says we will stay in Iraq for 100 years. Ron Paul has pointed out the absurdity of what has happened in Iraq. First, we blew up all of the Iraqi bridges with cruise missiles. Then we borrowed billions from the Chinese to rebuild the Iraqi bridges. Meanwhile, bridges in the United States are collapsing and thousands of our bridges are rated structurally deficient. David Walker, former Comptroller General of the United States, has warned that the current unfunded liability for future Social Security and Medicare payments is $53 trillion, or $455,000 per household. This unfunded liability increases by $7 billion per day. To quote Mr. Walker, “We are mortgaging the future of our children and grandchildren at record rates, and that is not only an issue of fiscal irresponsibility, it’s an issue of immorality.”

The Federal debt has risen from $542 billion to more than $9 trillion since 1975. Debt as a percentage of GDP, once at 35%, is now above 60%. This is not a situation that will resolve itself gradually. A dramatic change is needed within the next 10 years to save this country from permanent economic decline.

We have a limited number of choices. We can either accept huge tax increases which would depress our economy or cut spending somewhere. The interest on the debt will continue to grow as long as we run deficits. We spend $12 billion per month on the wars in Iraq and Afghanistan. The only reasonable financial solution to this crisis is what has been advocated by Ron Paul. Stop our empire building and bring our troops home from across the globe. President Eisenhower warned the country in 1960 about the rise of the military industrial complex. The Government Accountability Office just reported that 95 US major weapons systems have exceeded their original budgets by $295 billion, bringing their total costs to $1.6 trillion, and are two years late on average. We would save $1 trillion per year, by bringing our troops home from throughout the world, that could be used to fund our Social Security and Medicare liabilities for our elderly, fix our infrastructure, fund our energy independence initiatives, and pay down our national debt. The great empires of Rome and Britain were not defeated militarily, they went broke. We have a choice. Continue on our current unsustainable track or take dramatic action now.

David Walker has recently resigned from his position as Comptroller of the U.S. to become CEO of the Peterson Foundation. Pete Peterson was Secretary of Commerce under Richard Nixon. The Foundation’s mission is to enhance public understanding of the nature and urgency of selected key sustainability challenges that threaten America’s future, to propose sensible and workable solutions to address these challenges and to build public will to do something about them. These issues include: unsustainable entitlement benefits, unsustainable deficits and unsustainable healthcare costs. Pete Peterson is a Republican. His view on the Bush tax cuts in his own words is, “When we sit around here and talk about all these tax cuts and we say it’s our money, your money and mine, I think we ought to be honest with the American people. In the first place, it’s also our debt and it’s our children’s debt. But secondly, a tax cut isn’t really a tax cut long-term unless you reduce spending. Because then it becomes a tax increase on your children. So we’re inflicting this awful bill not simply on ourselves but most importantly on our kids. And it is that phenomenon that is very troublesome.”

In conclusion, I wanted to provide a quote from Ron Paul that sums up our situation. In November 2007 Congressman Paul said the following to Ben Bernanke during Congressional hearings, “We’re indeed stuck between a rock and a hard place, and we don’t talk about how we got here; we talk about how we are going to patch it up. The solutions proposed so far —stimulus packages, bailouts and interest rate cuts —just amount to printing more money, which will lead to greater currency devaluation, contribute to the rising cost of living, and further squeeze the middle class and our senior citizens.” Ron Paul and David Walker are honest, straightforward, brave men who have the best interest of our country at heart, versus the selfish agendas of our political leaders.



On May 1, 2003 President Bush triumphantly landed on the deck of the USS Abraham Lincoln in a fighter jet. It must have brought back glorious memories from his days defending the skies over Texas during the Vietnam War. With a huge Mission Accomplished banner hung from the deck behind him by the Karl Rove propaganda machine, President Bush spoke these words. “My fellow Americans, major combat operations in Iraq have ended in the battle of Iraq, the United States and our allies have prevailed.” How stirring, inspiring and 100% completely wrong. Since these words were spoken, over 4,000 American soldiers have been killed and over 25,000 have been wounded. This is a prime example of the Bush administration’s arrogance and twisting of facts to suit their own purposes. The twisting of facts began in earnest after the worst terrorist incident in world history on September 11, 2001. On that day, 19 terrorists (15 Saudis, no Iraqis) under the direction of Osama Bin Laden hijacked planes and murdered 3,000 Americans. The entire world was supportive of the United States. We had almost complete worldwide support for eliminating the Taliban and killing Osama Bin Laden. Since this time George Bush has frittered away all of this goodwill, managed to alienate most of the world, started a war based upon faulty skewed intelligence, driven oil prices from $31 a barrel to $130 a barrel, increased the national debt by $4 trillion, driven inflation up by the most since the 1980′s and currently has the lowest approval rating of any President in history.

President Bush has been blustering about appeasement in the last few weeks. As usual, his neo-con speech writers have no sense of history. Either that, or young Georgie wasn’t paying attention in 6th grade history class. As defined by Merriam-Websters dictionary, appeasement is to buy off an aggressor by concessions usually at the sacrifice of principles. The classic case was Neville Chamberlin, Prime Minister of Great Britain, giving Hitler half of Czechoslovakia in the Munich agreement to avoid war. Now, anyone who says that they will employ diplomacy or even speak with our “enemies” is considered an appeaser according to Bush, Cheney, and the other neo-cons. Not supporting the war is unpatriotic and traitorous in Bush world. Speaking with other leaders, whether we agree with their views, is not buying them off or conceding anything. More diplomacy and less cowboy style shoot first, ask questions later may have saved thousands of American lives in the last five years.

The Bush administration also used the appeasement card leading up to the Iraq invasion. Dr. John Hussman wrote in February 2003, “The willingness to choose long and frustrating diplomacy instead of war does not constitute “appeasement” – a word that has been recklessly contorted in recent months. Appeasement involves the grant of concessions – generally dishonorable ones – to an enemy, in return for assurances of nonaggression (as when Hitler was offered part of Czechoslovakia in the Munich Agreement, over the objections of Czechoslovakia, which was barred from attending). Appeasement is not inherent in the pursuit of diplomacy, nor in the demand for grave justifications as a precondition for war. The argument against war is also not an argument against U.S. security or the defense of its interests, but rather a recognition of the elements that are necessary to achieve those aims. It is exactly in pursuit of American security and interests that the Administration should emphasize containment, deterrence and diplomacy – even years of it if necessary – instead of a war on a government that, while tyrannical, is of questionable threat. A war would predictably increase international resentments, further destabilize very tangible risks in North Korea, and ultimately radicalize countless potential terrorists, with no central authority from which surrender could be obtained.” Dr. Hussman showed that his investing prowess is matched by his wisdom in world affairs. We destabilized the Muslim world and have not made the world a safer place.

Since 9/11 2001, anyone who has questioned the Bush doctrine of pre-emptive war has been branded a traitor, left winger, or a fool. I fully admit that I was 100% behind President Bush’s decision to invade Iraq. I believed Colin Powell when he showed pictures of mobile biological warfare labs. I believed Muhammed Atta met with Iraqi agents. I believed there were weapons of mass destruction, because my government was sure they existed and I trusted my government. I still remember having a spirited argument in an Irish Pub with a work colleague from Sweden about the need for an invasion. We know now that the administration started planning the Iraq invasion shortly after 9/11, with no shred of evidence linking Iraq to 9/11. When it was proven that all of these “facts” were false, I admitted that I was wrong and changed my mind. This is a logical thing to do. What I find illogical are people who justify the war based on a whole new set of criteria such as: Sadaam was an evil dictator, it’s better to fight them over there than over here, and we are promoting democracy in the Middle East. The fact is that there was no imminent threat from Iraq, so we should not have invaded. Case closed.

I have the utmost respect for those who opposed the Iraq invasion when it wasn’t popular to do so. Ron Paul stood in front of Congress on October 8, 2002 and said, “Despite all of the information to which I have access, I remain very skeptical that the nation of Iraq poses a serious and immanent terrorist threat to the United States. If I were convinced of such a threat I would support going to war, as I did when I supported President Bush by voting to give him both the authority and the necessary funding to fight the war on terror. Mr. Speaker, I rise in opposition to this resolution, which regardless of what many have tried to claim will lead us into war with Iraq.” As the only member of Congress with knowledge of our Constitution and what our Founding Fathers meant, Ron Paul pointed out that James Madison wrote in 1798, “The Constitution supposes what the history of all governments demonstrates, that the executive is the branch of power most interested in war, and most prone to it. It has, accordingly, with studied care, vested the question of war in the legislature.” Instead of exercising their Constitutional responsibility, Congress was bullied into relinquishing this obligation by Bush and his Karl Rove propaganda machine. We could use a few more James Madison’s and few less George Bush’s and Dick Cheney’s leading our country today.

Now we need to assess whether we are winning. Since this is not a traditional war, like World War II, success cannot be measured in casualties and ground taken from the enemy. Osama bin Laden was financially supported by the U.S. government when he fought against the Soviet Union in Afghanistan. He offered his services to the Saudi government after Saddam Hussein invaded Kuwait in 1991. His services were turned down by the Saudi rulers, as the U.S. came to the rescue and saved Saudi Arabia and Kuwait. His hate for America was triggered by the U.S. maintaining a military base in Saudi Arabia. Non-Muslims are considered infidels in bin Laden’s world. He doesn’t hate America because we are free and democratic. He wants us out of the Muslim world, just like he wanted the Soviets out of Afghanistan.

Al Qaeda was formed in 1988 by Bin Laden recruiting veterans of the Afghan war with the Soviet Union. According to an Arab security service, al-Qaeda had a loose configuration of approximately 3,000 members in 2001. Today, the number may be 10,000 scattered throughout the world. Bin Laden uses his personal fortune of approximately $300 million and money funded by supporters to undertake his terrorist missions. The attack on the Twin Towers was designed to show the Muslim world that the most powerful country on earth could be hurt badly. The symbolism of destroying our largest buildings and successfully hitting the center of our military power, the Pentagon, was supposed to inspire the Muslim world against Western style governments. I don’t think bin Laden anticipated how the next 7 years would develop.

It is unlikely that he foresaw the reaction of the Bush administration to this horrific attack on the American people. With the world behind America, the Taliban were quickly defeated in Afghanistan. We were able to kill or capture many al Qaeda fighters. But, we have still not found bin Laden. Three years later, he clearly stated his goal. In a videotape released in October 2004, bin Laden said, “We are continuing this policy in bleeding America to the point of bankruptcy.” His plan is to “use guerrilla warfare and the war of attrition to fight tyrannical superpowers”. He is confident in this strategy because it has worked before. “We, alongside the mujahedeen, bled Russia for 10 years until it went bankrupt and was forced to withdraw in defeat.” He realizes the economic impact on the United States is significant. “Every dollar of al Qaeda defeated a million dollars, by the permission of Allah, besides the loss of a huge number of jobs. As for the economic deficit, it has reached astronomical numbers estimated to total more than a trillion dollars.” His view on Bush’s Iraq policy is that, “the darkness of black gold blurred his vision and insight, and he gave priority to private interests over the public interests of America. So, the war went ahead, the death toll rose, the American economy bled, and Bush became embroiled in the swamps of Iraq that threaten his future.

“According to Michael Scheuer, a CIA analyst who spent three years as the Counterterrorist Center’s Bin Laden station chief, in his book Imperial Hubris, has pointed out that the fundamental flaw in our thinking about Bin Laden is that “Muslims hate and attack us for what we are and think, rather than what we do. Muslims are bothered by our modernity, democracy, and sexuality, but they are rarely spurred to action unless American forces encroach on their lands. It’s America’s foreign policy that enrages Osama and al-Qaeda, not American culture and society.” Now we are occupying Iraq and Afghanistan, along with Saudi Arabia. This has further inflamed the Muslim world against us. Muslims total 1.25 billion out of a worldwide population of 6.5 billon, or 19% of the people on earth. Only a miniscule number of these Muslims are terrorists. Aysha Chowdhry and Andrew Masloski, Middle East experts at the Brookings Institution, point out that Muslims share the same vision held by humanity everywhere a secure future for their children and a life defined by dignity and liberty. Estimates are that 30% of all Muslims live below the poverty line. Policy makers would likely reduce terrorism by partnering with Muslims in bettering the livelihoods in Muslim societies.

As I have grown older I found myself to be less sure of things than I was in my youth. I see more sides to issues now that I have life experience and more knowledge. I no longer trust people who are so positive their view is correct, that they are unwilling to listen to an alternative view. Humbleness is a virtue that seems to be missing from American society and American diplomacy. More cooperation and listening to opponents would be a step forward in repairing the damage that has been done by the Bush administration. Dr. Hussman spoke more words of wisdom in March 2007. “The outlook for fiscal stability and international peace will continue to be undermined so long as our leaders imagine that violence can remove violence especially when there is no central authority from which to extract surrender, and when each act of escalation creates far more enemies than can ever be destroyed. The effort to open a dialogue as a step toward peace (rather than requiring peace as a step toward dialogue); to understand those we call enemies; would not be an act of weakness but an act of strength and self-defense. Particularly with numerous, scattered factions, the attempt to find common ground and negotiate disputes is also most probably the only way to achieve peace.”

“It is the beginning of wisdom to listen and understand the motivations of each side – their fears, hatreds, misconceptions, ignorance, suffering, feelings of injustice, and aspirations, without each side branding the other as inhuman, and somehow unworthy of human rights, or lacking any human commonalities. Diplomacy doesn’t require us to appease an enemy by granting dishonorable concessions, but only to ask “To what is each side entitled?” For a nation with a history of respect for diplomacy, international cooperation, human rights, and beyond all else, the sacrifice of our troops, the present course is no path to peace, and is no way to lead.” The Bush doctrine of pre-emptive war is not consistent with our Constitution or our history of moral world leadership. The end of the Bush reign will hopefully lead to a renewed use of diplomacy and consensus building. Time will tell.

Have the goals of Bush’s War on Terror ever been clearly defined? I haven’t been able to find any concrete goals which would allow someone to measure success or failure. This is very beneficial for the Bush administration. If no one knows the goals, they have a harder time proving that you are failing. Below is my assessment of the likely goals and our success thus far.

                GOAL                                                        PROGRESS

1. Capture or kill Osama bin Laden Seven years after 9/11, bin Laden is still alive probably living in the mountains of Pakistan. If we had not invaded Iraq and poured those resources into catching bin Laden, would we be better off today?
2. Remove the Taliban as the rulers of Afghanistan Successfully removed the Taliban from power, but failed to eliminate them at Tora Bora. After the US shifted their attention to Iraq, the Taliban have made a resurgence. Afghanistan is a more dangerous and less stable place today than it was 5 years ago.
3. Protect the American public from further terrorist attacks There have been no terrorist attacks in the U.S. since 9/11. Attacks have occurred in England & Spain. Bin Laden is nothing if not patient. After the 1st bombing of the World Trade Center, he waited 8 years until the next attack.
4. Remove Saddam Hussein from power so that he wouldn’t use his weapons of mass destruction The US invaded Iraq and removed Hussein from power, but failed to find any weapons of mass destruction. All the claims of WMD and links to 9/11 have proven to be false. We are now stuck in a never ending morass, based on a blizzard of lies.
5. Turn Iraq into a Democracy After spending $600 billion and sacrificing over 4,000 American lives, democracy is just a pipedream at this point. A civil war lasting decades is the most likely scenario.


The Bush administration has chosen to take the offensive regarding all aspects of their foreign policy. When proven wrong, they do not admit they are wrong. They either insist that they are right or change the reasons for following the same policy. This hubris and arrogance has alienated the U.S. in the world community. We are left to shoulder the full financial and manpower burden of the wars we started. It is time to realize that as the only superpower left on earth, we do not need to use force as our first response. Diplomacy, with the unspoken threat of force, will be more effective in the world we occupy today.

Why the Government Views You As Collateral Damage


Posted on 31st July 2014 by Administrator in Economy |Politics |Social Issues

The illusions, mistakes and misconceptions of central planners take their toll in a great variety of ways — mostly as costly nuisances.

Occasionally, when they are particularly ambitious, they make the history books.

Napoleon’s march on Moscow. Mao’s great famine. The Soviet Union’s 70-year economic experiment. These fiascos are caused by well-meaning, smart public officials. They are the Hell to which the road paved with good intentions leads.

The pretension of the central planner is that he knows a better future — one that he can design and bring about.

Sometimes, a mistaken public policy can be reversed or abandoned before it has done serious harm. Mostly, however, a combination of special circumstances makes correction impossible. The disastrous policies are reinforced until they finally reckon themselves out in a catastrophic way.

Large-scale planners fail because they believe three things that aren’t true.

First, that they know the exact and entire present state of the community they are planning for (wants, desires, hopes, capabilities, resources); second, that they know where the community ought to go (what future would be best); third, that they are capable of creating the future they want.

None of those things is more than an illusion. Together, they constitute what F. A. Hayek called “the fatal conceit, that man is able to shape the world around him according to his wishes.”

Full knowledge of current conditions would require an infinite amount of real information. As 19th century philosopher, Samuel Bailey, wrote in 1840, it would require “minute knowledge of a thousand particulars which will be learnt by nobody but him who has an interest in knowing them.” The planners have nothing like that. Instead, they rely on a body of popular theories, claptrap and statistical guesswork.

As to the second point — that they are blessed with some gift that tells them what the future should be — we pass over it without argument.

No one really believes that people in the United State Congress or the French National Assembly or in the bureaucracies and think tanks of these nations have anything more to guide them than anyone else. Which is to say; all they have is their own likes and dislikes, prejudices and fears, and self-serving ambitions.

Each man always does his level best to shape his world in a way that pleases him. One wants a fat wife. One wants a fortune. One wants to spend his time playing golf. Each will try to get what he wants depending upon the circumstances.

And the future will happen.

The pretension of the central planner is that he knows a better future — one that he can design and bring about. The god-like vanity of this assertion is staggering. No one really knows what future is best for humankind. People only know what they want.

I presume that the best future is the one in which people get what they want… or at the very least what they deserve. A man burning in hell may want ice cream; it doesn’t mean he will get it. But the central planner presumes to know not only what he wants, but what he should have.

It is scarcely worth mentioning, additionally, that the central planner’s hands are as empty as his head. He has no ice cream to give anyone. Where individual plans and evolution will take us collectively, no one knows. Fate will have the final say. But the central planner will have his say first, disrupting the plans of millions of people in the process.

He certainly has no ‘amor fati’ … a faith in, and an affection for, Fate. It would put him out of business.

Instead, he steps in to impose his own version of the future. And as soon as the smallest bit of time and resources are shanghaied for his ends rather than those of individual planners, the rate of natural, evolutionary progress slows. That is, the millions of private trials that would have otherwise taken place are postponed or canceled. The errors that might have been revealed and corrected are not discovered. The future has to wait.

Even when they are applied with ruthless thoroughness, central plans inevitably and eventually go FUBAR. No ‘workers’ paradise’ ever happens. The War on Drugs (or Poverty… or Crime… or Terror… or Cancer) ends in a defeat, not a victory. Unemployment does not go down. The ‘war to end war’ doesn’t end war. The Domino Theory falls; the dominoes don’t.

Or, if any of these grand programs ‘succeeds,’ it does so by undoing previous plans often at a cost that is far out of balance with the reward. World War II is an example of central planning that seemed to work. But the Allies were merely nullifying the efforts of more ambitious central planners in Germany and Japan.

Generally, life on planet Earth is not so ‘rational’ that it lends itself to simpleminded, heavy-handed intervention by the naïve social engineer.

Sure, we can design bridges. Houses too. And particle accelerators. But we cannot design economies. No more than we can invent real languages. Societies. Customs. Markets. Love. Marriages. Children. Or any of the other important things in life.

Large-scale central planning can be effective, but only by pulverizing the delicate fabric of evolved civilized life.

Not to overstate the case, however, it is also true that humans can design and achieve a certain kind of future. If the planners at the Pentagon, for example, decided that a nuclear war would be a good thing, they could bring it about. The effects would be huge. And hugely effective.

This extreme example reveals the only kind of alternative future that the planners are capable of delivering.

Large-scale central planning can be effective, but only by pulverizing the delicate fabric of evolved civilized life. It is a future that practically no one wants, because it means destroying the many different futures already in the works — marriages, businesses, babies, baptisms, hunting trips, shopping, investment, and all the other activities of normal life.

Not all central planning produces calamities on that scale, of course. But all, to the extent they are effective, are repulsive. The more they achieve the planners’ goals, the more they interfere with private goals, and the more they retard or destroy the progress of the human race.

Still, this view I am putting forth is hardly accepted wisdom.

Most people would dispute that it is wisdom at all. It is a minority view, held by such a small group that all of its members together could be soused with a single bottle of good whiskey.


Bill Bonner
for The Daily Reckoning

Ed. Note: In today’s issue of The Daily Reckoning readers saw a chance to grab a copy of Bill’s new book before it is available on Amazon or anywhere else. Just a small part of being a reader of the FREE Daily Reckoning email edition. Click here to sign up right now and never miss another great opportunity like this.

Me, Derbyshire, and Darwin


Posted on 29th July 2014 by Administrator in Economy |Politics |Social Issues

Guest Post by Fred Reed

An Excavation

July 28, 2014

Over the years I have occasionally expressed doubts over the tenets of evolutionism which, perhaps wrongly, has seemed to me a sort of political correctness of science, or maybe a metaphysics somewhat related to science. As a consequence I have been severely reprehended. The editor of a site devoted to genetic expression furiously began deleting any mention of me from his readers. Others, to include Mr. John Derbyshire of Taki’s Magazine, have expressed disdain, though disdaining to explain just why.

In all of this, my inability to get straight answers that do not shift has frustrated me. I decided to address my questions to an expert in the field, preferably one who loathed me and thus might produce his best arguments so as to stick it to me. To this end I have settled on Mr. Derbyshire.

He has the several advantages of being highly intelligent, an excellent writer, ardent of all things evolutionary and genetic, and well versed in them. I would profit by his instruction in things in which I am only an amateur—should he be so inclined. (He may well have other things to do.) To this end, I submit a few questions which have strained my admittedly paltry understanding for some time. They are not new questions, but could use answers. I agree in advance to accept his answers (if any be given) as canonical.

(1) In evolutionary principle, traits that lead to more surviving children proliferate. In practice, when people learn how to have fewer or no children, they do. Whole industries exist to provide condoms, diaphragms, IUDs, vasectomies, and abortions, attesting to great enthusiasm for non-reproduction. Many advanced countries are declining in population.   How does having fewer surviving children lead to having more surviving children? Less cutely, what selective pressures lead to a desire not to reproduce, and how does this fit into a Darwinian framework?

Two notes: (1) The answer cannot rely on contraception, which is not a force imposed from outside. Just as people invented spears because they wanted to kill food and each other, they invented condoms because they wanted not to have children. The question is how that desire evolved. (2) The non-evolutionary explanation is clear and simple. “We could have two children and a nice condo, or fifteen and live in a shack.”

(2) Morality. In evolution as I understand it, there are no absolute moral values: Morals evolved as traits allowing social cooperation, conducing to the survival of the group and therefore to the production of more surviving children. The philosophical case for this absence of absolutes usually consists in pointing out that in various societies everything currently regarded as immoral has been accepted as acceptable (e.g., burning heretics to death).

I cannot refute the argument. However, I think it intellectually disreputable to posit premises and then not accept their consequences.

Question: Why should I not indulge my hobby of torturing to death the severely genetically retarded? This would seem beneficial. We certainly don’t want them to reproduce, they use resources better invested in healthy children, and it makes no evolutionary difference whether they die quietly or screaming.

(3) Abiogenesis. This is not going to be a fair question as there is no way anyone can know the answer, but I pose it anyway. The theory, which I cannot refute, is that a living, metabolizing, reproducing gadget formed accidentally in the ancient seas. Perhaps it did. I wasn’t there. It seems to me, though, that the more complex one postulates the First Critter to have been, the less likely, probably exponentially so, it would have been to form. The less complex one postulates it to have been, the harder to explain why biochemistry, which these days is highly sophisticated, cannot reproduce the event. Question: How many years would have to pass without replication of the event, if indeed it be not replicated, before one might begin to suspect that it didn’t happen? For all I know, it may be accomplished tomorrow. But the check cannot be in the mail forever.

(4) You can’t get there from here. Straight-line evolution, for example in which Eohippus gradually gets larger until it reaches Clydesdale, is plausible because each intervening step is a viable animal. In fact this is just selective breeding. Yet many evolutionary transformations seem to require intermediate stages that could not survive.

For example there are two-cycle bugs (insects, arachnids) that lay eggs that hatch into tiny replicas of the adults, which grow, lay eggs, and repeat the cycle. The four-cycle bugs go through egg, larva, pupa, adult. Question: What are the viable steps needed to evolve from one to the other? Or from anything to four-cycle?

Here I am baffled. As best I can see, the eggs of the two-cycler would have to evolve toward being caterpillars, which are enormously different structurally and otherwise from adults. Goodbye legs, chitinous exoskeleton; head, thorax, and abdomen, on and on. Whatever the first mutation toward this end, the resulting newly-hatched mutant would have to be viable—able to live and reproduce until the next mutation occurred.

It is difficult to see how the evolution from insect to caterpillar could occur at all, or why. But if it did, it would lead to a free-standing race of caterpillars, a new species, necessarily being able to reproduce. Then, for reasons mysterious to me, these would have to decide to pupate and become butterflies. Metamorphosis from caterpillar to butterfly is enormously complex and if you don’t get it right the first time, it’s curtains. Where would it have gotten the impossibly complex genetic blueprint of the butterfly?

Among intellectual loin-cloth-wearers like me, there seems no answer. I do not doubt that Mr. Derbyshire can provide one. Upon receiving same, I promise to shut up.

(5) You can’t get anywhere else from here. Mr. Derbyshire believes strongly in genetic determinism—that we are what we are and behave as we do because of genetic programming. I see no flaw in this. From the baby’s suckling through walking and talking, the adolescent’s omniscience, making love and war, and cooling off with age things seem undeniably genetic.

Behavior less obviously biological also seems built-in. Political orientation, for example.  Note that conservatives usually see the world as dangerous and life as struggle; to have intense loyalty to the pack (patriotism), to reverence the military, to feel empathy for members of their tribe (our fallen heroes, etc.) and none at all for enemy dead; to favor capitalism; and to be hostile to or disdainful of other racial and ethnic groups. That these traits tend strongly to appear together though they are logically independent suggests a genetic basis.

In his book, We Are Doomed, Mr. Derbyshire describes the brain, correctly as far as I can tell, as an electrochemical mechanism, and somewhat delicately hints at chemical determinism in that organ. I see no way of avoiding this conclusion.

But again, does one not have to accept the consequences of one’s suppositions? A physical (to include chemical) system cannot make decisions. All subsequent states of a physical system are determined by the initial state. So, if one accepts the electrochemical premise (which, again, seems to be correct) it follows that we do not believe things because they are true, but because we are predestined to believe them. Question: Does not genetic determinism (with which I have no disagreement) lead toa  paradox: that the thoughts we think we are thinking we only think to be thoughts when they are really utterly predetermined by the inexorable working of physics and chemistry?

(That was fun. I recall Samuel Johnson’s remark on the existence of free will: All theory is against it, but all experience is for it.)

(6) The evolutionary noise level. In principle, traits spread through a population because they lead to the having of greater numbers of children. Consider the epicanthic fold, the flap that makes the eyes of East Asians seem slanted. In evolutionary writings this is often described as an adaptation either to save energy or to protect the eyes from icy winds. We will here assume that actual studies have shown that it actually does so.

I do not understand how the fold evolved.

Unless it results from a point mutation, (and I do not think it does), it must have evolved gradually. This means, does it not, that even a partial fold conferred so great an advantage in survival that the possessor had more children than their unfolded relatives.

Being as I am untutored in these matters, the idea seems ludicrous. Did the eyes of the unfolded freeze, leaving the Folded One to get all the girls? Did the folded conserve so much energy that they could copulate more vigorously?

While grounds can doubtless be found for dismissing the example of the epicanthic fold, countless instances exist of traits that become universal or nearly so while lacking any plausible connection to greater fecundity.

Here I sink into a veritable La Brea of incomprehension.  Genes already exist in populations for extraordinary superiority of many sorts—for the intelligence of Stephen Hawking, the body of Mohammed Ali, for 20/5 vision, for the astonishing endurance in running of the Tarahumara Indians, and so on. To my unschooled understanding, these traits offer clear and substantial advantage in survival and reproduction, yet they do not become universal, or even common. The epicanthic fold does. Question: Why do seemingly trivial traits proliferate while clearly important ones do not?

(7) The universality of the unnecessary. Looking at the human body, I see many things that appear to have no relation to survival or more vigorous reproduction, and that indeed work against it, yet are universal in the species. For example, the kidneys contain the nervous tissue that makes kidney stones agonizingly painful, yet until recently the victim has been able to do nothing about them. Migraine headaches are paralyzing, and would appear to convey little advantage in having more children. (“No, honey, I have a violent headache….”)

Sensing pain clearly has evolutionary advantages. If you fall on your head, it hurts, so you are careful not to, and thus survive and have more children (though frankly I have sometimes thought that it might be better to fall on one’s head). Wounds are painful, so you baby them, letting them heal. But, Question: What is the reproductive advantage of crippling pain (migraines can be crippling) about which pre-recently, the sufferer could do nothing?

(8) Finally, the supernatural. Unfairly, as it turned out, in regard to religion I had expected Mr. Derbyshire to strike the standard “Look at me, I’m an atheist, how advanced I am” pose. I was wrong. In fact he says that he believes in a God. (Asked directly, he responded, “Yes, to my own satisfaction, though not necessarily to yours.”) His views are reasoned, intellectually modest, and, though I am not a believer, I see nothing with which to quarrel, though for present purposes this is neither here nor there. Question: If one believes in or suspects the existence of God or gods, how does one exclude the possibility that He, She, or It meddles in the universe—directing evolution, for example?

A belief in gods would seem to leave the door open to Intelligent Design, the belief that the intricacies of life came about not by accident but were crafted by Somebody or Something. The view, anathema in evolutionary circle, is usually regarded as emanating from Christianity, and usually does.

Though this column is not about me or my beliefs, to head off a lot of email let me say that I am not remotely a Christian but a thoroughgoing agnostic, more so it seems than Mr. Derbyshire, and my suspicions regarding Intelligent Design—suspicions is all they are—are not deductions from Christianity but inferences from observation. To my eye, the damned place looks designed. By what, I am clueless.

To close, I ask these questions in a spirit of inquiry, not of ideological warfare. Mr. Derbyshire is far deeper in these matters than I, who can barely distinguish a phosphodiester bond from a single-nucleotide polymorphism. All I seek are clear, straightforward, unambiguous answers devoid of the evasion I have so often encountered. I do not doubt that he can help me if so inclined.



Posted on 28th July 2014 by Administrator in Economy |Politics |Social Issues

, , , ,

Everyone knows the Social Security Disability program is racked with fraud and abuse. Shyster lawyers and Obama’s minions have a program made in heaven. Just fake a back injury or eat yourself to 300 pounds of hoveround level diabetes and you’re in baby. 

Well there are consequences to every action. The SSDI fund will be depleted in 2016. That’s two years folks. I can hear the shrills from liberals, Pelosi, and the dykes on MSNBC. How could we cut the benefits of the disabled? Only evil Republicans could possibly allow it to happen. The script is already written. The feckless politicians will save the day by using funds from the SS fund to pay full benefits to the Free Shit Disabled Army.

Therefore, the depletion date of the SS fund will not be 2033 as detailed by the Trustees in the report below. The fund will deplete on or around 2028.

Guess what year I’m eligible for SS benefits?

That’s right – 2028.

No biggie. The American Empire of Debt will have collapsed before that date and none of these reports will matter anymore. That which cannot be sustained will not be sustained.


Social Security and Medicare Boards of Trustees


Each year the Trustees of the Social Security and Medicare trust funds report on the current and projected financial status of the two programs. This message summarizes the 2014 Annual Reports.

Neither Medicare nor Social Security can sustain projected long-run program costs in full under currently scheduled financing, and legislative changes are necessary to avoid disruptive consequences for beneficiaries and taxpayers. If lawmakers take action sooner rather than later, more options and more time will be available to phase in changes so that the public has adequate time to prepare. Earlier action will also help elected officials minimize adverse impacts on vulnerable populations, including lower-income workers and people already dependent on program benefits.

Social Security and Medicare together accounted for 41 percent of Federal expenditures in fiscal year 2013. The general revenue transfers into SMI and interest payments made to the trust funds are resulting in mounting pressure on the unified budget, as will the eventual decline in the level of total reserves held by the Social Security and HI Trust Funds. Both programs will experience cost growth substantially in excess of GDP growth through the mid-2030s due to rapid population aging caused by the large baby-boom generation entering retirement and lower-birth-rate generations entering employment and, in the case of Medicare, to growth in expenditures per beneficiary exceeding growth in per capita GDP. In later years, projected costs expressed as a share of GDP trend up slowly for Medicare and are relatively flat for Social Security, reflecting slower growth in per-beneficiary health care costs and very gradual population aging caused by increasing longevity.

Social Security

Social Security’s Disability Insurance (DI) program satisfies neither the Trustees’ long-range test of close actuarial balance nor their short-range test of financial adequacy and faces the most immediate financing shortfall of any of the separate trust funds. DI Trust Fund reserves expressed as a percent of annual cost (the trust fund ratio) declined to 62 percent at the beginning of 2014, and the Trustees project trust fund depletion late in 2016, the same year projected in the last Trustees Report. DI costs have exceeded non-interest income since 2005 and the trust fund ratio has declined in every year since peaking in 2003. While legislation is needed to address all of Social Security’s financial imbalances, the need has become most urgent with respect to the program’s disability insurance component. Lawmakers need to act soon to avoid automatic reductions in payments to DI beneficiaries in late 2016.

To summarize overall Social Security finances, the Trustees have traditionally emphasized the financial status of the theoretical combined trust funds for DI and for Old Age and Survivors Insurance (OASI). The combined trust funds, and expenditures that can be financed in the context of the combined trust funds, are theoretical constructs because there is no legal authority to finance one program’s expenditures with the other program’s taxes or reserves. Social Security’s total expenditures have exceeded non-interest income of its combined trust funds since 2010 and the Trustees estimate that Social Security cost will exceed non-interest income throughout the 75-year projection period. The Trustees project that this annual cash-flow deficit will average about $77 billion between 2014 and 2018 before rising steeply as income growth slows to its sustainable trend rate after the economic recovery is complete while the number of beneficiaries continues to grow at a substantially faster rate than the number of covered workers. Redemption of trust fund asset reserves from the General Fund of the Treasury will provide the resources needed to offset Social Security’s annual aggregate cash-flow deficits. Since the cash-flow deficit will be less than interest earnings through 2019, reserves of the combined trust funds will continue to grow but not by enough to prevent the ratio of reserves to one year’s projected cost (the combined trust fund ratio) from declining. (This ratio peaked in 2008, declined through 2013, and is expected to decline steadily in future years.) After 2019, Treasury will redeem trust fund asset reserves to the extent that program cost exceeds tax revenue and interest earnings until depletion of combined trust fund reserves in 2033, the same year projected in last year’s Trustees Report. Thereafter, tax income would be sufficient to pay about three-quarters of scheduled benefits through the end of the projection period in 2088.

Under current projections, the annual cost of Social Security benefits expressed as a share of workers’ taxable earnings will grow rapidly from 11.3 percent in 2007, the last pre-recession year, to roughly 17.1 percent in 2037, and will then decline slightly before slowly increasing after 2050. Costs display a slightly different pattern when expressed as a share of GDP. Program costs equaled 4.1 percent of GDP in 2007, and the Trustees project these costs will increase to 6.2 percent of GDP for 2037, then decline to about 6.0 percent of GDP by 2050, and thereafter rise slowly reaching 6.1 percent by 2088.

The projected 75-year actuarial deficit for the combined Old-Age and Survivors Insurance and Disability Insurance (OASDI) Trust Funds is 2.88 percent of taxable payroll, up from 2.72 percent projected in last year’s report. This deficit amounts to 22 percent of program non-interest income or 17 percent of program cost. A 0.06 percentage point increase in the OASDI actuarial deficit would have been expected if nothing had changed other than the one-year extension of the valuation period to 2088. The effects of recently enacted legislation, updated demographic and economic data, and improved methodologies on net worsened the actuarial deficit by 0.10 percent of taxable payroll.

While the theoretical combined OASDI Trust Fund fails the long-range test of close actuarial balance, it does satisfy the test for short-range (10-year) financial adequacy. The Trustees project that the combined trust fund asset reserves at he beginning of each year will exceed that year’s projected cost through 2027.


The Trustees project that the Medicare Hospital Insurance (HI) Trust Fund will be the next to face depletion after the DI Trust Fund. The projected date of HI Trust Fund depletion is 2030, four years later than projected in last year’s report. At that time dedicated revenues will be sufficient to pay 85 percent of HI costs. The Trustees project that the share of HI cost that can be financed with HI dedicated revenues will decline slowly to 75 percent in 2047, and will then stay about flat. HI non-interest income less HI expenditures is projected to be negative this year (as it has been in every year since 2008), and then turn positive for six years (2015-2020) before turning negative again in 2021.

The projected HI Trust Fund’s long-term actuarial imbalance is smaller than that of the combined Social Security trust funds under the assumptions employed in this report. The estimated 75-year actuarial deficit in the HI Trust Fund is 0.87 percent of taxable payroll, down from 1.11 percent projected in last year’s report. The HI fund again fails the test of short-range financial adequacy, as its trust fund ratio is already below 100 percent and is expected to decline continuously until reserve depletion in 2030. The fund also continues to fail the long-range test of close actuarial balance. The HI 75-year actuarial imbalance amounts to 23 percent of tax receipts or 19 percent of program cost.

The improvement in the outlook for HI long-term finances is principally due to lower-than-expected spending in 2013 for most HI service categories, which reduced the base period expenditure level about 1.5 percent and contributed to the Trustees’ decision to reduce projected near-term spending growth trends. Taken together, these changes lowered the actuarial deficit by about 0.29 percent of taxable payroll. Other changes resulted in an increase in the actuarial deficit of 0.05 percent.

Unlike in past years, the Medicare Part B cost projection featured in this report and summarized below (the “projected baseline”) assumes that reductions in Medicare payment rates for physician services called for by the Sustainable Growth Rate (SGR) formula will be overridden in the future as they have been from January 2003 through March 2015. Specifically, the projected baseline assumes that physician payment rates will remain at their current levels through the end of 2015, and will then rise at the same rate currently slated for the 10-year period ending March 31, 2015 (0.6 percent annually) through 2023. Relative to the current-law projection featured in the 2013 report, this change in the conceptual basis for the baseline projection raises the growth rate of projected Part B costs by about 0.3 percentage points on average over the next 75 years. While legislation overriding physician fee reductions has in recent years included provisions offsetting the 10-year cost of the overrides, the division of those offsets between Medicare savings and savings in other parts of the budget has varied. Because it is difficult to anticipate the extent to which policy makers will finance future overrides with other Medicare savings, the Medicare projected baseline does not include any offsets. This projection represents neither a legislative prediction nor a policy recommendation by the Trustees.

The Trustees project that Part B of Supplementary Medical Insurance (SMI), which pays doctors’ bills and other outpatient expenses, and Part D of SMI, which provides access to prescription drug coverage, will remain adequately financed into the indefinite future because current law automatically provides financing each year to meet the next year’s expected costs. However, the aging population and rising health care costs cause SMI projected costs to grow steadily from 1.9 percent of GDP in 2013 to approximately 3.3 percent of GDP in 2035, and then more slowly to 4.5 percent of GDP by 2088. General revenues will finance roughly three-quarters of these costs, and premiums paid by beneficiaries almost all of the remaining quarter. SMI also receives a small amount of financing from special payments by States and from fees on manufacturers and importers of brand-name prescription drugs.

The Trustees project that total Medicare costs (including both HI and SMI expenditures) will grow from approximately 3.5 percent of GDP in 2013 to 5.3 percent of GDP by 2035 and will increase gradually thereafter to about 6.9 percent of GDP by 2088.

In recent years U.S. national health expenditure (NHE) growth has slowed relative to historical patterns. There is uncertainty regarding the extent to which this slowdown in the rate of cost growth reflects one-time effects of the recent economic downturn and other non-persistent factors or structural changes in the health care sector that may produce additional cost savings in the years ahead. The Trustees are hopeful that U.S. health care practices are in the process of becoming more efficient as providers anticipate a future in which the rapid cost growth rates of previous decades, in both the public and private sectors, do not return. Indeed, the Trustees have revised down their projections for near-term Medicare expenditure growth in response to the recent favorable experience. In addition, the methodology for projecting Medicare finances had already assumed a substantial long-term reduction in per capita health expenditure growth rates relative to historical experience, to which the Affordable Care Act’s cost-reduction provisions would add substantial further savings. Notwithstanding recent favorable developments, both the projected baseline and current law projections indicate that Medicare still faces a substantial financial shortfall that will need to be addressed with further legislation. Such legislation should be enacted sooner rather than later to minimize the impact on beneficiaries, providers, and taxpayers.


Lawmakers should address the financial challenges facing Social Security and Medicare as soon as possible. Taking action sooner rather than later will leave more options and more time available to phase in changes so that the public has adequate time to prepare.

By the Trustees:

Jacob J. Lew,
Secretary of the Treasury,
and Managing Trustee
of the Trust Funds.

Sylvia M. Burwell,
Secretary of Health
and Human Services,
and Trustee.

Charles P. Blahous III,
Thomas E. Perez,
Secretary of Labor,
and Trustee.
Carolyn W. Colvin,
Acting Commissioner of
Social Security,
and Trustee.

Robert D. Reischauer,


The most immediate financing challenge facing any of the trust funds is the projected depletion of the Social Security Disability Insurance (DI) Trust Fund in late 2016. For Social Security as a whole as well as Medicare, projected long-range costs are not sustainable with currently scheduled financing and will require legislative action to avoid disruptive consequences for beneficiaries and taxpayers. If lawmakers act sooner rather than later, they can consider a wider array of options and more time will be available to phase in the changes, giving the public adequate time to prepare. Earlier action would also provide more opportunity to ameliorate any adverse impacts on vulnerable populations, including lower-income workers and people already significantly dependent on program benefits.

What Are the Trust Funds? Congress established trust funds managed by the Secretary of the Treasury to account for Social Security and Medicare income and disbursements. The Treasury credits Social Security and Medicare taxes, premiums, and other income to the funds. There are four separate trust funds. For Social Security, the Old-Age and Survivors Insurance (OASI) Trust Fund pays retirement and survivors benefits and the DI Trust Fund pays disability benefits. (OASDI is the designation for the two trust funds when they are considered on a theoretical combined basis.) For Medicare, the Hospital Insurance (HI) Trust Fund pays for inpatient hospital and related care. The Supplementary Medical Insurance (SMI) Trust Fund comprises two separate accounts: Part B, which pays for physician and outpatient services, and Part D, which covers the prescription drug benefit. In 2013, 47.0 million people received OASI benefits, 11.0 million received DI benefits, and 52.3 million were covered under Medicare.

The only disbursements permitted from the funds are benefit payments and administrative costs. Federal law requires that all excess funds be invested in interest-bearing securities backed by the full faith and credit of the United States. The Department of the Treasury currently invests all program revenues in special non-marketable securities of the U.S. Government which earn a market rate of interest. The balances in the trust funds, which represent the accumulated value, including interest, of all prior program annual surpluses and deficits, provide automatic authority to pay benefits.

What Were the Trust Fund Results in 2013? A summary of trust fund operations is shown in the following table. The OASI and SMI Trust Funds showed a net increase in asset reserves in 2013; reserves in the DI and HI Trust Funds declined.

Table 1. Trust Fund Operations
(in billions)
Reserves (end of 2012) $2,609.7 $122.7 $220.4 $67.2
Income during 2013 743.8 111.2 251.1 324.6
Cost during 2013 679.5 143.4 266.2 316.7
    Net change in Reserves 64.3 -32.2 -15.0 7.9
Reserves (end of 2013) 2,674.0 90.4 205.4 75.1

Note: Totals do not necessarily equal the sum of rounded components.
The following table shows payments, by category, from each trust fund in 2013.

Table 2. Program Cost
(in billions)
Category (in billions) OASI DI HI SMI
Benefit payments $672.1 $140.1 $261.9 $313.1
Railroad Retirement financial interchange 3.9 0.6
Administrative expenses 3.4 2.8 4.3 3.7
Total 679.5 143.4 266.2 316.7

Note: Totals do not necessarily equal the sum of rounded components.
Trust fund income, by source, in 2013 is shown below.

Table 3. Program Income
(in billions)
Source (in billions) OASI DI HI SMI
Payroll taxes $620.8 $105.4 $220.8
Taxes on OASDI benefits 20.7 0.4 14.3
Beneficiary premiums 3.4 $73.3
Transfers from States 8.8
General Fund reimbursements 4.2 0.7 0.9 4.3
General revenues $232.5
Interest earnings 98.1 4.7 9.3 2.4
Other 2.4 3.7
Total 743.8 111.2 251.1 324.6

Note: Totals do not necessarily equal the sum of rounded components.

In 2013, Social Security’s cost continued to exceed the combined program’s tax income and also continued to exceed its non-interest income, a situation that the Trustees project to continue throughout the long-range period (2014-88) and beyond. The 2013 deficit of tax income (Table 3, first two lines) relative to cost was $76 billion.

In 2013, the HI fund used $9 billion of interest income (Table 3) and $15 billion of asset reserves (Table 1) to finance expenditures beyond those that could have been made solely on the basis of tax and premium income. For SMI, transfers from the General Fund of the Treasury, which are set prospectively based on projected costs, represent the largest source of income. Part B spending was lower than anticipated in 2013 resulting in an $8 billion increase in account asset reserves (Table 1).

What is the Outlook for Future Social Security and Medicare Costs in Relation to GDP? One instructive way to view the projected costs of Social Security and Medicare is to compare the costs of scheduled benefits and administrative costs for the programs with the gross domestic product (GDP), the most frequently used measure of the total output of the U.S. economy (Chart A). Under the intermediate assumptions employed in the reports and throughout this Summary, costs for the programs increase substantially through 2035 when measured this way because: (1) the number of beneficiaries rises rapidly as the baby-boom generation retires; and (2) the lower birth rates that have persisted since the baby boom cause slower growth of the labor force and GDP. Social Security’s projected annual cost increases to about 6.2 percent of GDP by 2035, declines to 6.0 percent by 2050, and remains between 6.0 and 6.1 percent of GDP through 2088. Under the projected baseline,, 1 Medicare cost rises to 5.4 percent of GDP by 2035, largely due to the rapid growth in the number of beneficiaries, and then to 6.9 percent in 2088, with growth in health care cost per beneficiary becoming the larger factor later in the valuation period.

In 2013, the combined cost of the Social Security and Medicare programs equaled 8.4 percent of GDP. The Trustees project an increase to 11.5 percent of GDP in 2035 and 13.0 percent of GDP by 2088. Although Medicare cost (3.5 percent of GDP) was smaller than Social Security cost (4.9 percent of GDP) in 2013, the gap closes gradually until 2052, when Medicare is projected to be the more costly program. During the final decade of the long-range projection period, Medicare is about 12 percent more costly than Social Security.


Chart A—Social Security and Medicare Cost as a Percentage of GDP
click on graph for underlying data


The projected costs for OASDI and HI depicted in Chart A and elsewhere in this document reflect the full cost of scheduled current-law benefits without regard to whether the trust funds will have sufficient resources to meet these obligations. Current law precludes payment of any benefits beyond the amount that can be financed by the trust funds, that is, from annual income and trust fund reserves. In years after trust fund depletion, the amount of benefits that would be payable is lower than shown, as described later in this summary, because benefit cost exceeds annual income. In addition, the projected costs assume realization of the full estimated savings of the Affordable Care Act. As described in the Medicare Trustees Report, the projections for HI and SMI Part B depend significantly on the sustained effectiveness of various current-law cost-saving measures—in particular, the lower increases in Medicare payment rates to most categories of health care providers—and assume that SGR physician payment reductions scheduled under current law will be overridden.

What is the Outlook for Future Social Security and Medicare HI Costs and Income in Relation to Taxable Earnings? Since the primary source of income for OASDI and HI is the payroll tax, it is informative to express the programs’ incomes and costs as percentages of taxable payroll—that is, of the base of worker earnings taxed to support each program (Chart B). Both the OASDI and HI annual cost rates rise over the long run from their 2013 levels (13.97 and 3.55 percent). Projected Social Security cost grows to 17.14 percent of taxable payroll by 2037, declines to 16.89 percent in 2050, and then rises gradually to 18.19 percent in 2088. The projected Medicare HI cost rate rises to 5.11 percent of taxable payroll in 2050, and thereafter increases to 5.56 percent in 2088. HI taxable payroll is almost 25 percent larger than that of OASDI because the HI payroll tax is imposed on all earnings while OASDI taxes apply only to earnings up to an annual maximum ($117,000 in 2014).

The OASDI income rate—which includes scheduled payroll taxes at the current 12.4 percent level, taxes on benefits, and any other transfers of revenues to the trust funds excepting interest payments—was 12.77 percent in 2013 and increases slowly over time, reaching 13.29 percent in 2088. Annual income from the taxation of OASDI benefits will increase radually relative to taxable payroll as a greater proportion of Social Security benefits is subject to taxation in future years, but will continue to be a relatively small component of program income.


Chart B—OASDI and HI Income and Cost as a Percentage of Taxable Payroll
click on graph for underlying data


The HI income rate—which includes payroll taxes and taxes on OASDI benefits, but excludes interest payments—rises gradually from 3.28 percent in 2013 to 4.29 percent in 2088 due to the Affordable Care Act’s increase in payroll tax rates for high earners that began in 2013. Individual tax return filers with earnings above $200,000, and joint return filers with earnings above $250,000, pay an additional 0.9 percent tax on earnings above these earnings thresholds. An increasing fraction of all earnings will be subject to the higher tax rate over time because the thresholds are not indexed.

How Will Cost Growth in the Different Parts of Medicare Change the Sources of Program Financing? As Medicare cost grows over time, general revenue and beneficiary premiums will play an increasing role in financing the program. Chart C shows scheduled cost and non-interest revenue sources under the projected baseline for HI and SMI combined as a percentage of GDP. The total cost line is the same as displayed in Chart A and shows Medicare cost rising to 6.9 percent of GDP by 2088.


Chart C—Medicare Cost and Non-Interest Income by Source as a Percentage of GDP
click on graph for underlying data


Projected revenue from payroll taxes and taxes on OASDI benefits credited to the HI Trust Fund increases from 1.4 percent of GDP in 2014 to 1.8 percent in 2088 under the projected baseline, while projected general revenue transfers to the SMI Trust Fund increase from 1.4 percent of GDP in 2014 to 3.3 percent in 2088, and beneficiary premiums increase from 0.5 to 1.2 percent of GDP. The share of total non-interest Medicare income from taxes falls substantially (from 41 percent to 28 percent) while general revenue transfers rises (from 43 to 52 percent), as does the share of premiums (from 14 percent to 18 percent). The distribution of financing changes in part because in Parts B and D—the Medicare components that are financed largely from general revenues—costs increase at a faster rate than Part A cost under the Trustees’ projections. By 2088, the projected HI deficit represents 0.5 percent of GDP and there is no provision under current law to finance that shortfall through general revenue transfers or any other revenue source.

The Medicare Modernization Act (2003) requires that the Board of Trustees determine each year whether the annual difference between program cost and dedicated revenues (the bottom four layers of Chart C) under current law exceeds 45 percent of total Medicare cost in any of the first seven fiscal years of the 75-year projection period, in which case the annual Trustees Report must include a determination of “excess general revenue Medicare funding.” The Trustees made that determination every year from 2006 through 2013, but because the difference between program cost and dedicated revenues is not expected to exceed the 45 percent threshold during fiscal years 2014-20, there is no such determination in this year’s report.

What are the Budgetary Implications of Rising Social Security and Medicare Costs? Concern about the long-range financial outlook for Medicare and Social Security often focuses on the depletion dates for the HI and OASDI trust funds—the times when the projected trust fund balances under current law will be insufficient to pay the full amounts of scheduled benefits. A more immediate issue is the effect the programs have on the unified Federal budget prior to depletion of the trust funds.

Chart D shows the excess of scheduled costs over dedicated tax and premium income for the OASDI, HI, and SMI trust funds expressed as percentages of GDP. Each of these trust funds’ operations will contribute increasing amounts to Federal unified budget deficits in future years. General revenues pay for roughly 75 percent of all SMI costs. Until 2030, interest earnings and asset redemptions, financed from general revenues, will cover the shortfall of HI tax and premium revenues relative to expenditures. In addition, general revenues must cover similar payments as a result of growing OASDI deficits through 2033.2

In 2014, the projected difference between Social Security’s expenditures and dedicated tax income is $80 billion. For HI, the projected difference between expenditures and dedicated tax and premium income is $25 billion. 3 The projected general revenue demands of SMI are $248 billion. Thus, the total General Fund requirements for Social Security and Medicare in 2014 are $352 billion, or 2.0 percent of GDP. Redemption of trust fund bonds, interest paid on those bonds, and transfers from the General Fund provide no new net income to the Treasury, which must finance these payments through some combination of increased taxation, reductions in other government spending, or additional borrowing from the public.


Chart D—Projected SMI General Revenue Funding
plus OASDI and HI Tax Shorfalls
[Percentage of GDP]
click on graph for underlying data


Chart D shows that the difference between cost and revenue (expressed as a percentage of GDP) from dedicated payroll taxes, income taxation of benefits, and premiums will grow rapidly through the 2030s as the babyboom generation reaches retirement age, under the assumption that scheduled benefits will be paid even in the absence of an increase in dedicated tax revenues. 4 This imbalance would result in vastly increasing pressure on the unified Federal budget, with such financing requirements equaling 4.4 percent of GDP by 2040.

What Is the Outlook for Short-Term Trust Fund Adequacy? The reports measure the short-range adequacy of the OASI, DI, and HI Trust Funds by comparing fund asset reserves at the start of a year to projected costs for the ensuing year (the “trust fund ratio”). A trust fund ratio of 100 percent or more—that is, asset reserves at least equal to projected cost for the year—is a good indicator of a fund’s short-range adequacy. That level of projected reserves for any year suggests that even if cost exceeds income, the trust fund reserves, combined with annual tax revenues, would be sufficient to pay full benefits for several years.

By this measure, the OASI Trust Fund is financially adequate throughout the 2014-23 period, but the DI Trust Fund fails the short-range test because its trust fund ratio was 62 percent at the beginning of 2014, with projected depletion of all reserves in late 2016.

The HI Trust Fund also does not meet the short-range test of financial adequacy; its trust fund ratio was 76 percent at the beginning of 2014 based on the year’s anticipated expenditures, and the projected ratio does not rise to 100 percent within five years. Projected HI Trust Fund asset reserves become fully depleted in 2030. Chart E shows the trust fund ratios through 2040 under the intermediate assumptions.


Chart E—OASI, DI, and HI Trust Fund Ratios
[Asset reserves as a percentage of annual cost]
click on graph for underlying data


The Trustees apply a less stringent annual “contingency reserve” test to SMI Part B asset reserves because (i) the financing for that account is set each year to meet expected costs, and (ii) the overwhelming portion of the financing for that account consists of general revenue contributions and beneficiary premiums, which were 73 percent and 25 percent of total Part B income in calendar year 2013. Part D premiums paid by enrollees and the amounts apportioned from the General Fund of the Treasury are determined each year. Moreover, flexible appropriation authority typically established by lawmakers for Part D allows additional General Fund financing if costs are higher than anticipated, limiting the need for a contingency reserve in that account.

What Are Key Dates in OASI, DI, and HI Financing? The 2014 reports project that the DI, OASI, and HI Trust Funds will all be depleted within the next 25 years. The following table shows key dates for the respective trust funds as well as for the hypothetical combined OASDI trust funds.5


Year of peak trust fund ratiob 2011 2003 2008 2003
First year outgo exceeds income excluding interestc 2010 2005 2010 2021
First year outgo exceeds income including interestc 2022 2009 2020 2023
Year trust funds are depleted 2034 2016 2033 2030


a Column entries represent key dates for the hypothetical combined OASI and DI funds.
b Dates pertain to the post-2000 period.
c Dates indicate the first year that a condition is projected to occur and to persist annually thereafter through 2088.

DI Trust Fund asset reserves, which have been declining since 2008, are projected to be fully depleted in 2016, as reported last year. Payment of full DI benefits beyond 2016, when tax income would cover only 81 percent of scheduled benefits, will require legislation to address the financial imbalance. Lawmakers may consider responding to the impending DI Trust Fund reserve depletion, as they did in 1994, solely by reallocating the payroll tax rate between OASI and DI. Such a response might serve to delay DI reforms and much needed financial corrections for OASDI as a whole. However, enactment of a more permanent solution could include a tax reallocation in the short run.

The OASI Trust Fund, when considered separately, has a projected reserve depletion date of 2034, one year earlier than in last year’s report.

The theoretical combined OASDI trust funds have a projected depletion date of 2033, unchanged from last year’s report. After the depletion of reserves, continuing tax income would be sufficient to pay 77 percent of scheduled benefits in 2033 and 72 percent in 2088.

The OASDI reserves are projected to grow in 2014 because anticipated interest earnings ($99 billion in 2014) still substantially exceed the non-interest income deficit. This year’s report indicates that annual OASDI income, including payments of interest to the trust funds from the General Fund, will exceed annual cost every year until 2020, increasing the nominal value of combined OASDI trust fund asset reserves. The trust fund ratio (the ratio of projected reserves to annual cost) will continue to decline gradually (Chart E), as it has since 2008, despite this nominal balance increase. Beginning in 2020, net redemptions of trust fund asset reserves with General Fund payments will be required until projected depletion of these reserves in 2033.

The projected HI Trust Fund depletion date is 2030, four years later than reported last year. Under current law, scheduled HI tax and premium income would be sufficient to pay 85 percent of estimated HI cost in 2030 and 77 percent by 2088.

This report anticipates that in 2014 the HI Trust Fund’s non-interest income deficit ($22 billion) will exceed projected interest earnings ($8 billion), requiring the use of $14 billion in asset reserves. Non-interest income is projected to exceed cost for 2015 through 2020 as the economic recovery continues, followed by increasing annual shortfalls of non-interest income through the remainder of the long-range projection period.

What is the Long-Range Actuarial Balance of the OASI, DI, and HI Trust Funds? Another way to view the outlook for payroll tax-financed trust funds (OASI, DI, and HI) is to consider their actuarial balances for the 75-year valuation period. The actuarial balance measure includes the trust fund asset reserves at the beginning of the period, an ending fund balance equal to the 76th year’s costs, and projected costs and income during the valuation period, all expressed as a percentage of taxable payroll for the 75-year projection period. Actuarial balance is not an informative concept for the SMI program because Federal law sets premium increases and general revenue transfers at the levels necessary to bring SMI into annual balance.

The actuarial deficit represents the average amount of change in income or cost that is needed throughout the valuation period in order to achieve actuarial balance. The actuarial balance equals zero if cost for the period can be met for the period as a whole and trust fund asset reserves at the end of the period are equal to the following year’s cost. The OASI, DI, and HI Trust Funds all have long-range actuarial deficits under the intermediate assumptions, as shown in the following table.

(As a percentage of taxable payroll)
Actuarial deficit 2.55 0.33 2.88 0.87

The Trustees project that the annual deficits for Social Security as a whole, expressed as the difference between the cost rate and income rate for a particular year, will decline from 1.29 percent of taxable payroll in 2014 to 1.06 percent in 2017 before increasing steadily to 3.95 percent in 2037. Annual deficits then decline slightly through 2050 before resuming an upward trajectory and reaching 4.90 percent in 2088 (Chart B). The relatively large annual variations in deficits indicate that a single tax rate increase for all years starting in 2014 sufficient to achieve actuarial balance would result in sizable annual surpluses early in the period followed by increasing deficits in later years. Sustained solvency would require payroll tax rate increases or benefit reductions (or a combination thereof) by the end of the period that are substantially larger than those needed on average for this report’s long-range period (2014-88).

The Trustees project that the HI cost rate will exceed the income rate in 2014 by 0.11 percent of taxable payroll, followed by a period of small tax-income surpluses in 2015 through 2021. Deficits subsequently re-emerge to grow rapidly with the aging of the baby boom population through about 2045, when the annual deficit reaches 1.23 percent of taxable payroll. After 2050, the annual deficits level off through 2088 at approximately 1.30 percent of taxable payroll.

The financial outlooks for both OASDI and HI depend on a number of demographic and economic assumptions. Nevertheless, the actuarial deficit in each of these programs is large enough that averting trust fund depletion under current-law financing is extremely unlikely. An analysis that allows plausible random variations around the intermediate assumptions employed in the report indicates that OASDI trust fund depletion is highly probable by mid-century.

How Has the Financial Outlook for Social Security and Medicare Changed Since Last Year? Under the intermediate assumptions, the combined OASDI trust funds have a projected 75-year actuarial deficit equal to 2.88 percent of taxable payroll, 0.16 percentage point larger than last year’s estimate. The anticipated depletion date for the theoretical combined asset reserves remains 2033. The actuarial deficit increased by about 0.06 percent of payroll due to advancing the valuation date by one year and including the year 2088. The remaining increase in the deficit is due primarily to changes in methods, assumptions, and starting values.

Medicare’s HI Trust Fund has a long-range actuarial deficit equal to 0.87 percent of taxable payroll under the intermediate assumptions, 0.24 percentage point smaller than reported last year. This improvement is primarily due to lower projected spending for most HI service categories—especially for inpatient hospitals—that reflects lower-than-expected spending in the projection base year (2013) and other recent data, lower utilization assumptions for inpatient hospitals, and lower case mix assumptions for skilled nursing facilities and home health agencies. The projected date of depletion of the HI Trust Fund is now 2030, four years later than reported last year.

How Are Social Security and Medicare Financed? For OASDI and HI, the major source of financing is payroll taxes on earnings paid by employees and their employers. Self-employed workers pay the equivalent of the combined employer and employee tax rates. During 2013, an estimated 163 million people had earnings covered by Social Security and paid payroll taxes; for Medicare the corresponding figure was 167 million. Current law establishes payroll tax rates for OASDI, which apply to earnings up to an annual maximum ($117,000 in 2014) that ordinarily increases with the growth in the nationwide average wage. In contrast to OASDI, covered workers pay HI taxes on total earnings. The scheduled payroll tax rates (in percent) for 2014 are:

Employees 5.30 0.90 6.20 1.45 7.65
Employers 5.30 0.90 6.20 1.45 7.65
Combined total 10.60 1.80 12.40 2.90 15.30

The Affordable Care Act applies an additional HI tax equal to 0.9 percent of earnings over $200,000 for individual tax return filers, and on earnings over $250,000 for joint return filers.

Payments from the General Fund currently finance about 75 percent of SMI Part B and Part D costs, with most of the remaining costs covered by monthly premiums charged to enrollees or in the case of low-income beneficiaries, paid on their behalf by Medicaid for Part B and Medicare for Part D. Part B and Part D premium amounts are determined by methods defined in law and increase as the estimated costs of those programs rise.

In 2014, the Part B standard monthly premium is $104.90. There are also income-related premium surcharges for Part B beneficiaries whose modified adjusted gross income exceeds a specified threshold. In 2014 through 2019, the threshold is $85,000 for individual tax return filers and $170,000 for joint return filers. Income-related premiums range from $146.90 to $335.70 per month in 2014.

In 2014, the Part D “base monthly premium” is $32.42. Actual premium amounts charged to Part D beneficiaries depend on the specific plan they have selected and average around $31 for standard coverage. Part D enrollees with incomes exceeding the thresholds established for Part B must pay income-related monthly adjustment amounts in addition to their normal plan premium. For 2014, the adjustments range from $12.10 to $69.30 per month. Part D also receives payments from States that partially compensate for the Federal assumption of Medicaid responsibilities for prescription drug costs for individuals eligible for both Medicare and Medicaid. In 2014, State payments will cover about 10 percent of Part D costs.

Who Are the Trustees? There are six Trustees, four of whom serve by virtue of their positions in the Federal Government: the Secretary of the Treasury, the Secretary of Labor, the Secretary of Health and Human Services, and the Commissioner of Social Security. The other two Trustees are public representatives appointed by the President and confirmed by the Senate: Charles P. Blahous III, Research Fellow at the Hoover Institution and Senior Research Fellow at the Mercatus Center, and Robert D. Reischauer, President Emeritus and Distinguished Fellow of the Urban Institute.

1 Recent Medicare Trustees Reports featured current-law projected costs which incorporated scheduled reductions in physician payment rates under the sustainable growth rate (SGR) formula. The reports noted that those reductions were unlikely to occur and warned readers that, therefore, projected costs for Part B were probably understated. This year’s report (and this Summary) gives primary emphasis to the projected baseline, in which it is assumed that SGR reductions are overridden by Congress, as has occurred in every year since 2003.
2 As noted earlier in this summary, if trust fund depletion actually occurred as projected for HI in 2030 and for OASDI in 2033, each program could pay benefits thereafter only up to the amount of continuing dedicated revenues. Chart D, by contrast, compares dedicated sources of tax and premium income with the full cost of paying scheduled benefits under each program. In practice, lawmakers have never allowed the asset reserves of the Social Security or Medicare HI trust funds to become depleted.
3 This difference is projected on a cash rather than the incurred expenditures basis applied elsewhere in the long-range projections, except where explicitly noted otherwise.
4 As previously noted, this scenario would require a change in law to allow for the timely payment of all scheduled benefits upon trust fund depletion.
5 HI results in this section of the Summary are on a cash rather than the incurred expenditures basis.


For the past several years, the annual Trustees Reports have warned lawmakers and the public of the financing shortfalls facing the Social Security and Medicare programs, emphasizing that continued delay in legislating corrective measures is likely to make the challenge ever more difficult to resolve and result in undesirable consequences. Notwithstanding the enactment of the Affordable Care Act (ACA) in 2010 and the recent slowdown in the growth of national health expenditure (NHE) and Medicare spending, further legislative changes will be required to ensure Medicare’s financial sustainability. While Social Security has not been the object of significant financing reforms since 1983, its need for additional measures has been recognized for over two decades. Now, in the middle of the second decade of the 21st century, the adverse consequences of delaying necessary corrections in both programs are beginning to be realized. The most immediate financing threat facing either program is the impending depletion of Social Security Disability Insurance (DI) Trust Fund reserves in late 2016. This is the closest that any of the separate trust funds has come to depletion in over two decades. The major component of the solution to the last reserve depletion crisis, enacted in 1994, was to reallocate payroll taxes from the Old-Age and Survivors Insurance (OASI) Trust Fund to the DI Trust Fund. This response reflected the fact that, at that time, the DI Trust Fund faced both a more immediate and relatively larger shortfall than did the OASI Trust Fund.

The present situation is very different from that of 1994. While there are administrative issues and policy concerns unique to DI, the DI fund’s currently projected depletion is, to a great extent, related to financing pressures that afflict both the OASI and DI Trust Funds. Of the two funds, OASI faces the larger long-term imbalance between income and obligations. The earlier depletion date of the DI Trust Fund’s reserves largely reflects the fact that the baby boomers have been aging through the years of high disability incidence before reaching the ages at which they are eligible for OASI benefits. As baby boomers receiving DI benefits reach Social Security’s full retirement age, the costs of their benefits shift from DI to OASI, increasing costs for the latter trust fund. The DI Trust Fund’s impending reserve depletion signals that the time has arrived for reforms that strengthen the financing outlooks for OASI and DI alike.

The urgency of addressing the financial challenges facing both programs is underscored by the fact that the financing shortfall in the theoretical combined Social Security trust funds has now grown to a size substantially greater, even relative to today’s larger economy, than the shortfall corrected in the landmark bipartisan Social Security amendments of 1983. Those reforms, which included a six-month delay in cost-of-living adjustments, exposing benefits to income taxation for the first time, requiring new Federal employees to join the system and pay payroll taxes, raising the age of eligibility for full retirement benefits, accelerating a previously scheduled payroll tax increase, and other measures, were intensely controversial and difficult to enact. It is sobering to consider that financing corrections today would require more significant measures than those. Furthermore, the longer corrective action is put off, the more severe the measures will have to be and the fewer the cohorts who can be asked shoulder a portion of the burden. Unless Social Security’s historical financing structure is to be altered to finance some or all of the program from the Federal government’s General Fund on a permanent basis, and thereby weaken the historical tie between individual contributions and benefits, legislators must act to eliminate this financing shortfall. This task becomes progressively more difficult, and therefore less assured of success, with each passing year.

Long before the reserves of the OASI and HI Trust Funds are depleted, the finances of Social Security and Medicare will be challenging because of the growing pressure these programs exert on the Federal budget. This is a central concern from the standpoint of program financing because the reserves of each of the various trust funds are invested wholly in U.S. Treasury securities. Monitoring interactions between the trust funds and the General Fund is one of our core duties. When lawmakers created the public trustee positions in 1983 pursuant to a recommendation of the Greenspan Commission, that commission made its recommendation to create public trustees in the “investment procedures” section of its report, rather than in those sections pertaining to actuarial balance. While the Greenspan Commission presented different opinions on the issue of whether Social Security should be included within the unified Federal budget, members of the commission agreed that it was important that Social Security’s impact on the budget be laid out in a transparent fashion. The minority advocated for Social Security’s “impact thereon to be seen more clearly” while the majority’s arguments included making clear “the effect and presence of any payments from the General Fund of the Treasury to the Social Security program.” Indeed, our public trustee positions exist in large part because of lawmakers’ concern that the economic and fiscal implications of the trust funds’ buildup and drawdown be fully understood and properly managed. One of the first actions taken by the program’s original two public trustees in 1985, the year of their first report, was to direct a study of these implications in response to the concerns.

Resources for Social Security and Medicare trust fund interest payments, asset redemptions, and other General Fund payments—most notably those for SMI—must be found in competition with other spending and borrowing within the unified Federal budget, while Federal lawmakers maintain the ability to change the programs’ benefit and tax schedules as warranted by broader fiscal considerations. Accordingly, a thorough assessment of the degree of risk associated with scheduled benefit payments cannot be limited solely to assessing the level of reserves present in the trust funds, but also requires cognizance of the degree of pressure such payments will place on other components of the Federal budget. The rising cost of Medicare has long strained the Federal budget largely because the preponderance of Medicare SMI expenditures is financed from the General Fund. Pressure arising from increasing Social Security expenditures attained a new significance when program costs began to exceed incoming tax revenue in 2010. In 2013, these programs’ costs together required $357 billion (2.1 percent of GDP) from the General Fund.

Whether one regards the Medicare financing challenge to be more or less serious than Social Security’s depends on the perspective taken. Of the two programs, Social Security has the larger actuarial imbalance and the reserves of one of its two trust funds (DI) are in more imminent danger of depletion. On the other hand, Medicare’s long-term cost growth is still projected to exceed Social Security’s, and its operations stand to place greater strain on the Federal budget. As with Social Security, legislative actions of a significant magnitude will be required to place Medicare on a sound financial footing.

Upon the release of last year’s Trustees Report, and in the months afterward, questions arose as to whether a recent slowdown in national health expenditure growth may indicate less urgency in legislating Medicare financing corrections than suggested by our intermediate projections. Unfortunately, this is not the case. The Trustees’ projections have long assumed that over the long term NHE growth will slow relative to historical trends. Overlaying the ACA’s required reductions in Medicare reimbursement rates on top of this projection methodology means that in the later decades of our long-range valuation period (2014-88) we project that per capita spending growth in many categories of Medicare payments will slow markedly relative to per capita GDP growth. Clearly it is to be hoped that NHE growth will continue to slow and that cost-saving mechanisms in current law will prove effective and sustainable. However, even with the assumption of decelerating spending growth Medicare’s financing shortfall, like Social Security’s, remains a reality warranting legislative corrections.

With this, our fourth annual reports as Public Trustees, we are once again pleased to vouch for the integrity of the process by which the Trustees’ projections are developed. We appreciate the dedication and skill of the capable staff that the ex officio Trustees have assigned to help develop these reports and the sophisticated analysis that lies behind the projections. While unanticipated economic and demographic developments and legislative changes will mean that actual results will differ from these projections, we believe the Trustees’ deliberation process is one fully deserving of public confidence.

Charles P. Blahous III,
Robert D. Reischauer,


The Case For A Bull Or Bear Market In Two Charts


Posted on 28th July 2014 by Administrator in Economy |Politics |Social Issues

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Submitted by Charles Hugh-Smith of OfTwoMinds blog,

Which appears more likely–a straight-line extension of the past two years’ rise in stocks, or another “impossible” decline to complete the megaphone pattern?

There are dozens of charts and data points supporting the case for a continuation of the Bull market in stocks or a reversal into a Bear market. For the sake of brevity I’ve distilled the two arguments into two charts, one for the Bull case and one for the Bear case.

The Bull case is easy: the economy has reached self-sustaining expansion, a.k.a. escape velocity; hotel occupancy rates are high, home valuations are rising, stocks are fairly valued based on forward earnings, debt has been paid down/written off, and the Fed has tapered its quantitative easing (QE) bond and mortgage buying with no ill effect.

Looking ahead, there is no fundamental or technical reason for stocks to drop significantly; stocks always go up in years ending in 5, and there is nothing magical about 2016 in terms of a decline, either. The market could advance for years.

Bottom line: the advance since early 2012 is founded on solid fundamentals and there’s no reason the advance can’t continue along with strengthening fundamentals such as corporate profits, rising tax revenues, etc.

The Bear case is based on sentiment, but this reliance on extremes of bullish sentiment is misplaced; the fact that everyone is talking about a bubble in stocks and expecting a correction just goes to show there is no bubble and a correction will simply offer another opportunity to buy the dip, a strategy that has been richly rewarded.

The Fed (and other central banks) have our back: any decline in risk assets will be washed away with another tsunami of near-zero-interest money, liquidity and credit.

The Bear Case is also simple: the supposedly solid fundamentals of earnings, stock buybacks, etc. are all based on an unprecedented expansion of debt, central bank monetary easing, leverage and systemic risk.

Finance trumps economic data, and financial risk has reached a tipping point:shadow banking is unraveling in China, the Fed already owns most of the new home mortgages that have been issued and has to taper lest it own the entire mortgage/Treasury markets, junk bonds have been bid to the moon, etc.

Debt, leverage and risk have reached bubble heights, and simple cause and effect means the stock market has also reached bubble heights.

Faith in the central banks’ ability and willingness to push stock markets higher has reached extremes. Volatility and complacency have both reached levels that historically correspond to major highs.

Take away massive buybacks funded by cheap credit and the market’s dependence on financial one-offs will be revealed: the Bull market was never about earnings; it was always about cheap credit, central banks pushing investors into risk assets like stocks and corporate buybacks. Bulls claiming hotel bookings, auto sales and profits are “proof” of a self-sustaining economy are looking at the effects, not the causes.

To understand the cycle of credit addiction, please read Are We Addicted to Failure?

Bulls and Bears alike tend to marry their convictions. As we all know, the human mind is uncomfortable with uncertainty, and so once a person chooses the Bull case, recency bias and confirmation bias kick in and the Bull selects recent data that confirms his conviction.

The same tropism toward certainty takes hold of Bears, and those of us without the conviction of marriage watch from the sidelines.

I have long been skeptical of the Bull case based on the unprecedented scale of central bank/state intervention, support and manipulation. If everything’s so great, then why does the Fed need to buy trillions of dollars in assets and manipulate markets with reverse repos, etc. and direct purchases via proxies? If a market only rises as a result of such outlandish one-off intervention, how can anyone claim it has any fundamental foundation?

Which appears more likely–a straight-line extension of the past two years’ rise in stocks, or another “impossible” decline to complete the megaphone pattern? If stocks continue climbing once the Fed ends its bond-buying in and stock buybacks drop to less frenzied levels, that will be evidence the Bulls are right about the economy’s escape velocity.

If the market tanks as soon as the monetary heroin is withdrawn, that will support the Bear’s case that financial legerdemain trumps economic data.

Two things favor the Bear case in my view: if volume is the weapon of the Bull (i.e. rising volume drives Bull markets), then the fact that volume has been declining for years is not supportive of the Bulls.

Secondly, I don’t see how the economy can reach escape velocity with household income declining in real terms: Five Decades of Middle Class Wages (Doug Short).



Posted on 28th July 2014 by Administrator in Economy |Politics |Social Issues

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Guest Post from Mike Shedlock

Bad Day for Bad Teachers, Good Day for Kids

This is a guest post courtesy of Richard Berman at the Capital Research Center, under the title A Bad Day for Bad Teachers.

Summary: In 1954, the U.S. Supreme Court issued the landmark decision Brown v. Board of Education, which struck down racially segregated schools because, the court said, they were inherently unequal and they unjustly harmed poor and minority children. Last month, a California court cited Brown v. Board as it struck down multiple state laws, passed at the behest of teachers’ unions, which the court said unjustly protected incompetent teachers and unconscionably harmed children, especially the least fortunate.

In a landmark decision that sent shock waves through the educational establishment, Los Angeles Superior Court Judge Rolf Treu ruled last month that California’s teacher tenure laws unconstitutionally deprive students of their guarantee to an education and to equal rights. “The evidence is compelling,” Judge Treu wrote. “Indeed, it shocks the conscience.”

In Vergara v. California, nine students sued the State of California, claiming that ineffective teachers were disproportionately placed in schools with large numbers of “minority” and low-income students. Judge Treu agreed and quoted the U.S. Supreme Court’s 1954 Brown v. Board of Education decision that education “is a right which must be made available to all on equal terms.”

Nine young people and their families filed suit against California’s laws on teacher retention and dismissal, which, they say, protect bad teachers and deprive students of a high-quality education.

The Vergara decision came down less than one month after the 60th anniversary of the Brown decision, in which the U.S. Supreme Court struck down state and federal laws establishing separate public schools for students classified by the government as “white” and “black.”

(In Brown, the Court consolidated cases from Kansas, Virginia, South Carolina, and Delaware, as well as the federal jurisdiction of Washington, D.C.) The Supreme Court found that the practice of segregation violated the provision in the U.S. Constitution that “No State shall make or enforce any law which shall . . . deny to any person within its jurisdiction the equal protection of the laws.”

The argument in the current case, Vergara, is that, by forcing schools to favor incompetent teachers with seniority over more capable junior teachers, the rules deprive students of the education that the state constitution guarantees them. Further, because these rules funnel bad teachers to districts with large numbers of poor and “minority” students, those students are denied the equal treatment of the law.

The Vergara lawsuit was backed by Students Matter, a nonprofit educational policy advocacy group funded by Silicon Valley entrepreneur David Welch. “The state has a responsibility of delivering an education for the betterment of the child,” said Welch. “The state needs to understand that [its] responsibility is to teach children, and teach all of them.” Welch’s organization recruited the nine students, from several school districts, to serve as the public face of the case.
Astonishingly, the teachers’ union response to the ruling was that it was actually an attack on children. “This decision today is an attack on teachers, which is a socially acceptable way to attack children,” said Alex Caputo-Pearl, the president-elect of the Los Angeles teachers union. Instead of providing for smaller classes or more counselors, the reformers “attack teacher and student rights.”

Welch answered that claim in an op-ed for the San Jose Mercury News in which he described the harm students suffer from bad teachers:

According to the testimony of Harvard economist Dr. Thomas Kane, a student assigned to the classroom of a grossly ineffective math teacher in Los Angeles loses almost an entire year of learning compared to a student assigned to a teacher of even average effectiveness. Students assigned to more than one grossly ineffective teacher are unlikely ever to catch up to their peers.
And far from wanting to attack all teachers, Welch in the same article pleaded with his fellow Californians to reward good teachers:

“Let’s offer teachers opportunities for promotions, such as to master teacher, teacher mentor, or department chair, where the skills of a truly excellent, creative educator can reach more children—as well as better pay with incentives for excellence and taking on extra responsibilities or difficult positions.”

No less a union friend than Rep. George Miller (D-Calif.), whose largest campaign support comes from unions, has bluntly admitted, “Vergara will help refocus our education system on the needs of students.” No wonder the teachers’ unions made five separate legal efforts to have the lawsuit dismissed on grounds other than the merits of the case.

California teacher union members number some 445,000. Both the California Teachers Association (CTA, an affiliate of the National Educational Association) and the California Federation of Teachers (CFT, an affiliate of the American Federation of Teachers) plan to appeal the court’s decision. Jim Finberg, a lawyer for the two teachers’ unions, said that Judge Treu’s decision “ignores overwhelming evidence the current laws are working.”

Actually, less than 0.002% of teachers in California are dismissed in any given year. Judge Treu noted that, when an effort is made to fire a teacher, “it could take anywhere from two to almost ten years and cost $50,000 to $450,000 or more to bring these cases to conclusion under the Dismissal Statute, and that given these facts, grossly ineffective teachers are being left in the classroom.”
Judge Treu concluded that “distilled to its basics,” the unions’ position requires them to defend the proposition that the state has a compelling interest in the de facto separation of students from competent teachers, and a like interest in the de facto retention of incompetent ones. The logic of this position is unfathomable and therefore constitutionally insupportable.

Seniority vs. Merit

The Vergara decision overturned a LIFO (last-in/first-out) law requiring that teacher layoffs be based on seniority, rather than individual merit. California’s Permanent Employment Law required that a teacher be tenured after two years at a school (which, because of an early notice requirement, worked out in practice to 18 months or less). California is one of only five states in which tenure may be received after such a short period. As noted by the blog Voices of San Diego:

Regardless of what we call it, here’s how it looks in San Diego Unified. Once they’re hired, rookie teachers have to make it through a two-year probationary period, during which they can be dismissed for pretty much any reason.

But because the district has to tell teachers by mid-March whether they’ll be invited back for the next school year, the trial period is actually shorter than two years. In the past, the district hasn’t been particularly aggressive in the number of probationary teachers it sends away—only about 1 percent wasn’t given tenure.

“With such little time, you don’t even have enough information to actually consider whether they’re an effective teacher,” said Nancy Waymack, a managing director for the reform-advocacy group National Council on Teacher Quality.

Compared to other states, California has some of the strongest laws in place to protect teacher employment. The effect of this case may spur action throughout the nation. “Without a doubt, this could happen in other states,” said Terry Mazany, who served as interim CEO of Chicago’s public schools in 2010-2011. A lawyer for Students Matter said they are already hoping to “engage with policymakers in New York and nationally,” and donor David Welch said the group would consider suits in other states (New Jersey, Connecticut, Maryland, Minnesota, New Mexico, and Oregon were mentioned as possible sites).

Undue Process

The term “due process” refers to a legal or quasi-legal system that protects the rights of an individual, such as by requiring a trial before a person can be executed. Unions defend the complicated procedures for firing teachers by claiming they amount to “due process” that protects those teachers from arbitrary, unfair treatment. As the Pew publication Stateline reports, “The unions argue that the rules protecting teachers are needed for school districts to attract and retain good teachers and to ensure that employees are not fired for arbitrary or unfair reasons.”

But the judge ruled in Vergara that the process has become so cumbersome—that it’s become so difficult to get rid of bad teachers—that it deprives students of their rights. He ridiculed the process as “über due process,” and observed that California state laws already provide a great deal of protection for government and private-sector employees facing dismissal. “Why,” he pleaded, “the need for the current tortuous process” that is mandated only for teachers, a process so unjust, he added, that it was even decried by witnesses called by the teachers’ unions?

James Taranto of the Wall Street Journal noted an irony at the center of the ruling: “The California Supreme Court had applied the same legal premises to hold unconstitutional funding disparities among districts and one district’s decision to end the school year six weeks early owing to a budgetary shortfall. Vergara doesn’t break new legal ground so much as apply precedent in a way that threatens the education establishment. It’s a case of judicial activism coming back to bite the left.”

A permanent job

As noted in Waiting for ‘Superman,’ a documentary promoting educational reform, one out of every 57 doctors loses his or her license to practice medicine, and one of every 97 lawyers loses his or her license to practice law. Yet, in many major cities, only one out of 1,000 teachers is fired for performance-related offenses. The reason is tenure, or as the unions call it, “permanent status.”
Tenure is the practice of guaranteeing a teacher his or her job. Originally, this was a due process guarantee, something intended to work as a check against administrators capriciously firing teachers and replacing them with friends or family members. It was also designed to protect teachers who took political stands the community might disagree with. Tenure as we understand it today was first seen at the university level, where, ideally, professors would work for years and publish many pieces of inspired academic work before being awarded what amounted to a job for life.

At the elementary and high school level, tenure has evolved from the original understanding of “due process” to the university-style “job for life.” In most states, teachers are awarded tenure after only a few years, after which time they become almost impossible to fire. The main function of these laws is to help bad teachers keep their jobs.

►One Los Angeles union representative has said: “If I’m representing them, it’s impossible to get them out. It’s impossible. Unless they commit a lewd act.” Unfortunately for the students who have to learn from these educators, virtually every teacher who works for the Los Angeles Unified School District receives tenure. In a study of its own, the Los Angeles Times reported that fewer than two percent of teachers are denied tenure during the probationary period after being hired. And once they have tenure, there’s no getting rid of them. Between 1995 and 2005, only 112 Los Angeles tenured teachers faced termination—eleven per year—out of 43,000. And that’s in a school district where the high school graduation rate in 2003 was a pathetic 51 percent.
►One New Jersey union representative was even blunter about what his union does to keep bad teachers in the classroom: “I’ve gone in and defended teachers who shouldn’t even be pumping gas.”
In 10 years, only about 47 out of 100,000 teachers were terminated from New Jersey’s schools. Original research conducted by the Center for Union Facts (CUF) has confirmed that almost no teacher is ever fired in Newark, which is New Jersey’s largest school district, no matter how bad a job the teacher does. Over one four-year period, CUF discovered, Newark’s school district successfully fired about one out of every 3,000 tenured teachers annually. This is a city where roughly two-thirds of students never graduate from high school.
►In New York City, the New York Daily News reported that “just 88 out of some 80,000 city schoolteachers have lost their jobs for poor performance” over 2007-2010.
Then there were the so-called “rubber rooms” of New York City, which operated until 2010. Teachers who couldn’t be relieved of duty would report to these “rubber rooms,” where they would be paid to do nothing for weeks, months, even years. According to the New York Daily News, at any given time an average of 700 teachers were being paid not to teach while the district jumped through the hoops, imposed by the union contract and the law, to pursue discipline or termination. (A city teacher in New York who ended up being fired spent an average of 19 months in the disciplinary process.) The Daily News reported that the New York City school district spent more than $65 million annually just to pay the teachers who were accused of wrongdoing. Millions more tax dollars were spent to hire substitutes.

After the embarrassing Daily News story and an exposé in the New Yorker, the union agreed to end the practice of rubber rooms but refused to expedite the dismissal process. Instead of whiling the days away doing nothing, the teachers were assigned to do clerical work and perform other semi-useful tasks.

The problem isn’t limited to teachers accused of wrongdoing. The city spends more than $100 million every year paying teachers who have been excessed (i.e., whose positions have been eliminated) but have yet to find jobs.

According to the Wall Street Journal, the ironclad union contract requires that any teacher with tenure be paid full salary and benefits if he or she is sent to the “Absent Teacher Reserve pool.” The average pay of a teacher in that pool is over $80,000 a year, and some teachers have stayed in the pool for years. The Journal reports that the majority of teachers in the pool had “neither applied for another job in the system nor attended any recruitment fairs in recent months.”

►Things are no better in New York as a whole. The Albany Times Union looked at what was going on statewide outside New York City and discovered some shocking data: Of 132,000 teachers, only 32 were fired for any reason between 2006 and 2011.
►In Chicago, a school system that has by any measure failed its students—only 28.5 percent of 11th graders met or exceeded expectations on that state’s standardized tests—Newsweek reported that only 0.1 percent of teachers were dismissed for performance-related reasons between 2005 and 2008. When barely one in four students nearing graduation can read and do math, how is it possible that only one in one thousand teachers is worthy of dismissal? It may well be that most of the city’s teachers are good teachers, but can 99.9% of them be good?

Effects of tenure and related teacher “protections”

Modeled after labor arrangements in factories, the typical teachers’ union contract is loaded with provisions that do not promote education. These provisions drive away good teachers, protect bad teachers, raise costs, and tie principals’ hands.

● The Dance of the Lemons

One of the more shocking scenes in the documentary Waiting for ‘Superman’ is an animated illustration of “The Dance of the Lemons.” This is no waltz or foxtrot. Rather, it’s the systematic shuffling of incompetent teachers from school to school. These teachers can’t be fired because union contracts require that “excessed” educators, no longer needed at their original school, must be given first crack at new job openings when slots open up elsewhere in the district. Administrators at other schools don’t want to hire these bad teachers, but districts are unable to fire them.
What happens? LA Weekly documented just how this process plays out in Los Angeles in a massive 2010 investigation. “The far larger problem in L.A. is one of ‘performance cases’—the teachers who cannot teach, yet cannot be fired. Their ranks are believed to be sizable—perhaps 1,000 teachers, responsible for 30,000 children. … The Weekly has found, in a five-month investigation, that principals and school district leaders have all but given up dismissing such teachers. In the past decade, LAUSD officials spent $3.5 million trying to fire just seven of the district’s 33,000 teachers for poor classroom performance—and only four were fired, during legal struggles that wore on, on average, for five years each. Two of the three others were paid large settlements, and one was reinstated. The average cost of each battle is $500,000.”
Unintended Consequences, a study by The New Teacher Project (TNTP), documented the damage done by this union-imposed staffing policy. In an extensive survey of five major metropolitan school districts, TNTP found that “40 percent of school-level vacancies, on average, were filled by voluntary transfers or excessed teachers over whom schools had either no choice at all or limited choice.” One principal decried the process as “not about the best-qualified [teacher] but rather satisfying union rules.”

● Thinning the talent pool

One problem related to the destructive transfer system is a hiring process that takes too long and/or starts too late, thanks in part to union contracts. Would-be teachers typically cannot be hired until senior teachers have had their pick of the vacancies, and the transfer process makes principals reluctant to post vacancies at all for fear of having a bad teacher fill it instead of a promising new hire.

In the study Missed Opportunities, The New Teacher Project found that these staffing hurdles help push urban districts’ hiring timelines later to the point that “anywhere from 31 percent to almost 60 percent of applicants withdrew from the hiring process, often to accept jobs with districts that made offers earlier.”

“Of those who withdrew,” the TNTP report continues, “the majority (50 percent to 70 percent) cited the late hiring timeline as a major reason they took other jobs.” It’s the better applicants who are driven away: “Applicants who withdrew from the hiring process had significantly higher undergraduate GPAs, were 40 percent more likely to have a degree in their teaching field, and were significantly more likely to have completed educational coursework” than the teachers who ended up staying around to finally receive job offers.

● Keeping experienced teachers away from poor children

Another common problem with the union contract is a “bumping” policy that fills schools which are more needy (but less desirable to teach in) with greater numbers of inexperienced teachers. In its report Teaching Inequality, the Education Trust noted: “Children in the highest-poverty schools are assigned to novice teachers almost twice as often as children in low-poverty schools. Similarly, students in high-minority schools are assigned to novice teachers at twice the rate as students in schools without many minority students.”

● Bad apples stay

A study conducted by Public Agenda polled 1,345 schoolteachers on a variety of education issues, including the role that tenure played in their schools. When asked “does tenure mean that a teacher has worked hard and proved themselves to be very good at what they do?” 58 percent of the teachers polled answered that no, tenure “does not necessarily” mean that. In a related question, 78 percent said a few (or more) teachers in their schools “fail to do a good job and are simply going through the motions.”

When Terry Moe, the author of Special Interest: Teachers Unions and America’s Public Schools, asked teachers what they thought of tenure, they admitted that the byzantine process of firing bad apples was too time-consuming: 55 percent of teachers, and 47 percent of union members, answered yes when asked “Do you think tenure and teacher organizations make it too difficult to weed out mediocre and incompetent teachers?”

● The union tax on firing bad teachers

So why don’t districts try to terminate more of their poor performers? The sad answer is that their chance of prevailing is vanishingly small. Teachers unions have ensured that even with a victory, the process is prohibitively expensive and time-consuming. In the 2006-2007 school year, for example, New York City fired only 10 of its 55,000 tenured teachers, or 0.018%. The cost to eliminate those employees averages out to $163,142, according to Education Week. The Albany Times Union reports that the average process for firing a teacher in New York state outside of New York City proper lasts 502 days and costs more than $216,000. In Illinois, Scott Reeder of the Small Newspaper Group found it costs an average of $219,504 in legal fees alone to move a termination case past all the union-supported hurdles. In Columbus, Ohio, the teachers’ union president admitted to the Associated Press that firing a tenured teacher can cost as much as $50,000. A spokesman for Idaho school administrators told local press that districts have been known to spend “$100,000 or $200,000” in litigation costs to toss out a bad teacher.

It’s difficult even to entice the unions to give up tenure for more money. In Washington, D.C., school chancellor Michelle Rhee proposed a voluntary two-tier track for teachers. On one tier, teachers could simply do nothing: Maintain their regularly scheduled raises and keep their tenure. On the other track, teachers could give up tenure and be paid according to how well they and their students performed, with the potential to earn as much as $140,000 per year. The union wouldn’t even let that proposal come up for a vote among its members, and stubbornly blocked efforts to ratify a new contract for more than three years. When the contract finally did come up for ratification by the rank and file, the two-tier plan wasn’t even an option.

● Taking money from good teachers to give to bad teachers

During the expansion of teacher collective bargaining in the mid-twentieth century, economists from Harvard and the Australian National University found, the average, inflation-adjusted salary for U.S. teachers rose modestly—while “the range of the [pay] scale narrowed sharply.” Measuring aptitude by the quality of the college a teacher attended, the researchers found that the advent of the collectively bargained union contract for teachers meant that on average, more talented teachers were receiving less, while less talented teachers were receiving more.

The earnings of teachers in the lowest aptitude group (those from the bottom-tier colleges) rose dramatically relative to the average wage, so that teachers who in 1963 earned 73 percent of the average salary for teachers could expect to earn exactly the average by 2000. Meanwhile, the ratio of the earnings of teachers in the highest-aptitude group to earnings of average teachers fell dramatically. In states where the highest-aptitude teachers began with an earnings ratio of 157 percent, they ended with a ratio of 98 percent.

Data from the National Center for Education Statistics, as reported by Education Week, add further evidence to the compressed-pay claim. The Center’s stats indicate that the average maximum teacher pay nationwide is only 1.85 times greater than the nationwide average salary for new teachers.

● Locking up education dollars

Much of the money commanded by teachers’ union contracts is not being used well, at least from the perspective of parents or reformers. Several provisions commonly found in union contracts that cost serious money have been shown to do little to improve education quality. A report from the nonprofit Education Sector found that nearly 19 percent of all public education spending in America goes towards things like seniority-based pay increases and outsized benefits—things that don’t go unappreciated by teachers, but don’t do much to improve the quality of teaching children receive. If these provisions were done away with, the report found, $77 billion in education money would be freed up for initiatives that could actually improve learning, like paying high-performing teachers more money.

● Putting kids at risk

Teachers unions push for contracts that effectively cripple school districts’ ability to monitor teachers for dangerous behavior. In one case, school administrators in Seattle received at least 30 warnings that a fifth grade teacher was a danger to his students. However, thanks to a union contract that forces schools to destroy most personnel records after each school year, he managed to evade punishment for nearly 20 years, until he was finally sent to prison in 2005 for having molested as many as 13 girls. As an attorney for one of the victims put it, according to the Seattle Times, “You could basically have a pedophile in your midst and not know it. How are you going to get rid of somebody if you don’t know what they did in the past?”

The Bottom Line

Too many schools are failing too many children. Americans should not remain complacent about how districts staff, assign, and compensate teachers. And too many teachers’ union contracts preserve archaic employment rules that have nothing to do with serving children.

Even Al Shanker, the legendary former president of the American Federation of Teachers, admitted, “a lot of people who have been hired as teachers are basically not competent.”

This is what the union wants: To keep teachers on the payroll regardless of whether or not they are doing any work or are needed by the school district. Why? As long as they are on the payroll, they keep paying union dues. The union doesn’t care about the children who will be hurt by this misallocation of tax dollars. All union leaders care about is protecting their members and, by extension, their own coffers.

Most teachers absolutely deserve to keep their jobs, and some have begun to speak out about the absurdity of teacher tenure, but it’s impossible to pretend that the number of firings actually reflects the number of bad teachers protected by tenure. As long as union leaders possess the legal ability to drag out termination proceedings for months or even years—during which time districts must continue paying teachers, and substitute teachers to replace them, and lawyers to arbitrate the proceedings—the situation for students will not improve.

The Vergara case offers hope, but supporters of better education cannot rely on judges to fix America’s schools. Parents and teachers must join together to eliminate teacher tenure systems that protect bad teachers and that divert our best teachers away from many of the students who could benefit most from their skills and experience.

*   *   *

About the Author:  Richard Berman is executive director of the Center for Union Facts. Some of this material appeared previously on the website TeachersUnionExposed.com, a project of the Center for Union Facts. This article originally appeared on the website Labor Watch, and is republished here with permission.

Mike “Mish” Shedlock

Read more at http://globaleconomicanalysis.blogspot.com/#qsqzLkhP1vv17k8o.99



Posted on 25th July 2014 by Administrator in Economy |Politics |Social Issues


Amazon lost $7 million in this quarter last year. Their master plan resulted in a loss of $126 million this year. Do you notice how hard it is to make money when your business model is dependent upon selling products at a loss? Maybe their drone delivery service will turn the tide. Oh yeah. That 60 Minutes puff piece was nothing but bullshit. The FAA will never allow it. Their loss was only 80% higher than the Wall Street shysters anticipated. I’m sure they’ll make it up on volume.

The stock is down from its high of $400 earlier this year. Of course there is no Fed induced stock market bubble. Companies that lose money year after year after year certainly should be trading north of $300 per share based on a storyline. PE ratios and price to book values and free cash flow are for old fogies. This is the internet age when profits aren’t required. Take advantage of  today’s 10% drop and buy Amazon on the cheap. It’s a can’t miss opportunity. Just ask Denninger.


First, revenues are rising as reported but expenses are going up even faster.  Notable places where expenses are exceeding revenue growth rates include:

Stock-based compensation up 31% (!) y/o/y

PPE purchases are up 50% (yikes!) compared against same-quarter last year, and capital lease additions doubled.

Shipping expenses are up 30%.

Marketing is up 40%.

Tech and content is up 40%.

In short – sweet Jesus, these guys are burning money like it’s newspaper in the fireplace!

The only good news is that the cost of goods sold is up 20%, but revenue was up a bit more, so they’re driving cost.  Of course that’s bad for their vendors; they’re getting squeezed.

Now here’s the kinda-ugly on the sales side.

International is slowing — it’s up 18% on sales while domestic is up 26%.  But, remember, we were told international was going to save the day!  Uh, that’s the same change y/o/y from last quarter – no improvement in either domestic or international.

If you remember my previous reporting one of the places I watched very, very carefully was media.  The reason is this – media is a high-margin business, electronics and general merchandise is a very low margin business.

So how’s that working out?

Well, domestically media is growing 13%, while merchandise was up 29%.  Internationally it’s much worse; media is only up 7%, and those are y/o/y comparisons on the quarter.

The bad news is that media decreased both domestically and internationally on the quarter!  In fact, it was down 13% domestically and 10% internationally.  OUCH.

The electronics business was also down internationally by 5%.  What made up for it was a 7% increate in (zero or even negative margin!) electronics and merchandise sales in North America.

This is crap performance, in short; media sales, which is where the margin is, in fact contracted on the quarter both in North America and internationally, and general merchandise was down sequentially internationally as well!  Of goods sold only merchandise in North America advanced on a quarterly basis.

It’s worse when you remove the effect of exchange rates (which helped internationally.)

Operating margin has gone in the toilet as well and is in fact negative — no surprise given the monster cost ramps compared against revenue.

Amazon is a huge firm that despite all the claims they would turn the corner, smash their competition and make an unbelievable amount of money they have failed to deliver on that promise for more than 10 years serially.  Costs continue to rise in several areas at rates exceeding sales and there is no margin improvement in sight.  In addition their AWS services, which they have touted as one of their saving graces, has become embroiled in a price war and they’re spending on PPE (probably for that service although I’m sure distribution is part of it) like a drunken sailor while having to continually slash pricing to obtain customers.

We’ve heard for years that Amazon was “investing” and that investment would reap rewards.  I see no improvements on an annualized basis in terms of growth rates against 2013, the company has its strongest unit growth in sales in areas where they make little, nothing or actually lose money when fulfillment costs are included and worse, their “cloud” service has become embroiled in a commodity style “race to zero” pricing paradigm and yet they’re still committing to spend like crazy on it.

I know what we’ll do!  We’ll lose money on every sale but make it up on volume!

This is a company with no justification for a stock price anywhere near where it sits, even given the well-justified implosion after hours.  If there was any reason to believe they could stem the price:cost problem with AWS that is spiraling out of control and stop fulfillment and marketing expense from rising faster than revenues there might be an argument for the stock to sell around $100, which would give it a forward P/E of about 30.

Unfortunately as it stands, given what is now a multi-year series of false dawns and promises that are never fulfilled to actually find a return on all this cash plowed back into the business, along with the apparent detonation of their cloud service cost:price structure due to massive slashing of prices (which one can presume is necessary to attract and retain customers) the stock is not worth $30/share.

Good luck if you’re long.