Fuzzy Treasury Math and Its Consequences

(Note: A version of this appeared on AlterNet earlier this week). If it sounds too good to be true, it’s probably false. Especially if it involves math, the Treasury Department, and two disparate political camps championing two different economic doctrines.

Yet, so goes the current telling of the deficit story. When the Congressional Budget Office (CBO) proclaimed that its projected deficit for 2013 had dropped to $642 billion, there was nary a question asked about how that number was conceivable.

Real-wage stagnation, epic student debt, more low-paying half-jobs accepted out of desperation than moderate-paying full-ones being created, health costs out of control, an ongoing Congressional war over sequestered funds, more federal debt being created even if tempered by zero-interest-rate policy and yet, the media jumped on the make-believe-bandwagon of an incomprehensible turn-around in the government’s books, where the deficit had grown as a direct result of debt created to float the banking system. Somehow the deficit had magically nearly-halved from around $1.1 trillion last year.

A battle of philosophies

When the deficit was announced to have undergone some kind of Fastest Loser diet, Keynesian types were thrilled that their philosophy was validated. The wondrous number, the ‘smallest shortfall since 2008’,  proved fiscal stimulus would ultimately boost the economy.  (Leave aside that John Maynard Keynes was actually an asset manager and successful speculator.) 

Where there is truth to part of this  (austerity never helped anyone but those not impacted by it) it ignores the fact that a vast portion of stimulus has been mirrored by a policy of cheap money, asset bubble manufacturing and providing a parking spot for Treasury and bank debt on the Fed’s books. Nearly 80% of the Treasury debt created since the financial crisis of 2008 has not been raise to even plug a deficit, but to float a flawed financial system. Still, blind acceptance that any federal stimulus helps the population and not its financial institutions does economics and more importantly, the country, a disservice.

Free-market types also considered the reduced deficit a philosophical triumph. By not overly helping or regulating the market (score another one for watering down the already tepid Frank-Dodd Act), the economy is marching back to normal on its own. See! So more budget cuts of social, but not corporate, welfare are necessary.

But blind-belief in the headline figure weakens their cause, too. A true free-marketer would be against the Federal Reserve propping up the treasury department and the debt market by printing money, buying lots of new treasuries, or allowing banks to park them on their books (to the tune of more than $1.5 trillion worth in excess reserves) and by buying $85 billion in toxic assets per month from banks shifting their rotting positions to the Fed, thereby freeing up space to speculate in other ways, in a well-orchestrated accounting gimmick.

Those debates of course will continue on. Meanwhile, there’s the matter of what sparked them - the CBO’s estimate of the 2013 deficit, the number that measures what the government takes in vs. what it spends. Examining it, shows that not much has changed in the past three years. 

First, a hat tip to Karl Dennniger at Market Ticker for boldly going where much of the media seemed too complacent or clueless to go.  According to Denninger’s analysis of Treasury data, since September 28th 2012, “there has been a net $762.6 billion of new debt added to the Federal balance sheet, not the $488 billion the Treasury Department claims.”

He shows how the Treasury’s cash statement indicates that “At the current run rate … the deficit on a cash basis this year is $1.188 trillion” compared to $1.210 trillion last year, or,  about the same.  If you include figures through the end of April, that run rate produces a deficit of about $1.307 trillion.

Regarding the $642 billion headline deficit number, simple logic (and a read of the news) showed that neither US debts, nor its largest expenditures had dropped.  At first, I just assumed the Treasury Department was excluding something major from the figures that the CBO was using - but the math doesn't work even if it excluded lots of costs or pumped up lots of revenues.  

The Truth is In there

The evidence of the real deficit projection lies in the Treasury's own report of receipts and outlays, the Monthly Treasury Statement which compiles activity from the start of the current fiscal year (October 2012) through April 2013. 

A cursory look at this report reveals items that ulimately don't support the CBO’s cheery projections. (Warning: there’s some math coming up.) Take Table 1. Its shows there have been $1.603 trillion in budget receipts so far for fiscal year 2013 vs. $2.090 trillion in outlays. This indeed produces a value for a current deficit (outlays minus receipts) of -$487 billion.

The same table (and also Table 2) shows there were $1.383 trillion in receipts for the same period in 2012 and $2.103 trillion (about the same as this year) in outlays. Combining those figures, we do get a  comparative deficit this time last year of -$719 billion.  Okay, so far, so on point with the headline cheer.

However. Just below Table 1 comes some small print. The Treasury Department appears to have changed some accounting methods: "The deficit figure differs by $2.23 billion due mainly to revisions in the data following the release of the Final Monthly Treasury Statement."  There’s no clarity on how those revisions worked and they are small in the scheme of things, so let’s raise an eyebrow and move on – to the good part.

The Fuzziness

Even if the rest of this year's receipts continue to come in 16% greater than they did last year (which is what this table shows so far) - and there’s no particular reason why they should -  we'd get total receipts of $1.603 trillion plus an additional $1.237 trillion. That equals $2.839 trillion in total receipts for 2013. Remember that number for a moment.

Now, consider that even if  the rest of this year's expenditures remain flat to last year, there would be $3.538 trillion in total outlays for 2013. Subtracting that $3.538 trillion in outlays from $2.839 trillion in receipts, yes, we do get a total deficit projection of around $698 billion, about $56 billion higher then the figure the CBO announced, but what’s $56 billion give or take between friends?

Yet there’s more.  There’s Table 2. According to Table 2, expenditures won't be flat; they will be higher, and reach $3.684 trillion.

Subtracting $3.684 trillion from $2.839 trillion, we get an expected deficit of $846 billion, not the $642 billion figure that the media spread. Again, what’s about $200 billion between friends? But, adding in the extra debt from Denninger’s analysis of reports, that isn’t in this report, of $275 billion could put the real deficit figure closer to $1.12 trillion, where it’s been for the past three years.

There’s always some danger in working with numbers and estimates. The financial crisis predicated on mortgage prices and related assets rising quickly after speed bumps (which is what former Treasury Secretary, Hank Paulson said they'd do in 2007) showed us that. Numbers can be massaged and shrouded with suppositions.

But, that’s not the full case here. This is a case of performing addition and subtraction using the Treasury’s own report. And doing so, even absent wondering about assumptions or potential illusions, reveals a discrepancy between the recent headline deficit number and the one in the report.

Before we can discuss whether government stimulus works or not (and more importantly how programs are designed and who they benefit; sometimes people, often banks and corporatios), we should ask why some people are so eager to accept numbers or be right about the forest, that they run smack into the trees. Let’s at least see the main tree, here – the actual deficit figure - and then, we can move onto economic doctrine discussions. 

The Real Libor Scandal by Paul Craig Robert & Nomi Prins

(Note: I was deeply honored to have been asked to be a co-author on this piece by Paul Craig Roberts)

According to news reports, UK banks fixed the London interbank borrowing rate (Libor) with the complicity of the Bank of England (UK central bank) at a low rate in order to obtain a cheap borrowing cost. The way this scandal is playing out is that the banks benefitted from borrowing at these low rates. Whereas this is true, it also strikes us as simplistic and as a diversion from the deeper, darker scandal.

Banks are not the only beneficiaries of lower Libor rates. Debtors (and investors) whose floating or variable rate loans are pegged in some way to Libor also benefit. One could argue that by fixing the rate low, the banks were cheating themselves out of interest income, because the effect of the low Libor rate is to lower the interest rate on customer loans, such as variable rate mortgages that banks possess in their portfolios. But the banks did not fix the Libor rate with their customers in mind. Instead, the fixed Libor rate enabled them to improve their balance sheets, as well as help to perpetuate the regime of low interest rates. The last thing the banks want is a rise in interest rates that would drive down the values of their holdings and reveal large losses masked by rigged interest rates.

Indicative of greater deceit and a larger scandal than simply borrowing from one another at lower rates, banks gained far more from the rise in the prices, or higher evaluations of floating rate financial instruments (such as CDOs), that resulted from lower Libor rates. As prices of debt instruments all tend to move in the same direction, and in the opposite direction from interest rates (low interest rates mean high bond prices, and vice versa), the effect of lower Libor rates is to prop up the prices of bonds, asset-backed financial instruments, and other "securities." The end result is that the banks' balance sheets look healthier than they really are.

On the losing side of the scandal are purchasers of interest rate swaps, savers who receive less interest on their accounts, and ultimately all bond holders when the bond bubble pops and prices collapse.

We think we can conclude that Libor rates were manipulated lower as a means to bolster the prices of bonds and asset-backed securities. In the UK, as in the US, the interest rate on government bonds is less than the rate of inflation. The UK inflation rate is about 2.8%, and the interest rate on 20-year government bonds is 2.5%. Also, in the UK, as in the US, the government debt to GDP ratio is rising. Currently the ratio in the UK is about double its average during the 1980-2011 period.

The question is, why do investors purchase long term bonds, which pay less than the rate of inflation, from governments whose debt is rising as a share of GDP? One might think that investors would understand that they are losing money and sell the bonds, thus lowering their price and raising the interest rate.

Why isn’t this happening?

PCR’s June 5 column, “Collapse at Hand,” explained that despite the negative interest rate, investors were making capital gains from their Treasury bond holdings, because the prices were rising as interest rates were pushed lower. 

What was pushing the interest rates lower?

The answer is even clearer now. First, as PCR noted, Wall Street has been selling huge amounts of interest rate swaps, essentially a way of shorting interest rates and driving them down. Thus, causing bond prices to rise.

Secondly, fixing Libor at lower rates has the same effect. Lower UK interest rates on government bonds drive up their prices.

In other words, we would argue that the bailed-out banks in the US and UK are returning the favor that they received from the bailouts and from the Fed and Bank of England’s low rate policy by rigging government bond prices, thus propping up a government bond market that would otherwise, one would think, be driven down by the abundance of new debt and monetization of this debt, or some part of it.

How long can the government bond bubble be sustained? How negative can interest rates be driven?

Can a declining economy offset the impact on inflation of debt creation and its monetization, with the result that inflation falls to zero, thus making the low interest rates on government bonds positive?

According to his public statements, zero inflation is not the goal of the Federal Reserve chairman. He believes that some inflation is a spur to economic growth, and he has said that his target is 2% inflation. At current bond prices, that means a continuation of negative interest rates.

The latest news completes the picture of banks and central banks manipulating interest rates in order to prop up the prices of bonds and other debt instruments. We have learned that the Fed has been aware of Libor manipulation (and thus apparently supportive of it) since 2008. Thus, the circle of complicity is closed. The motives of the Fed, Bank of England, US and UK banks are aligned, their policies mutually reinforcing and beneficial. The Libor fixing is another indication of this collusion.

Unless bond prices can continue to rise as new debt is issued, the era of rigged bond prices might be drawing to an end. It would seem to be only a matter of time before the bond bubble bursts.

Defiance, Denial and Downgrades Won’t Help our Economy

Yes, the US has a debt problem. But, more than that, it has a priorities and accountability problem. Yet, rather than giving Washington a pause for reflection, the S&P downgrade of US debt from ‘AAA’ to ‘AA+” merely gave Capitol politicians renewed opportunity for elaborately orchestrated hissy fits that won't lead to introspection or policy change.

First, let’s again acknowledge the irony that this rating agency rubberstamped $14 trillion of toxic assets in the five years leading up to the crisis of 2008, thereby enabling the Wall Street manufacturing and global dispersion machine to thrive. Then, let’s sign that Washington still doesn't get it.

We racked up debt predominantly, but not exclusively (less revenue due to fewer jobs and an antiquated system where not everyone pays a comparative share contributed, as did the cost of three wars) because of the choice to subsidize Wall Street.

Nearly 80% of the new debt created by the Treasury since the financial crisis was either sold through the banks, is sitting on the Fed's books doing nothing productive, or was used to bolster various elements of the banking system through cheap loans, guarantees for faulty assets, and other methods.

Chances are near one hundred percent, that this next round of debt will exhibit the same pattern. The Treasury will issue bonds and a big portion will wind up on the Fed’s books, doing zero for the greater population. More bi-partisan squabbling over why the economy isn’t growing quickly enough will eschew.

A few months ago, Treasury Secretary, Tim Geithner made the talk show rounds to declare empathically that there was ‘no chance’ of a downgrade of US debt. After the downgrade, with the stock market plummeting, President Obama took to the airwaves to explain that the US was ‘AAA’ no matter what ‘some rating agency says’.

As Obama opined that ‘there will always be economic factors we can’t control,’ the stock market kept dropping.  Some of that fall was for ‘technical reasons.’ People and firms borrow money to bet on the market, and put down collateral (or margin) in order to do so. When the value of their purchases (stocks) falls beneath a certain amount, they are required to put up more margin to continue to participate in the market. If they don’t have the cash, they have to sell stocks to come up with it, thereby pushing the market down further. These ‘margin calls’ were the technical cause of the Great Crash of 1929.

The other reason for the drop was uncertainty, precipitating cashing out stocks to buy bonds, and reaction to the fact that no matter what anyone says, we’re not in an economic recovery, and things are getting worse. In all, the Dow Jones Index dropped 633 points during the first post-downgrade trading day, regaining a third of it the next day.

The bond market shrugged off the downgrade, meaning global investors were buying, not selling, Treasury bonds. This puts the debt cap drama and catastrophic consequence threats into scary perspective. Recall, the sky was going to fall if we didn’t bail out and subsidize the banks, too. The political fear-mongering would be laughable if it didn’t have dire consequences for the rest of us – an anemic economy unable to add jobs effectively and a banking sector floated on debt.

So, does the downgrade matter? In terms of infusing the market with more uncertainty as to whether it might lead to another one – sort of. But, in terms of Washington, it means nothing. The GOP will blame Obama for causing it by not cutting spending further. President Obama and the Democrats will act defensive and dismissive about it.

Beneath the banter, remains the stark fact that the extra debt wasn’t created to help the economy, it was created to help Wall Street. Any future political fights (and there will be many) about debt, missing that point, will therefore be unable to tackle the most important economic problem we face – lack of job and real (not paper) growth in the US and throughout the globe. Political denial and finger-pointing is not productive growth policy, no matter which party is doing what.

S&P’s downgrade got a bit of this right when it labeled Washington dysfunctional, yet, by denying there’s more to the downgrade, S&P continues to shield its own actions in the crisis build-up and Washington’s reaction to it - massive bank subsidies and a tepid bank regulation bill that didn't even break up the too big to fail banks as Glass-Steagall did in the wake of the pain banks caused leading up to the Great Depression.

A one notch ratings drop from  AAA to AA+ makes no difference to the US production capacity. Indeed, with all the scaremongering about how much more expensive it would be to borrow at a higher rate (reflecting the lower credit rating), the bond market rose in a sigh of relief that the downgrade was ‘over’ rendering the cost of the downgrade minor. As for other countries dumping our bonds, though they should because our policy remains financial market subsidization through debt creation, as long as the dollar remains the dominant global currency, other countries will lend to us though buying our Treasury bonds. They don’t want their own portfolio of US Treasuries to decline in value.

Obama stated that, “we need jobs and growth.” Absolutely. But austerity compromises won’t get us there. A reality check might. He said that Americans have come through (more denial, as we haven’t come through anything, we’re still in it) the biggest financial crisis since the 1930s with grace. He made no mention of the dual DC-banks role at all.

In the 1930s, the government made a bi-partisan decision to smack the banking system into place and separate bank trading and commercial functions so banks couldn’t take risks with other people’s money; it didn’t lavish Wall Street with cheap loans and debt at the public’s expense.

All Americans should be deeply concerned that our government supported, and continues to support, banks over people. The Treasury Department and Fed continue to mislead us over this. And we all pay the price.