…Such “investment” produces no economic growth, but it has to be paid back nonetheless. Amid the Great Recession, many worried that the entire economy of the U.S., or even the world, would be “deleveraged.” Instead, we have a new world-wide debt bubble. “The billions of taxpayer dollars that have been spent on bailing out the banks,” Aaran Fronda recently wrote in London’s World Finance magazine, “combined with huge amounts of quantitative easing and reducing interest rates to rock-bottom levels resulted in advanced economies holding the highest public debt-to-GDP ratios that had ever been seen.” Global debt of all types grew by $57 trillion from 2007 to 2014 to a total of $199 trillion, the McKinsey Global Institute reported in February last year. That’s 286% of global GDP compared with 269% in 2007. The current ratio is above 300%. The big boost came from governments. The debt load, McKinsey noted, “poses new risks to financial stability and may undermine global economic growth.”, George Melloan, “Rising Global Debt and the Deflation Threat”, The Wall Street Journal, March 8, 2016

Opinion

Rising Global Debt and the Deflation Threat

Years of deficit spending and near-zero interest rates have led to massive borrowing but little growth.

PHOTO: GETTY IMAGES

By George Melloan

Franklin D. Roosevelt’s March 1933 inaugural line “that the only thing we have to fear is fear itself” was inspiring, but wrong. There was plenty to fear, not least the deflation that then gripped the nation.

Today we’re in a new age of anxiety, with voters opting for anti-establishment outsiders like Donald Trump and Bernie Sanders. Americans are not experiencing deflation, but there are some early symptoms. More important, the potential cause is apparent.

Among symptoms, dollar prices of oil and many other commodities have slumped; the U.S. consumer-price index hardly budged in 2015. The European Central Bank and central banks in Japan, Switzerland, Denmark and Sweden are now charging commercial banks interest on their reserve deposits (negative interest rates) to try to stimulate lending.

The decline in energy prices is appropriately celebrated, but the big question is whether the Federal Reserve and other central banks can arrest a slide into a general deflationary malaise. Here is a possible reason why they can’t: Years of government “stimulus” spending are working against them.

Irving Fisher, a prominent monetary economist in the 1920s and ’30s, explained how deflation could result from an abnormal buildup of debt. A debt bubble, he wrote ( Econometrica, 1933) ultimately would burst “through the alarm of either debtors or creditors or both.” Debt will be liquidated by the distress sales of assets, the contraction of bank deposits as bank loans are paid off, and the slowing down of monetary velocity (the turnover from account to account that modulates the effective supply of money).

With falling prices come plummeting profits that force employee layoffs. The resulting pessimism and loss of confidence leads to “hoarding and slowing down still more of velocity of [monetary] circulation.” The effective money supply contracts, hence deflation. In Fisher’s view, that’s why the American economy sank into Depression in the early 1930s. (Why it stayed depressed for a decade is another story.)

When global stock markets crashed in 2008, Fed Chairman Ben Bernanke was determined not to repeat a mistake made in 1929. After that crash the Fed failed to create enough money to compensate for the sudden loss of bank liquidity and a deflationary contraction of the money stock. And so Mr. Bernanke in December 2008 lowered the Fed’s interest-rate target to an upper bound of a quarter of a percentage point and a lower bound of zero. There it stayed until the quarter point increase in December 2015.

Unfortunately, Congress also passed, at President Obama’s urging, a massive and highly politicized $831 billion “stimulus” bill a few months later. The spending did not lead to much if any growth, but it was followed by a string of trillion-dollar-plus deficits. Federal debt, a bit over $10 trillion in 2009, has ballooned to more than $18 trillion.

In other words, while Mr. Bernanke and Ms. Yellen were trying to prevent deflation, the federal government was engineering its cause, excessive debt. And the Fed abetted the process by purchasing trillions of dollars of government paper, aka quantitative easing.

Near-zero interest rates also have encouraged consumers and business to releverage. Cars are now financed with low or no-interest five-year loans. With the 2008 housing debacle forgotten, easier mortgage terms have made a comeback. Corporations also couldn’t let cheap money go to waste, so they have piled up debts to buy back their own stock. Such “investment” produces no economic growth, but it has to be paid back nonetheless.

Amid the Great Recession, many worried that the entire economy of the U.S., or even the world, would be “deleveraged.” Instead, we have a new world-wide debt bubble. “The billions of taxpayer dollars that have been spent on bailing out the banks,” Aaran Fronda recently wrote in London’s World Finance magazine, “combined with huge amounts of quantitative easing and reducing interest rates to rock-bottom levels resulted in advanced economies holding the highest public debt-to-GDP ratios that had ever been seen.”

Global debt of all types grew by $57 trillion from 2007 to 2014 to a total of $199 trillion, the McKinsey Global Institute reported in February last year. That’s 286% of global GDP compared with 269% in 2007. The current ratio is above 300%. The big boost came from governments. The debt load, McKinsey noted, “poses new risks to financial stability and may undermine global economic growth.”

The Fed says it wants to “reflate” to the tune of 2% annual inflation—which would let the U.S. Treasury, among others, work off its debt with cheaper dollars. But the Fed isn’t getting the inflation it wants and the deflation risk persists. Its desperation can be deduced from Ms. Yellen’s suggestion that she would consider negative rates. “Helicopter money”—with the Fed bypassing the banks and somehow funneling money directly to consumer accounts—is even being discussed in the press.

Ironically, voters are turning toward a developer, Donald Trump, who never met a highly leveraged project he didn’t like. As for Bernie Sanders, his wishes are simple: more federal spending and borrowing on welfare programs. Should we be worried about any of this?

Mr. Melloan is a former deputy editor of the Journal editorial page. His book “When the New Deal Came to Town” will be published by Simon & Schuster in the fall.

“Why did this take investigative reporters time and effort to uncover what happened to these (over one hundred) billion in government settlement funds and they still couldn’t account for it all? Why didn’t these various state and federal government agencies provide a full accounting to the American people as to how these funds were used?  I’ll tell you why. As far as I am aware, none of these funds were obtained as a result of the facts and truth being uncovered in a court of law. In other words, these funds were just “made up”, highly negotiated amounts between big banks and big government, where no facts were admitted and the truth was never determined about anything. Think about this fact. A lot of these funds (except where banks wrote down or renegotiated mortgages, that they mostly would have done anyway, because it was in their interest to do), didn’t go to “mortgage victims” at all!!!! If looked at skeptically and objectively, these Big Bank settlements are evidence that the liberal views about the cause of the 2008 financial crisis….that it was greedy and reckless bankers and poor regulation….is not true.”, Mike Perry, former Chairman and CEO, IndyMac Bank

Markets

Big Banks Paid $110 Billion in Mortgage-Related Fines. Where Did the Money Go?

The largest U.S. banks were penalized for their role in inflating a mortgage bubble that helped cause the financial crisis. Who got that money?

New York state is spending $50 million of bank-settlement money to build a new horse barn and make other upgrades to the grounds at the state fair. PHOTO: HEATHER AINSWORTH FOR THE WALL STREET JOURNAL

By Christina Rexrode and Emily Glazer

The nation’s largest banks paid fines totaling about $110 billion for their role in inflating a mortgage bubble that helped cause the financial crisis. Where did that money go?

In New York, the annual state fair is using bank-settlement money to build a new horse barn and stables. In Delaware, proceeds are being used to subsidize email accounts for local police. In New Jersey, a mortgage firm owned by a former reality-television star collected $8.5 million as a reward for reporting a bank’s misconduct.

Banks also helped tens of thousands of homeowners with their mortgages in neighborhoods from Jacksonville, Fla., to Riverside County, Calif., funded loans for low-income borrowers and donated to dozens of community groups and legal-aid organizations.

Yet some of the biggest chunks of money stayed with the entity that levied the fines in the first place. Of $109.96 billion of federal fines related to the housing crisis since 2010, roughly $50 billion ended up with the U.S. government with little disclosure of what happened next, according to a Wall Street Journal analysis.

The Journal reviewed the terms of more than 30 settlements, filed public-records requests with a dozen agencies at the federal and state level and spoke to dozens of homeowners and others who obtained payouts, tried to or were otherwise involved with the distribution of the settlements. The results represent the most detailed breakdown yet of the billions paid out in the unprecedented deals.

The Wall Street Journal analyzed more than 30 settlements from the nation’s six largest banks. See an in-depth breakdown of who received the funds.

Out of the $110 billion, the Journal found that:

• The Treasury Department received almost $49 billion of the funds, including money the agency received directly and sums funneled to it by other departments, including government-chartered housing associations Fannie Mae and Freddie Mac. How the money is spent isn’t specified.
• About $45 billion was earmarked for “consumer relief,” a category that includes money dedicated to helping borrowers and funding housing-related community groups.
• The Justice Department, whose prosecutors led many of the negotiations with banks, collected at least $447 million. How it spends the money isn’t specified.
• States received more than $5.3 billion, usually to spend as they saw fit. Almost all states received payments from a national settlement in 2012 over mortgage-servicing abuses, and seven also received payments in the Justice Department’s blockbuster mortgage-securities settlements that started in 2013.
• Roughly $10 billion went to other recipients, including housing-related federal agencies, two federal agencies responsible for cleaning up failed banks or credit unions, and whistleblowers who helped the Justice Department. Some funds from these deals typically revert to the Treasury.

The White House said tens of billions of dollars have been recovered for American consumers since 2009, including funds that went to government agencies and programs and the Treasury, according ​to Deputy White House Press Secretary​Jen Friedman.

The lack of detailed disclosure bothers some people. “The government has a responsibility to its citizens to be transparent about where its revenues are going,” said Aaron Klein, who focuses on financial regulation for the Bipartisan Policy Center in Washington, D.C. “When settlement funds just go into the black box of the general fund of the government, who is accountable?”

Bank executives grumble privately about the opaque process and are critical the government didn’t ensure more money went to housing-related issues.

Given the historic scope of the fines, the money “shouldn’t just be a slush fund,” said Francis Creighton, executive vice president of government affairs at the Financial Services Roundtable, an industry group.

The settlements arose from bank behavior prosecutors said fueled the housing crisis and aggravated its effects. Among other things, banks were accused of pushing expensive mortgages on unqualified borrowers, selling hundreds of billions of dollars of securities that they knew were likely toxic and filing fraudulent paperwork on people being booted from their homes.

The Journal analysis included fines paid by the four biggest U.S. banks— Bank of America Corp., J.P. Morgan Chase & Co., Citigroup Inc. and Wells Fargo & Co.—as well as investment banks Morgan Stanley and Goldman Sachs Group Inc. One settlement, the Justice Department’s $16.65 billion deal with Bank of America, was the biggest ever imposed by the U.S. government on a single entity.

The analysis excluded settlements from private lawsuits—including some investor suits that resulted in multibillion-dollar payouts—as well as fines levied on banks for conduct outside the housing and mortgage crisis.

Fines generally are funneled to the Treasury, which manages the federal government’s finances. There, the money goes into the government’s general fund, where it can be spent on any budgeted item, including employee salaries or reducing the deficit. The Treasury Department said the settlement money isn’t specifically tracked.

A spokesman, Rob Runyan, said the funds are “spent as Congress authorizes.”

Massachusetts determined Karen Lojek, a staff accountant at a manufacturing company, had been harmed by a deceptive loan that violated state lending laws, and awarded her $19,600 from settlement money the state received. PHOTO: CHERYL SENTER FOR THE WALL STREET JOURNAL

Most of the money attributed to Treasury in the analysis came indirectly. Fannie Mae and Freddie Mac, which buy loans from lenders and package them into securities, and their regulator, the Federal Housing Finance Agency, collected more than $34 billion in fines. The bulk was transferred to Treasury, which spent $187.5 billion to bail out Fannie and Freddie during the financial crisis.

The housing companies said they have been profitable since 2012 and have together paid the Treasury about $246 billion in dividends.

There is precedent for broad use of penalties. Funds from a 1998 deal for tobacco companies to pay states an estimated $200 billion over 25 years, intended to help states pay for smoking-related health costs, have also been used to balance state budgets and to fund school reading programs, after-school services and infrastructure.

A Justice Department spokesman, Patrick Rodenbush, said the bank settlements “hold financial institutions accountable for various forms of fraud in the mortgage industry” and that the money compensated “government agencies and programs harmed by the banks’ conduct.”

In three major settlements analyzed by the Journal—$13 billion from J.P. Morgan Chase, $7 billion from Citigroup and the $16.65 billion from Bank of America—banks were censured for misleading investors about shoddy mortgage securities. The Justice Department played the lead role in doling out pieces to other agencies and states involved in the litigation, according to people involved in the lawsuits.

Seven states, most with attorneys general who played important roles in previous litigation against the banks, participated directly in those settlements and received funds for special projects and local residents.

In New York, Gov. Andrew Cuomo is using proceeds to help replace the Tappan Zee Bridge north of New York City, renovate the Port of Albany and provide high-speed Internet access in rural communities.

Last year, when Mr. Cuomo announced in a speech that the New York state fair would get $50 million for an overhaul, Troy Waffner, the acting director of the fair, jumped up and down and called his mother. The fair will use the funds for improvements like a bigger concert stage, making the grounds more accessible to the disabled and an equestrian facility with warm-water washing stations for the horses.

Some New York housing advocates said more money should have been directed to areas directly affected by the financial crisis. Mr. Waffner is among those who support a broader distribution. “The more money we can invest in bringing back the economy…I don’t think that’s a bad use of funds,” he said.

Gov. Cuomo’s office said his own $20 billion, five-year investment in affordable housing, homeless services and related programs, “far exceeds what the state has collected from financial settlements,” said Morris Peters, a spokesman for Mr. Cuomo’s budget office.

Most states have directed settlement funds to state pension plans, which oversee savings accounts for public employees such as teachers, judges and other government workers. Many of those funds had invested in mortgage securities that went sour during the crisis. California sent the bulk of its $700 million in bank penalties to its two biggest state pension funds. The office of state Attorney General Kamala Harris said it held back $28 million for itself “to support this and related litigation.”

Out of the $110 billion in settlements, the Justice Department retained at least $447 million, the Journal’s analysis showed. The department keeps up to 3% of most civil fines collected, in its Three Percent Fund. It isn’t required to disclose how much money it puts in the fund or how it is spent.

Last year, a report by the Government Accountability Office, the investigative arm of Congress, estimated the Three Percent Fund collected $158 million from all eligible civil fines in fiscal 2013.

Diana Maurer, a GAO director, said her office believes the Justice Department should develop better plans for the use of the Three Percent Fund. The Justice Department countered, according to Ms. Maurer, and said it wanted to avoid creating improper incentives for prosecutors.

“They did not want to plan out” the spending for the long term, Ms. Maurer said. “And we said, ‘No, you really should, this is hundreds of millions of dollars.’ ”

The Justice Department didn’t comment on the use of the fund.

Banks agreed to provide an estimated $45 billion from the settlements in the form of consumer relief.

For example, according to the independent monitor overseeing Bank of America’s $16.65 billion agreement—which sets aside $7 billion in consumer relief—the bank has so far modified mortgages for nearly 20,000 homeowners and made loans to more than 21,000 borrowers who are low-income, lost their previous homes to foreclosure or live in parts of the country hit especially hard by the housing crisis. The monitor, mediator Eric Green, said the bank has completed nearly 60% of its obligations.

Bank of America declined to comment beyond Mr. Green’s report.

Six years after the end of the recession, the housing sector is still on unsteady ground. Home prices have rebounded, but the weak pace of new home construction and a lack of first-time buyers raise concerns. A million homeowners or more are facing foreclosure, by industry estimates.

Massachusetts determined Karen Lojek, a staff accountant at a manufacturing company, had been harmed by a deceptive loan that violated state lending laws, according to the state attorney general’s office.

Ms. Lojek bought her Methuen, Mass., home in 2004. Her husband died soon after, leaving her struggling to make ends meet.

At the end of 2014 she learned she would receive $19,600, part of $80 million the Massachusetts attorney general’s office received in certain settlements.

The windfall only reduced her overall mortgage debt and didn’t cut her monthly payment of about $1,300, which is scheduled to climb when her interest rate resets in December.

Ms. Lojek estimated she now owes about $235,000 on the house, which is worth roughly $200,000.

“It just doesn’t make sense,” Ms. Lojek said. “With all the settlements that were made, I thought maybe it would all be fixed. How can I still be in this situation with everything that supposedly happened to correct the situation?”

…Preparing for higher rates involves hedging the duration mis-match between long-duration, fixed-rate, loans and securities and short-term and/or variable rate deposits or just frankly selling these assets before rates rise.”, Mike Perry

March 9, 2016, Aaron Back, The Wall Street Journal

Markets
Heard on the Street

How Big Banks Have Prepared for Higher Rates

The biggest U.S. banks have been actively preparing for higher interest rates, but yields haven’t played along

The Federal Reserve’s tightening of short-term rates hasn’t translated to increases in long-term yields. PHOTO: ANDREW HARNIK/ASSOCIATED PRESS

By Aaron Back

What if they build it and the Federal Reserve doesn’t come?

Big U.S. banks have continued to construct balance sheets that are ready for a rising interest-rate environment. So far, though, to little avail.

The four biggest banks— J.P. Morgan Chase, Bank of America, Citigroup and Wells Fargo —all substantially increased the portion of their securities that are classified as “held to maturity” in 2015. This seemingly arcane technical adjustment is essentially a way to protect against the downside to their massive bondholdings that could result from higher rates.

The big four designated an average 18.1% of their securities holdings as held to maturity at the end of 2015. That was up from 14.2% the previous year, according to regulatory data.

The biggest jump was at Wells Fargo, where held-to-maturity securities rose to 23% from 17.7% at the end of 2014. Just a few years ago, Wells Fargo had no held-to-maturity debt.

The significance of designating holdings as held to maturity is that it insulates a firm from short-term changes in their value. If, on the other hand, bonds are classified as being “available for sale,” gains or losses flow through to shareholders equity. Although this doesn’t affect earnings, it does impact book values and capital.

The downside of designating more bonds as being held is that banks lock themselves into holding this debt. They can’t generally take advantage of price gains should yields fall instead of rise. Should a bank decide to sell some of this held-to-maturity debt, the whole portfolio would have to be reclassified as available for sale. That would subject banks to a wider range of price volatility.

Apparently, the risk of being locked in is one the banks have judged worth taking. Ironically, though, rates overall have moved lower since the end of 2015. The Fed’s tightening of short-term rates hasn’t translated to increases in long-term yields. Indeed, so far this year the yield on 10-year Treasurys has fallen steeply, from 2.3% to less than 1.9%.

That likely means many available-for-sale securities have risen in value. Banks won’t gain from that, at least from holdings now designated as being held to maturity.

Still, caution is warranted. Banks have worked hard to bring their capital cushions in line with the new, stricter regulatory environment. They would hardly want capital and book value to be eroded by upward interest-rate moves when yields are at such low levels.

Bond yields have flummoxed traders the world over for some time now. For big banks backed by deposit insurance, and ultimately, taxpayers, there is no shame in holding to a better-safe-than-sorry approach.

……..Now, it’s certainly possible that a President Trump would seed the federal agencies with men and women who would abuse their powers….In real life, however, the compulsion to decree to one’s neighbor what’s best for him (and use the federal government to enforce it) is an affliction of modern American liberalism. In other words, the kind of people Hillary Clinton, if elected, would rely on to fill the federal bureaucracies, every last one of them eager and willing to impose rules on the American people that would never fly in Congress….The result is the effective transfer of power from the American people acting through their elected representatives to the American people being told what to do….and threatened with crushing fines if they do not…..by federal bureaucracies that use the vague congressional language in everything from Dodd-Frank to the Affordable Care Act to impose their own interpretations. Even worse, under the Supreme Court’s 1984 Chevron decision, the courts are basically told they must defer. President Obama didn’t create rule by the administrative state. But he may have best captured its spirit two years ago when, in response to a question about congressional resistance to his agenda, he declared his pen mightier than law. “I can use that pen to sign executive orders and take executive actions and administrative actions that move the ball forward.” And he now has. Now he hopes to pass the pen to Mrs. Clinton. And surely the one Hillary promise we can all believe is that, when it comes to ruling by executive fiat and using the federal bureaucracies to impose her agenda, she stands to outdo even Mr. Obama. Which leaves us here: At a moment when the media is thick with characterizations of Donald Trump as the new Hitler, America might do well to devote some attention to the soft despotism of the woman who promises to further embolden this unelected, unaccountable and out-of-control fourth branch of government.”, William McGurn, Hillary’s Soft Despotism, March 15, 2016

…While, to his credit, Sanders has supported the full audit of the Federal Reserve long advocated for by Ron Paul, he has fully advocated for the Fed to double down on these very same policies. In fact, almost every example the left points to regarding a “rigged economy” can be directly linked to the State. Be it Pharma Bro and the broken pharmaceutical industry, or the cost of healthcare in America, or the burden of student loans being felt by Millennials across the country, the market is blamed for the sins of government. Capitalism is demonized for the evils of interventionism.

As Ludwig von Mises wrote in Human Action:

[Advocates of government intervention] blame the market economy for the consequences of the very anticapitalistic policies which they themselves advocate as necessary and beneficial reforms. They fix on the market economy the responsibility for the inevitable failure and frustration of interventionism.

Unfortunately this anti-capitalist mentality continues to dominate politics today. Until that changes, politicians like Sanders will continue to find success demonizing a rigged economy they bear personal responsibility for creating.” Excerpt from The Mises Institute, March 9, 2016

…Clearly, the government’s well-intended policy to ban geography and therefore prevent racial discrimination (“red-lining”), also means that consumer and mortgage underwriting and risk-based pricing models are flawed. In other words, well-intended government is once again distorting free and fair markets from making the most rational economic decision. This is just one simple example of how our government distorts rational private markets, yet when these markets fail, government inevitably blames the failure on the private sector and not the government’s distortions. That’s the 2008 financial crisis in a nut-shell.” Mike Perry, former Chairman and CEO, IndyMac Bank

March 8, 2016, Ianthe Jeanne Dugan and Telis Demos, The Wall Street Journal

Markets

Online Finance Draws on Geographical Data, Raising Questions

Traditional lenders have been sued by federal regulators for skipping neighborhoods

Harlan Seymour set up a computer program to invest in consumer loans that filtered out potential bets partly on geography. As a result, he put more money into thriving places such as La Jolla, Calif., above. PHOTO: GETTY IMAGES

By Ianthe Jeanne Dugan and Telis Demos

When Harlan Seymour wanted to invest in consumer loans in 2014, the software engineer set up a computer program that filtered out potential bets partly by where a borrower lives.

The strategy paid off. He said he earned about 8.5% over the next year on hundreds of thousands of dollars in loans he funded on electronic lending sites that arrange loans for borrowers and then sell the loans to investors. “I found that the economic health of a borrower’s city affected loan performance,” said Mr. Seymour, 54 years old, of San Mateo, Calif.

Mr. Seymour’s strategy shows how the fast-growing online-finance business has brought a new twist to one of the most sensitive topics in lending: geography. Lenders, including these online services known as “peer to peer” marketplaces, aren’t allowed to discriminate based on age, race and other factors. Skipping neighborhoods, or marketing to one neighborhood over another, has been the basis for “redlining” suits in which federal regulators accuse banks of discrimination.

The fair-lending rules were written before the boom in online lending. And they don’t deal specifically with the investors who fund the loans online.

That has created questions about whether it is appropriate for investors in online loans to look at geographic data, something some say is important to their investment choices.

“It may be unclear whether the investors in marketplace loans would have liability,” said Jo Ann Barefoot, a senior fellow at the John F. Kennedy School of Government’s Mossavar-Rahmani Center for Business and Government at Harvard University and a former adviser to the Consumer Financial Protection Bureau. “It almost certainly falls in the growing realm of regulatory gray space.”

The Equal Credit Opportunity Act, for example, defines creditors as lenders who make credit decisions and set terms, such as interest rates. It doesn’t specifically refer to investors in these platforms, which didn’t yet exist when the act was passed in the 1970s.

The CFPB, one of the agencies that enforce federal fair-lending laws, is beginning to review the structure of new lending platforms, said people with knowledge of the government agency’s research.

The agency said it aims to ensure that companies aren’t incorporating potentially discriminatory factors into marketing or underwriting.

More than $37 billion in U.S. consumer and business digital marketplace loans were made from 2007 to 2015, said analysts at Autonomous Research.

About 16% of people who buy loans from online marketplaces use a borrower’s state to make lending decisions, said NSR Invest, a marketplace-lending investment-advisory firm.

The two largest sites that sell loans to retail investors, LendingClub Corp. and Prosper Marketplace Inc., said they don’t discriminate or enable their investors to discriminate and don’t make potentially discriminatory data available. In late 2014, for example, LendingClub in its public filings stopped disclosing the city or neighborhood where a borrower lives beyond the first three digits of the ZIP Code, which often refers to a broader region.

The more broad the territory—skipping states for example—the less risky legally, regulators say. Some state regulators have at times barred online lending, so some states have been left out anyway.

Still, many investors say they consider geography and other unconventional factors when funding loans. Many hold loans that were made when more narrow data about geography was available.

“Plenty of investors, myself included, avoid Florida and Nevada,” said Simon Cunningham, a peer-to-peer investor who runs an online information service called LendingMemo Media LLC. He extolled his philosophy in a piece he posted online in 2014 titled, “The Joy of Redlining: Why I Never Lend Money to Florida.” He said the state had lower returns in his analysis.

“If you’re an investor and you’re not discriminating by race, then filtering by state seems like a great way to earn a higher return,” he said. “Why would I take on extra risk?”

Ashees Jain, a founder of a peer-to-peer investment firm called Blue Elephant Capital Management in Irvington, N.Y., with about $100 million in assets, said that when oil prices began dropping in 2014, the firm stopped lending in Texas, Pennsylvania and Virginia.

“We are now seeing unemployment going up there,” he said. “These are three- and five-year loans. So we need to think ahead.”

At Asset Avenue Inc., an online platform that connects investors with small real-estate entrepreneurs, ZIP Codes are among the criteria, along with type of property and the borrower’s credit rating. “Geography is a very large indicator of the quality of a loan,” said David Manshoory, president.

The program created by Mr. Seymour, the software engineer, weighed unemployment, per-capita income, real estate and other statistics to calculate the health of a city. He said he didn’t consider race or age.

Following the program, he put more money into thriving communities such as La Jolla in San Diego and less into less thriving places. He said the program could be applied to municipal bonds and other investments.

“It’s not my obligation to fund a whole region,” Mr. Seymour said. “Investors have a right to know the true default risk.”

…He’s talking mainly about insurance companies and pension funds, a topic he’s hit on a number of times. “And the damage extends to all savers; households worldwide that saved/invested money for college, retirement or for medical bills. They have been damaged, and only now are becoming aware of it.” Negative rates are “an enigma to almost all global investors,” he says, that undermine the basic architecture of the financial markets. “But central bankers seem ever intent on going lower, ignorant in my view of the harm being done to a classical economic model that has driven prosperity – until it reached a negative interest rate dead end and could drive no more.” Mr. Gross takes note of the “somewhat suspicious uniform attack on high denomination bills,” the sudden crop of arguments against the $100 U.S. bill or the €500 euro. Why might that be? “ It appears that the one remaining escape hatch for ordinary citizens is being closed,” he wrote. “The cashless society which appears over the horizon may come sooner than the demise of the penny.” If actually banning cash doesn’t do the trick, the central bankers might be forced into literal “helicopter” drops of money (or perhaps, in the parlance of the times, that should be drone drops). “Can any/all of these policy alternatives save the system?” he asked. “We shall find out, but current evidence of the past seven years’ experience would support only a D+ report card grade.”,Paul Vigna, “Bill Gross: Negative Rates Are Finance Economy’s Last, Dying Gasp”, The Wall Street Journal, March 4, 2016

MoneyBeat

Bill Gross: Negative Rates Are Finance Economy’s Last, Dying Gasp

By Paul Vigna

PHOTO: REUTERS

Much like the sun, the financialization of the economy has provided an endless stream of fuel for growth, Janus Capital Bill Gross said in his latest outlook letter. Unlike the sun, though, which has a good five billion years left in it, the finance economy’s fuel is just about spent. The move into the black hole of negative rates might just be the final act, Mr. Gross added

“Instead of historically generating economic growth via a wealth effect and its trickle-down effect on the real economy, negative investment rates and the expansion of central bank balance sheets via quantitative easing are creating negative effects,” he wrote. Negative rates threaten bank profits as well as any business models that depend upon 7-8% annual returns on assets. He’s talking mainly about insurance companies and pension funds, a topic he’s hit on a number of times. “And the damage extends to all savers; households worldwide that saved/invested money for college, retirement or for medical bills. They have been damaged, and only now are becoming aware of it.”

Negative rates are “an enigma to almost all global investors,” he says, that undermine the basic architecture of the financial markets. “But central bankers seem ever intent on going lower, ignorant in my view of the harm being done to a classical economic model that has driven prosperity – until it reached a negative interest rate dead end and could drive no more.”

Mr. Gross takes note of the “somewhat suspicious uniform attack on high denomination bills,” the sudden crop of arguments against the $100 U.S. bill or the €500 euro. Why might that be? “ It appears that the one remaining escape hatch for ordinary citizens is being closed,” he wrote. “The cashless society which appears over the horizon may come sooner than the demise of the penny.” If actually banning cash doesn’t do the trick, the central bankers might be forced into literal “helicopter” drops of money (or perhaps, in the parlance of the times, that should be drone drops).

“Can any/all of these policy alternatives save the system?” he asked. “We shall find out, but current evidence of the past seven years’ experience would support only a D+ report card grade. Barely passing. As an investor though – and as a citizen in this election year – you should be aware that our finance based economic system which like the sun has provided life and productive growth for a long, long time – is running out of fuel and that its remaining time span is something less than 5 billion years.”

The investment implications are rough. He cautions against reaching for yield, or buying the “momentum-driven higher prices” of government bonds. “A 30-year Treasury at 2.5% can wipe out your annual income in one day with a 10 basis point increase,” he writes. Instead, he advocates searching out bonds with shorter maturities with attractive yields “in a mildly levered form.” That should provide a 5-6% return with some cover on the downside.

“No guarantees,” he says.

…for years and hurt the economy and employment. How so? In this case, don’t you think VW or any German or European firm, for that matter, will feel pretty negative and uncertain about conducting business and/or investing the U.S. in the future, given these unusual and arbitrary actions by our current government officials? It would be far better if the individual politicians and government officials respected The Rule of Law and The Constitution, so we all knew in advance what was expected (and the consequences) and frankly cared less about whether a liberal or conservative administration was currently in charge of our government. I believe the time has come to create “a stick” for politicians and government officials who don’t respect The Rule of Law and The Constitution. If you hold government enforcement power and were grossly negligent and willfully ignored The Rule of Law and The Constitution (and had your decisions overturned by our Courts), you should be criminally prosecuted. If you were not grossly negligent, but you have had two reversals by our Courts, your time as a politician or government official should be over, permanently. In this way, it will be rarer that individuals or groups within our government abuse their enforcement power against individuals or private institutions (which are just group’s of individuals).”, Mike Perry

March 8, 2016, Devlin Barrett and Aruna Viswanatha, The Wall Street Journal

Business  

U.S. Pursues New Tack in VW Emissions Probe

Federal prosecutors employ financial-fraud law and weigh tax charges over fuel-efficiency credits

Government prosecutors are pursuing auto maker Volkswagen over its marketing and sales of diesel-powered cars in the U.S., including now looking at charges over tax credits for fuel-efficient vehicles. PHOTO: VOLKSWAGEN/YOUTUBE/ASSOCIATED PRESS

By Devlin Barrett and Aruna Viswanatha

WASHINGTON—The Justice Department is expanding its probe of Volkswagen AG using a far-reaching law against bank fraud to go after the German auto maker over emissions cheating, and it is looking at possible violations of tax laws, according to people familiar with the probe.

The Justice Department has issued a subpoena under the Financial Institutions Reform, Recovery and Enforcement Act, or Firrea, to pursue possible wrongdoing at Volkswagen, these people said.

That is a novel use of the civil financial fraud law that the Obama administration deployed to extract record-setting multibillion-dollar settlements from big banks in the wake of the 2008 financial crisis. It suggests the car maker faces another potential source of penalties after admitting it used illegal software that allowed diesel-powered vehicles to pollute more on the road than during government emissions tests.

Prosecutors also have used Firrea to probe alleged misdeeds in the auto loan industry, but the Volkswagen subpoena marks the first known instance of the government using a banking law to pursue potential wrongdoing that is not directly linked to financial misconduct.

Using the law this way “is pushing the legal theory to its outermost limits, against a defendant that is not particularly sympathetic,’’ said John Coffee, a law professor at Columbia University who studies white-collar prosecutions.

The company already faces a multifront fight—including battling the Environmental Protection Agency, the Justice Department’s criminal division, state attorneys general and civil lawsuits from car buyers—over alleged fraud in marketing the fuel efficiency of some 580,000 of its vehicles in the U.S.

A Volkswagen spokeswoman declined to comment on its discussions with regulators. “We are committed to regaining the trust of our customers and dealers and will continue to cooperate with all relevant government agencies,” the spokeswoman said.

‘Everybody would like a little credit for doing something to Volkswagen.’

—John Coffee, Columbia University

The new investigation comes as German prosecutors widened their criminal investigation into the emissions scandal to include 17 people.

A Firrea-based investigation adds a front that could pose new issues because the statute allows the Justice Department’s civil division lawyers to look back at conduct over 10 years, twice as far as many fraud statutes allow.

“This has become a competition among enforcers, and you’re now getting a free-for-all without much coordination,’’ said Mr. Coffee who added that among government agencies, “everybody would like a little credit for doing something to Volkswagen.’’

Volkswagen has set aside $7.3 billion to cover the cost of fixing the tainted engines, and said an internal investigation found a “chain of mistakes’’ and a “culture of tolerance’’ for rule-breaking led to the cheating and deception. The scandal resulted in the ouster of former CEO Martin Winterkorn, as the company faces more than $18 billion in fines from the civil lawsuit the Justice Department filed in January on behalf of the EPA.

Using Firrea, the department’s civil division is now exploring whether lenders were harmed by financing customers’ purchases of the cars under inflated values, the people said. The law permits investigations of potential fraud “affecting” financial institutions. The resale value of the diesel cars has dropped since the software use became public last September.

Firrea was originally passed in 1989 in response to the savings and loan crisis as a way of probing fraud in the banking industry. In recent years, it was used to investigate big banks that packaged shoddy mortgages into securities that lost much of their value when the U.S. housing market collapsed. Those probes led to record-setting settlements with J.P. Morgan Chase & Co., Bank of America Corp., and others.

The law gives criminal prosecutors and civil government lawyers flexibility to share information, making it an attractive option for the government. If prosecutors get the information through a grand jury subpoena, they are generally unable to share it with their civil counterparts. “The advantage of doing it this way is that your hands aren’t tied,” said former civil frauds prosecutor Brian Feldman, who is now a lawyer at Harter Secrest & Emery LLP.

In the Volkswagen case, federal prosecutors also are examining whether the company may be on the hook legally and financially for customers who obtained tax credits when they bought cars they thought emitted fewer pollutants than they actually did, the people familiar with the matter said. Before 2011, Americans could receive $1,300 tax credits for purchasing certain clean burning vehicles, including some of the Volkswagen models at issue in the case.

Volkswagen remains in discussions with the government to create a fix for the cars. Last week, Volkswagen representatives met with U.S. officials at the Justice Department to argue they would be unable to meet a March 24 deadline to provide an update on how the company plans to fix the emissions software in existing cars, according to people familiar with the discussions.

A federal judge overseeing the civil case along with hundreds of lawsuits filed by Volkswagen customers had set the deadline, and said he would move the litigation along quickly if authorities didn’t approve any offered resolution by then.

…and related financial and economic crises not on their own well-intended distortions of free and fair markets, but inappropriately on irrational consumers and the “greedy and reckless” private sector. This ironically then leads to more government central planning of our economy….like China! That makes no sense, right? Then why do so many Americans buy this false line (without reason) by liberals in our government? Think about this fact: The banking and mortgage lending businesses, even pre-crisis, were some of the most heavily government-regulated industries in our Country and whose financial activities/decisions could be easily distorted by the central bankers at the Fed through monetary policy. In other words, the reality is that higher government involvement/central planning seems to correlate with the increased risk of asset bubbles/busts and financial crises/economic instability.”, Mike Perry

March 6, 2016, Mark Magnier and Lingling Wei, The Wall Street Journal

World

China’s Leaders Put the Economy on Bubble Watch

Beijing aims to spur key sectors as growth slows, but officials are cautious about a buildup of debt

Chinese Premier Li Keqiang, right, and President Xi Jinping during the opening session of the National People’s Congress in Beijing on Saturday. PHOTO: ASSOCIATED PRESS

By Mark Magnier and Lingling Wei

BEIJING—China’s leaders made clear they are emphasizing growth over restructuring this year, but suggested they are trying to avoid inflating debt or asset bubbles as they send massive amounts of money coursing through the economy.

The government’s announcement of a 6.5% to 7% growth target for 2016 at the start of the National People’s Congress over the weekend came with subtle acknowledgment that some of its efforts to jump-start a persistently decelerating economy have misfired, failing to steer stimulus to the most productive sectors.

In his report to the annual legislative session, which opened Saturday, Premier Li Keqiang promised tax cuts that could leave companies with more money to invest. And for the first time, the Chinese government specified total social financing—a broad measure of credit that includes both bank loans and nonbank lending—as a metric for helping determine monetary policy.

In the past, leaders have just said total social financing should be kept at an appropriate level, while they have set clear targets for M2 money supply, which covers all cash in circulation and most bank deposits.

Both measures have increased sharply in recent months. But the money-supply measure fails to capture how banks and financial institutions use the funds. For instance, M2 jumped 13.3% last year while total social financing grew 12.4%, according to official data. The discrepancy indicates not all deposits were used by banks to make loans to companies; instead, some of the funds were tapped for such purposes as margin loans for stock-market speculation.

This year, the two targets are paired, with both set to rise 13%. “The government seeks to more accurately show where the money is going, and whether credit is being used to support the real economy,” said Sheng Songcheng, head of the central bank’s survey and statistics department, in an interview.

China’s past efforts to direct credit to entrepreneurs and other desired sectors of the economy have fallen short. And its loose monetary policy risks giving inefficient companies more room to avoid shutting down or retooling.

Much of China’s breakneck growth over the past two decades has been fueled by state-led investment and debt. Concerns about a credit buildup have grown as the economy has slowed.

The recent sharp rise in money supply—which rose 14% in January from a year earlier—“enlivens” capital markets but bears careful monitoring, said Fu Yuning, chairman of China Resources Holdings Ltd., a diversified conglomerate with interests from real estate to energy. “We are closely watching the financial risks that come from the increase in monetary supply,” Mr. Fu said on the sidelines of the National People’s Congress.

Companies’ financial liabilities now amount to 160% of gross domestic product, up from 98% in 2008, according to estimates by ratings firm Standard & Poor’s Financial Services LLC. That compares with around 70% for U.S. firms.

Bad loans reached 1.67% of bank portfolios at the end of 2015, according to the China Banking Regulatory Commission, the highest since June 2009. Analysts believe the figure widely understates the problem. Last week, Moody’s Investors Service downgraded its outlook for China’s sovereign debt, along with that of 25 financial institutions and 38 state-owned companies.

Xu Shaoshi, head of China’s planning agency, played down both both Moody’s concern about rising debt and fears of mass layoffs, saying that some companies have cut workers’ hours and salaries but have kept them on the payroll, and that new jobs are being created in the service sector and by private enterprises. “All predictions of a hard landing will definitely fail,” he told reporters on the sidelines of the legislative meeting Sunday.

China says it needs to post at least 6.5% growth through 2020 to double per capita income over 2010 levels in time for the Communist Party’s 100th anniversary in 2021.

Zhang Liqun, researcher with the State Council’s Development Research Center, said China can achieve that without undermining its reshaping of the economy. “Economic growth and restructuring are not contradictory,” he said.

But China’s plan to reform the state-owned sector is vague, suggesting that many debt-ridden giants will retain preferential access to markets and cheap financing, disadvantaging the entrepreneurs China is counting on to power the economy as manufacturing, foreign trade and investment weaken.

Private-sector delegates at the meeting were heartened by Mr. Li’s pledge to reduce corporate taxes and fees this year. “We just want to be treated equally, alongside state-owned enterprises,” said Chen Zhilie, executive chairman of EVOC Intelligent Technology Co. Ltd.

But many of the new engines that Beijing has identified to spur growth are untested in China. Mr. Li expects that 60% of China’s economic growth in coming years should come from scientific and technological advances, a sharp departure for an economy where spending on fixed assets such as factories and apartments accounts for half the output.

Among the spending pledges Mr. Li outlined over weekend was 800 billion yuan ($123 billion) for railway construction and 1.65 trillion yuan to build roads, in line with traditional formulas for investment-led growth, often via infrastructure projects.

Mr. Li said China would increase its budget deficit to 3% of GDP from 2.3% last year, a move that could allow authorities to cut taxes on businesses to free up more of their funds for innovation and other investments.

But economists said the move might have limited impact. According to calculations by Goldman Sachs Group Inc. and other banks, the actual deficit last year was closer to 3.5% of GDP when spending from off-the-books government accounts is included.

“There is little chance of a big fiscal stimulus,” said Commerzbank AG economist Zhou Hao.

Officials at China’s central bank had urged policy makers to let the shortfall reach 4% or 4.5% of GDP, according to a recommendation reviewed by The Wall Street Journal.

—Chuin-Wei Yap contributed to this article.

…In other words, markets seem to believe that the Greenspan put has become the Yellen put. It’s not without basis, at least from historical analysis of the Fed’s behavior. A 2011 studyby Pamela Hall of the Swiss National Bank found that a model to describe Fed policy from 1987 to 2008 was more accurate when it included a reaction to asset declines than if it used purely economic indicators. And to the degree that the Greenspan put is real, and continues, it raises difficult questions. It might seem great to keep markets from falling too much, but that can create complacency and just encourage investors to take greater risk — creating much more damage when the bubble ultimately pops. This arguably is part of what happened in the 2008 financial crisis: that years of Greenspanian work to keep markets from plummeting had made the entire financial system brittle and overleveraged.”, Neil Irwin, “Fed’s 3 Mandates: Price Stability, Jobs, and….Wall Street?”, The New York Times, February 28, 2016

Fed’s 3 Mandates: Price Stability, Jobs and … Wall Street?

Economic View

By NEIL IRWIN

Suppose a visitor from the future comes and tells you these facts about the financial markets in the year 2030: The stock market has fallen sharply, as have the price of oil and investors’ expectations for interest rate increases over the next couple of years.

You would probably assume that the economy was heading down the tubes and in real trouble, quite possibly moving toward a recession.

A different visitor from the future arrives and tells you of this state of the world in 2035: The jobless rate is below 5 percent, and employers are hiring at a rapid clip and giving workers their biggest raises in years. Service industries that account for a large percentage of the economy are growing nicely, and consumers are spending money at a steady pace. Everything is just fine.

You’ve surely already guessed that both these descriptions apply to the United States in 2016, with big implications for businesses of all stripes and for the presidential election. But the tension — between a miserable few months in the financial markets and generally solid economic data — also exposes one of the thorniest questions with which policy makers at the Federal Reserve must grapple.

Alan Greenspan in 1987. Credit George Tames/The New York Times

Should they believe market data or economic data? Bloomberg or FRED? That is, should they rely on the information that appears on the financial data terminals many Fed officials keep on their desks, or on economic indicators conveniently collected in the Federal Reserve Economic Data database?

If it’s market data, then Janet L. Yellen, the Fed’s chairwoman, and her colleagues should forestall any further interest rate increases indefinitely and perhaps reverse their quarter-point increase in December and entertain instead more radical easing measures. If it’s economic data, they should feel comfortable proceeding with pushing interest rates higher.

But beneath that question lies an even harder one. Can Ms. Yellen wean the economy off what is often called “the Greenspan put?” And should she?

The Greenspan put is the idea — much disputed within the halls of the Fed, but taken for granted in much of the financial world — that the central bank will forever stand willing to intervene to keep markets from falling too much. Greenspan is, of course, Alan Greenspan, the Fed chairman from 1987 to 2006, and a put is an options contract that insures against decline.

Perhaps most famously, in October 1987, the morning after the stock market crashed, the Fed offered this one-sentence statement: “The Federal Reserve, consistent with its responsibilities as the nation’s central bank, affirmed today its readiness to serve as a source of liquidity to support the economic and financial system.”

It did the trick. The market stabilized, and the United States economy kept growing for four more years. Eleven years later, when a crisis in emerging markets seemed to threaten the booming American economy, the Fed cut interest rates three times, successfully containing the damage. When the dot-com bubble was collapsing in 2001, it did the same, less successfully.

In each case, Fed officials argued that they were not focused on trying to prop up the market for its own sake, but were trying to keep the economy on an even keel despite market turmoil. When the stock market drops, Americans are less wealthy and so would be expected to spend less money, and capital is more expensive for businesses, which would tend to make them less inclined to invest.

While headlines tend to focus on the stock market during periods of turmoil, these episodes usually involve a lot more happening in the financial world beneath the surface, like the interest rates on riskier bonds spiking relative to those of safer bonds, and the drying up of credit availability. In effect, the Fed cut rates in these episodes not to try to bail out investors in the stock market, but to offset these effects for ordinary consumers and businesses.

That’s the line you’ll hear from Fed officials, anyway. The challenge is that, in practice, this behavior looks an awful lot like the Fed stepping in to bail out the stock market — so much so that financial markets tend to price in lower future interest rates whenever there is a drop in the stock market, as has happened in the early weeks of 2016.

The Fed started the year with signals that it would most likely raise its short-term interest rate target four times in 2016. After an approximately 10 percent drop in the Standard & Poor’s 500-stock index — but steady economic data — futures markets now suggest only one rate rise is the most likely outcome. In other words, markets seem to believe that the Greenspan put has become the Yellen put.

It’s not without basis, at least from historical analysis of the Fed’s behavior. A 2011 study by Pamela Hall of the Swiss National Bank found that a model to describe Fed policy from 1987 to 2008 was more accurate when it included a reaction to asset declines than if it used purely economic indicators.

And to the degree that the Greenspan put is real, and continues, it raises difficult questions.

It might seem great to keep markets from falling too much, but that can create complacency and just encourage investors to take greater risk — creating much more damage when the bubble ultimately pops. This arguably is part of what happened in the 2008 financial crisis: that years of Greenspanian work to keep markets from plummeting had made the entire financial system brittle and overleveraged.

There’s a simpler moral case against central banks propping up falling markets, which is that it implies a government entity using public resources to keep a predominantly wealthy investor class from losing money. The interests of Wall Street and Main Street don’t always align.

There are some hints that the Yellen Fed is reluctant to react to the latest palpitations in markets. On Tuesday, the Fed vice chairman, Stanley Fischer, noted that there had been episodes in which markets tumbled but no broader slump ensued.

“If the recent financial market developments lead to a sustained tightening of financial conditions, they could signal a slowing in the global economy that could affect growth and inflation in the United States,” Mr. Fischer said in a speech at an energy conference in Houston. “But we have seen similar periods of volatility in recent years — including in the second half of 2011 — that have left little visible imprint on the economy, and it is still early to judge the ramifications of the increased market volatility of the first seven weeks of 2016.”

The challenge, as Mr. Fischer suggested, is to decide which type of market move this really is.

Is it more like mid-2007, when turmoil in financial markets was the early warning of a recession that wouldn’t begin until the end of that year? Or is it more like 1998, when the Fed cut rates in response to market turmoil that never caused economic ripples on United States shores?

He and Ms. Yellen will show their conclusions through their actions — and in the process send a signal to Wall Street about whether, a decade after Mr. Greenspan left office, his approach to the job persists.

A version of this article appears in print on February 28, 2016, on page BU6 of the New York edition with the headline: Grappling With What Greenspan Would Do