Sallie Mae Directors to Profit Handsomely
Inside Higher Ed, August 6, 2007
When the directors of Sallie Mae meet next week to consider a $25 billion offer to buy the student loan giant, they will be voting on a transaction that will benefit the company, and also themselves — significantly.
A proxy filing by Sallie Mae with the Securities and Exchange Commission last month shows that the company’s directors will earn a total of about $370 million in profit if the sale of Sallie Mae to J.C. Flowers, Friedman Fleischer & Lowe, Bank of America and JPMorgan Chase goes through on August 15. The bulk of that money — almost $225 million — will go to Sallie Mae’s chairman and former CEO, Albert L. Lord. (A list of the directors and the value of their shares appears below.)
But some current and former higher education officials on the board will benefit handsomely as well, and to some observers, the significant sums going to Sallie Mae directors are symptomatic of larger questions raised by the sale of the mammoth lender, which had its roots as a quasi-governmental entity. Is it appropriate for a company that was built to a large extent through its connection to the federal government profit so enormously as it has slowly shed those ties?
“Sallie Mae was built to serve a public purpose, of providing student loans,” said Robert Shireman, executive director of the Project on Student Debt and a longtime observer of the student loan programs. “It was set free and no one really knew whether the federal government got a good deal or not. This level of profiteering off the corporation suggests that ultimately the deal that was struck may well have undercompensated taxpayers.”
While the funds going to the company’s directors and officers are a tiny portion of the money that will flow to Sallie Mae and its share holders, Shireman said, “those figures are indicative of the nature of the deal that was struck.”
Tom Joyce, a Sallie Mae spokesman, said that it is typical when companies are bought and sold for the men and women who have overseen their success to see personal gain. “It happens in every single transaction,” Joyce said. And while the figures may seem large to many in higher education, Joyce said, that’s because Sallie Mae is an unusually large entity in the college world — at least unusual as a huge and hugely profitable for-profit company.
Joyce rejected the notion that Sallie Mae’s profitability at this point — a decade after it began transitioning away from being a government-sponsored enterprise — can still be attributed to its historic federal ties. “The company has diversified greatly away from being dependent on federal guaranteed student loans, and it has shed its skin a couple times,” Joyce said. “Since 1997, when this board really came into being, it has gone head to head with the major financial institutions in the United States and outperformed them. Should directors be compensated for that? They’re compensated with stock, and now they’re getting rewarded for that.”
Below is a table showing the Sallie Mae directors, their positions (and ties to higher education, if any), and the profit they will see in the sale of their Sallie Mae stock, which is calculated by multiplying the number of shares they own by the amount that the $60 sale price exceeds the “strike price” they would need to pay to exercise their stock options. (All told, the share of officers and directors are worth $750 million at the $60 price.)
Some names familiar to many in higher education appear on the list, including Diane Suitt Gilleland, former director of the Arkansas Department of Higher Education, and Barry A. Munitz, former chancellor of the California State University System.
Name
Title
Net profit from Sallie Mae sale
Non-employee directors
Ann Torre Bates
Strategic and financial consultant
$7,114,311
Charles L. Daley
Director and executive VP, TEB Associates, Inc.
$10,160,011
William M. Diefenderfer III
Partner, Diefenderfer, Hoover & Wood
$4,737,178
Diane Suitt Gilleland
Associate professor of higher education, U. of Arkansas at Little Rock.
$4,595,391
Earl A. Goode
Deputy chief of staff, Indiana Gov. Mitch Daniels
$3,350,189
Ronald F. Hunt
Lawyer
$4,532,269
Benjamin J. Lambert III
State senator, Virginia
$7,280,313
Albert L. Lord
Chairman, Sallie Mae
$225,920,802
Barry A. Munitz
Trustee professor, California State U. at Los Angeles
$609,509
A. Alexander Porter Jr.
Founder and partner, Porter Orlin, Inc.
$25,193,904
Wolfgang Schoellkopf
Managing partner, Lycos Capital Management
$3,874,610
Steven L. Shapiro
CPA
$9,983,250
Barry L. Williams
President, Williams Pacific Ventures
$5,954,446
Sallie Mae Officers
C.E. Andrews
Chief executive officer
$16,116,200
Robert S. Autor
Executive VP, consumer operations
$16,022,128
Robert S. Lavet
Senior VP and general counsel
$9,730,191
Sandra L. Masino
Senior VP, accounting
$666,165
June M. McCormack
Executive VP, servicing, technology and sales marketing
$8,975,958
Kevin F. Moehn
Executive VP, sales and originations
$5,461,750
— Doug Lederman
Monday, February 4, 2008
Student Loan Companies Overpaid
Confusion Cited In Overpayments To Student Lenders
Subsidy Loophole Cost U.S. Government Millions
By Amit R. Paley
Washington Post Saturday, October 20, 2007; A01
Education Secretary Margaret Spellings has acknowledged that the federal government "had some responsibility" for "confusion" over subsidy rules that helped student loan companies reap hundreds of millions of dollars in potentially excessive payments at taxpayer expense.
But Spellings said in a recent interview that she has no plans to pursue a full accounting of the cost of what the Education Department's inspector general termed "improper" payments in a program that guarantees lenders a 9.5 percent interest rate for certain loans even when market rates are much lower. Nor does the department plan to seek reimbursement.
The inspector general concluded last year that the government had overpaid one lender, Nebraska-based Nelnet, $278 million from 2003 to 2005 -- a finding the lender disputes. In addition, a Washington Post analysis of data obtained recently through the Freedom of Information Act suggests that potential overpayments to other lenders from 2003 to 2006 could total roughly $300 million.
Two lenders, the New Hampshire Higher Education Loan Corp. and the Arkansas Student Loan Authority, said they returned millions of dollars in subsidy payments voluntarily after they discovered errors themselves.
"It seemed like they would just pay subsidies to almost anyone without checking at all," said Tara Payne, a vice president of the New Hampshire lender.
The existence and approximate magnitude of the questionable payments has been known for some time, but until now there has not been an estimate of a total. The Government Accountability Office warned three years ago that a failure to shut down legal loopholes could lead the government to pay billions of dollars in unnecessary subsidies.
Although some subsidy payments in the 9.5 percent program are broadly accepted as legitimate, critics have questioned aggressive financing techniques that lenders used in recent years to expand the volume of loans that qualify for the lucrative subsidy. Auditors for Education Department Inspector General John P. Higgins Jr. concluded that some of those techniques failed to meet criteria that would qualify the lenders for payments.
In 2004 and 2006, Congress enacted legislation meant to phase out the subsidy. Spellings went a step further in January, shutting down any future payments of the sort the inspector general had questioned.
But Spellings said she would not pursue reimbursement of any previous payments because rules had not been made clear to the lenders. "The department, I believe, had some responsibility with respect to that confusion," she said in a recent interview with The Post.
Indeed, the subsidy's 27-year history shows that the government at some points sought to restrict the subsidy and at other points stood by while lenders used aggressive financial techniques to maximize profits during years of low market rates.
The program began in 1980 as an effort to help ensure student access to low-cost loans at a time of double-digit interest rates. The government guaranteed lenders a 9.5 percent return on loans financed by tax-exempt bonds.
When interest rates fell, the guarantee became a boon for lenders. Congress pared back the program in 1993 but retained the 9.5 percent guarantee for loans financed with previously issued tax-exempt bonds. It was assumed the subsidies would dwindle and eventually disappear.
But some officials within the department realized as early as 2002 that the opposite was occurring: Lenders were taking steps to inflate the volume of loans that qualified for the subsidies. They did that by shifting the financing of loans among bonds that qualified for the special subsidies and bonds that did not. Lenders then claimed that the larger pool of loans financed by both types of bonds qualified for the subsidies.
Some inside the department sounded alarms.
"I have come across what appears to be significant federal waste," department researcher Jon H. Oberg wrote in a 2003 memo to agency officials. "I estimate it amounts to about $30,000 per day, perhaps more."
Oberg urged the department, without success, to clarify the rules on subsidy payments through a letter to lenders or new regulations.
"We tried hard in 2002 to modify" federal guidance to lenders "but had to back off," Mirek Halaska, director of a Texas field office, wrote in a 2004 e-mail to department officials.
In 2003, Nelnet devised a plan, known internally as Project 950, according to the inspector general's report, that shuffled loan financing quickly from one bond to another to increase the volume of loans that qualified for the subsidies. Nelnet wrote the department in May 2003 to ask for confirmation that its plan was legal. The department, then led by Rod Paige, did not respond for 13 months. In that time, Nelnet inflated the volume of loans qualifying for the subsidies from $551 million to about $3.66 billion, the inspector general found. In June 2004, the department sent Nelnet a three-paragraph reply that offered no conclusion on whether the plan was legal.
In May 2005, the inspector general reported that the New Mexico Educational Assistance Foundation had collected as much as $35 million in excessive payments and urged the department to recover the money. The nonprofit lender disagreed with the findings. So did Spellings, who took office in January. She decided not to seek to recoup the funds.
But Spellings took action after the inspector general's September 2006 report on Nelnet found that the lender stood to collect an estimated $882 million in future years if the problem wasn't fixed. In a January settlement between the government and Nelnet, the lender denied wrongdoing and was allowed to keep all subsidies as long as it stopped collecting the disputed subsidies in the future. Spellings extended the policy to every lender in the country.
"We had legal risk, in my view, and the prudent course of action was to, once and for all, end this practice and provide certainty in the industry that that was not allowable," Spellings told The Post. "While it cost us $278 million to make that final call, it also saved us potentially a billion dollars had we lost the litigation."
The government's total cost, however, is undoubtedly higher than $278 million because Nelnet did not act alone. Spellings said the agency has no plans to conduct audits to calculate a total. "I don't know if it's a knowable number," she said. "I guess it's knowable by somebody. But my inspector general doesn't know it, to my knowledge. And I don't. We haven't found out."
Nelnet spokesman Ben Kiser reiterated that Nelnet did nothing wrong and followed the law as the department had articulated it.
In July, the department responded to a Post request for data on the 9.5 percent loan subsidies. The Post analyzed payments from 2001 to 2006 to lenders from across the country, attempting to use criteria applied in the inspector general's report on Nelnet. The analysis found as much as $330 million in potential overpayments to 10 other lenders.
Department officials contend that only comprehensive audits can determine the amount overpaid to lenders. Diane Auer Jones, assistant secretary for postsecondary education, called The Post's analysis flawed. "We don't believe meaningful inferences can be made" from the data the department provided, Jones said in a statement. But four experts in higher education finance who reviewed the analysis at The Post's request -- Christopher Avery, a Harvard University professor; Laura W. Perna, a University of Pennsylvania professor; Robert B. Archibald, a College of William & Mary professor; and Robert Shireman, president of the Institute for College Access and Success -- said it would provide a rough estimate of the potential cost to taxpayers.
Ellis E. Tredway, an executive vice president for Brazos Higher Education Authority, said the lender was not to blame for receiving what the Post analysis found may have been $20 million in overpayments. The Education Department, he said, was responsible.
"I think there is fault with the department," Tredway said. "They came out with a new interpretation of what history had been."
Subsidy Loophole Cost U.S. Government Millions
By Amit R. Paley
Washington Post Saturday, October 20, 2007; A01
Education Secretary Margaret Spellings has acknowledged that the federal government "had some responsibility" for "confusion" over subsidy rules that helped student loan companies reap hundreds of millions of dollars in potentially excessive payments at taxpayer expense.
But Spellings said in a recent interview that she has no plans to pursue a full accounting of the cost of what the Education Department's inspector general termed "improper" payments in a program that guarantees lenders a 9.5 percent interest rate for certain loans even when market rates are much lower. Nor does the department plan to seek reimbursement.
The inspector general concluded last year that the government had overpaid one lender, Nebraska-based Nelnet, $278 million from 2003 to 2005 -- a finding the lender disputes. In addition, a Washington Post analysis of data obtained recently through the Freedom of Information Act suggests that potential overpayments to other lenders from 2003 to 2006 could total roughly $300 million.
Two lenders, the New Hampshire Higher Education Loan Corp. and the Arkansas Student Loan Authority, said they returned millions of dollars in subsidy payments voluntarily after they discovered errors themselves.
"It seemed like they would just pay subsidies to almost anyone without checking at all," said Tara Payne, a vice president of the New Hampshire lender.
The existence and approximate magnitude of the questionable payments has been known for some time, but until now there has not been an estimate of a total. The Government Accountability Office warned three years ago that a failure to shut down legal loopholes could lead the government to pay billions of dollars in unnecessary subsidies.
Although some subsidy payments in the 9.5 percent program are broadly accepted as legitimate, critics have questioned aggressive financing techniques that lenders used in recent years to expand the volume of loans that qualify for the lucrative subsidy. Auditors for Education Department Inspector General John P. Higgins Jr. concluded that some of those techniques failed to meet criteria that would qualify the lenders for payments.
In 2004 and 2006, Congress enacted legislation meant to phase out the subsidy. Spellings went a step further in January, shutting down any future payments of the sort the inspector general had questioned.
But Spellings said she would not pursue reimbursement of any previous payments because rules had not been made clear to the lenders. "The department, I believe, had some responsibility with respect to that confusion," she said in a recent interview with The Post.
Indeed, the subsidy's 27-year history shows that the government at some points sought to restrict the subsidy and at other points stood by while lenders used aggressive financial techniques to maximize profits during years of low market rates.
The program began in 1980 as an effort to help ensure student access to low-cost loans at a time of double-digit interest rates. The government guaranteed lenders a 9.5 percent return on loans financed by tax-exempt bonds.
When interest rates fell, the guarantee became a boon for lenders. Congress pared back the program in 1993 but retained the 9.5 percent guarantee for loans financed with previously issued tax-exempt bonds. It was assumed the subsidies would dwindle and eventually disappear.
But some officials within the department realized as early as 2002 that the opposite was occurring: Lenders were taking steps to inflate the volume of loans that qualified for the subsidies. They did that by shifting the financing of loans among bonds that qualified for the special subsidies and bonds that did not. Lenders then claimed that the larger pool of loans financed by both types of bonds qualified for the subsidies.
Some inside the department sounded alarms.
"I have come across what appears to be significant federal waste," department researcher Jon H. Oberg wrote in a 2003 memo to agency officials. "I estimate it amounts to about $30,000 per day, perhaps more."
Oberg urged the department, without success, to clarify the rules on subsidy payments through a letter to lenders or new regulations.
"We tried hard in 2002 to modify" federal guidance to lenders "but had to back off," Mirek Halaska, director of a Texas field office, wrote in a 2004 e-mail to department officials.
In 2003, Nelnet devised a plan, known internally as Project 950, according to the inspector general's report, that shuffled loan financing quickly from one bond to another to increase the volume of loans that qualified for the subsidies. Nelnet wrote the department in May 2003 to ask for confirmation that its plan was legal. The department, then led by Rod Paige, did not respond for 13 months. In that time, Nelnet inflated the volume of loans qualifying for the subsidies from $551 million to about $3.66 billion, the inspector general found. In June 2004, the department sent Nelnet a three-paragraph reply that offered no conclusion on whether the plan was legal.
In May 2005, the inspector general reported that the New Mexico Educational Assistance Foundation had collected as much as $35 million in excessive payments and urged the department to recover the money. The nonprofit lender disagreed with the findings. So did Spellings, who took office in January. She decided not to seek to recoup the funds.
But Spellings took action after the inspector general's September 2006 report on Nelnet found that the lender stood to collect an estimated $882 million in future years if the problem wasn't fixed. In a January settlement between the government and Nelnet, the lender denied wrongdoing and was allowed to keep all subsidies as long as it stopped collecting the disputed subsidies in the future. Spellings extended the policy to every lender in the country.
"We had legal risk, in my view, and the prudent course of action was to, once and for all, end this practice and provide certainty in the industry that that was not allowable," Spellings told The Post. "While it cost us $278 million to make that final call, it also saved us potentially a billion dollars had we lost the litigation."
The government's total cost, however, is undoubtedly higher than $278 million because Nelnet did not act alone. Spellings said the agency has no plans to conduct audits to calculate a total. "I don't know if it's a knowable number," she said. "I guess it's knowable by somebody. But my inspector general doesn't know it, to my knowledge. And I don't. We haven't found out."
Nelnet spokesman Ben Kiser reiterated that Nelnet did nothing wrong and followed the law as the department had articulated it.
In July, the department responded to a Post request for data on the 9.5 percent loan subsidies. The Post analyzed payments from 2001 to 2006 to lenders from across the country, attempting to use criteria applied in the inspector general's report on Nelnet. The analysis found as much as $330 million in potential overpayments to 10 other lenders.
Department officials contend that only comprehensive audits can determine the amount overpaid to lenders. Diane Auer Jones, assistant secretary for postsecondary education, called The Post's analysis flawed. "We don't believe meaningful inferences can be made" from the data the department provided, Jones said in a statement. But four experts in higher education finance who reviewed the analysis at The Post's request -- Christopher Avery, a Harvard University professor; Laura W. Perna, a University of Pennsylvania professor; Robert B. Archibald, a College of William & Mary professor; and Robert Shireman, president of the Institute for College Access and Success -- said it would provide a rough estimate of the potential cost to taxpayers.
Ellis E. Tredway, an executive vice president for Brazos Higher Education Authority, said the lender was not to blame for receiving what the Post analysis found may have been $20 million in overpayments. The Education Department, he said, was responsible.
"I think there is fault with the department," Tredway said. "They came out with a new interpretation of what history had been."
Student Loans Burden Students
High-Priced Student Loans Spell Trouble
By MARCY GORDON, AP Business Writer
San Francisco Chronicle Sunday, September 30, 2007
The near doubling in the cost of a college degree the past decade has produced an explosion in high-priced student loans that could haunt the U.S. economy for years.
While scholarship, grant money and government-backed student loans — whose interest rates are capped — have taken up some of the slack, many families and individual students have turned to private loans, which carry fees and interest rates that are often variable and up to 20 percent.
Many in the next generation of workers will be so debt-burdened they will have to delay home purchases, limit vacations, even eat out less to pay loans off on time.
Kristin Cole, 30, who graduated from Michigan State University's law school and lives in Grand Rapids, Mich., owes $150,000 in private and government-backed student loans. Her monthly payment of $660, which consumes a quarter of her take-home pay, is scheduled to jump to $800 in a year or so, confronting her with stark financial choices.
"I could never buy a house. I can't travel; I can't do anything," she said. "I feel like a prisoner."
A legal aid worker, Cole said she may need to get a job at a law firm, "doing something that I'm not real dedicated to, just for the sake of being able to live."
Parents are still the primary source of funds for many students, but the dynamics were radically altered in recent years as tuition costs soared and sources of readily available and more costly private financing made higher education seemingly available to anyone willing to sign a loan application.
Students with no credit history and no relatives to co-sign loans (or co-signing parents with tarnished credit) were willing to bet that high-priced loans were a trade-off for a shot at the American dream. But high-paying jobs are proving elusive for many graduates.
"This is literally a new form of indenture ... something that every American parent should be scared of," said Barmak Nassirian, associate executive director of the American Association of Collegiate Registrars and Admissions Officers.
More than $17 billion in private student loans were issued last year, up from $4 billion a year in 2001. Outstanding student borrowing jumped from $38 billion in 1995 to $85 billion last year, according to experts and lawmakers.
Rocketing tuition fees made borrowing that much more appealing. Consumer prices on average rose less than 29 percent over the past 10 years while tuition, fees, and room and board at four-year public colleges and universities soared 79 percent to $12,796 a year and 65 percent to $30,367 a year at private institutions, according to the College Board.
Scholarship and grant money have increased, yet for almost 15 years, the maximum available per person in government-guaranteed student loans, which by law can't charge rates above 6.8 percent, has remained at $23,000 total for four years. That's less than half the average four-year tuition, room and board of $51,000 at public colleges and $121,000 at private institutions.
Sallie Mae, formally known as SLM Corp., has been on the winning side of the loan bonanza. Its portfolio of 10 million customers includes $25 billion in private and $128 billion in government-backed education loans. However, private-equity investors who had offered $25 billion to buy the company backed out last week, citing credit market weakness and a new law cutting billions of dollars in subsidies to student lenders.
Citigroup Inc., Bank of America Corp., JPMorgan Chase & Co., Wells Fargo & Co., Wachovia Corp. and Regions Financial Corp. are also big players in the private student loan business. And there has been an explosion in specialized student loan lenders, such as EduCap, Nelnet Inc., NextStudent Inc., Student Loan Corp., College Loan Corp., CIT Group Inc. and Education Finance Partners Inc.
The question is whether everyone who borrowed will be able to repay. Experts don't track default rates on private student loans, but many predict sharp increases in years to come.
Dr. Paul-Henry Zottola, a 35-year-old periodontist in Rocky Hill, Conn., faces paying $1,600 a month on his student loan on top of a $2,300 mortgage payment and $1,500 on the loan he took out to start his practice.
His credit record remains solid but he owes more than $300,000 in student loans as he and his wife, Heather, an elementary school administrator, raise two young children.
"It would be very easy to feel crushed by it," Zottola said in an interview. "All my income for the next 10 years is spoken for."
Meanwhile, complaints about marketing of private loans — like ads promising to approve loans worth $50,000 in just minutes — are on the rise. The complaints have made their way to lawmakers, who see a need to regulate the highly profitable and diverse group of companies and the loans they make to college students.
In August, the Senate Banking Committee approved a bill that would mandate clearer disclosure of rates and terms on private student loans. The bill also would require a 30-day comparison shopping period after loan approval, during which time the offer terms could not be altered.
New York Attorney General Andrew Cuomo said many graduates who borrowed owe as much if not more than most homeowners owe on mortgages. Unlike mortgages with clear consumer disclosure requirements — even from nonbank lenders, private lending is "the Wild West of the student loan industry," he said in a telephone interview.
Critics say what happened in the mortgage market could happen in the student loan market. Cuomo, who conducted a nationwide investigation, said the parallels between the two markets are "provocative."
Demand for bundled student loans sold to institutional investors worldwide fueled lending to students. The market for private student loan-backed securities leapt 76 percent last year, to $16.6 billion, from $9.4 billion in 2005, according to Moody's Investors Service.
The student loan-backed securities market has yet to suffer noticeable effects of a global credit squeeze that was triggered this summer by a mortgage meltdown of borrowers with risky credit.
"Once the economy starts to slow, you're going to see a large increase of these people in bankruptcy court," said Robert Manning, a professor at Rochester Institute of Technology who has written about college students and credit cards.
A 2005 change to bankruptcy law puts private student loans on par with child support and alimony payments: Lenders can garnish wages if someone doesn't pay.
Cuomo's probe revealed what he calls an "appalling pattern of favoritism" for student lenders that provided kickbacks, revenue-sharing plans and trips to college administrators in exchange for recommended lender status. Other critics allege widespread corrupt arrangements propelled a student loan boom.
Lenders deny such charges, arguing that industry growth resulted from surging education costs and that higher interest rates are justified for unsecured loans to borrowers with blemished or insufficient credit records.
"Lenders take 100 percent of the repayment risk on flexible private-education loans made to people with limited credit histories, on which they will not get repaid for several years," Barry Goulding, a Sallie Mae official, told Congress last spring.
New regulations could dry up access to education financing, he and other industry executives argue. Some experts are skeptical, predicting waves of student loan delinquencies and defaults on what is outstanding.
"Should private student loans suffer the same sort of failure as (subprime) mortgages, as students graduate or drop out and find themselves unable to pay, we will do serious damage not only to the lives of many students but also to the economic and social fabric of our country that depends on college graduates for its strength," said Luke Swarthout at the U.S. Public Interest Research Group.
http://sfgate.com/cgi-bin/article.cgi?f=/n/a/2007/09/30/financial/f111354D50.DTL
By MARCY GORDON, AP Business Writer
San Francisco Chronicle Sunday, September 30, 2007
The near doubling in the cost of a college degree the past decade has produced an explosion in high-priced student loans that could haunt the U.S. economy for years.
While scholarship, grant money and government-backed student loans — whose interest rates are capped — have taken up some of the slack, many families and individual students have turned to private loans, which carry fees and interest rates that are often variable and up to 20 percent.
Many in the next generation of workers will be so debt-burdened they will have to delay home purchases, limit vacations, even eat out less to pay loans off on time.
Kristin Cole, 30, who graduated from Michigan State University's law school and lives in Grand Rapids, Mich., owes $150,000 in private and government-backed student loans. Her monthly payment of $660, which consumes a quarter of her take-home pay, is scheduled to jump to $800 in a year or so, confronting her with stark financial choices.
"I could never buy a house. I can't travel; I can't do anything," she said. "I feel like a prisoner."
A legal aid worker, Cole said she may need to get a job at a law firm, "doing something that I'm not real dedicated to, just for the sake of being able to live."
Parents are still the primary source of funds for many students, but the dynamics were radically altered in recent years as tuition costs soared and sources of readily available and more costly private financing made higher education seemingly available to anyone willing to sign a loan application.
Students with no credit history and no relatives to co-sign loans (or co-signing parents with tarnished credit) were willing to bet that high-priced loans were a trade-off for a shot at the American dream. But high-paying jobs are proving elusive for many graduates.
"This is literally a new form of indenture ... something that every American parent should be scared of," said Barmak Nassirian, associate executive director of the American Association of Collegiate Registrars and Admissions Officers.
More than $17 billion in private student loans were issued last year, up from $4 billion a year in 2001. Outstanding student borrowing jumped from $38 billion in 1995 to $85 billion last year, according to experts and lawmakers.
Rocketing tuition fees made borrowing that much more appealing. Consumer prices on average rose less than 29 percent over the past 10 years while tuition, fees, and room and board at four-year public colleges and universities soared 79 percent to $12,796 a year and 65 percent to $30,367 a year at private institutions, according to the College Board.
Scholarship and grant money have increased, yet for almost 15 years, the maximum available per person in government-guaranteed student loans, which by law can't charge rates above 6.8 percent, has remained at $23,000 total for four years. That's less than half the average four-year tuition, room and board of $51,000 at public colleges and $121,000 at private institutions.
Sallie Mae, formally known as SLM Corp., has been on the winning side of the loan bonanza. Its portfolio of 10 million customers includes $25 billion in private and $128 billion in government-backed education loans. However, private-equity investors who had offered $25 billion to buy the company backed out last week, citing credit market weakness and a new law cutting billions of dollars in subsidies to student lenders.
Citigroup Inc., Bank of America Corp., JPMorgan Chase & Co., Wells Fargo & Co., Wachovia Corp. and Regions Financial Corp. are also big players in the private student loan business. And there has been an explosion in specialized student loan lenders, such as EduCap, Nelnet Inc., NextStudent Inc., Student Loan Corp., College Loan Corp., CIT Group Inc. and Education Finance Partners Inc.
The question is whether everyone who borrowed will be able to repay. Experts don't track default rates on private student loans, but many predict sharp increases in years to come.
Dr. Paul-Henry Zottola, a 35-year-old periodontist in Rocky Hill, Conn., faces paying $1,600 a month on his student loan on top of a $2,300 mortgage payment and $1,500 on the loan he took out to start his practice.
His credit record remains solid but he owes more than $300,000 in student loans as he and his wife, Heather, an elementary school administrator, raise two young children.
"It would be very easy to feel crushed by it," Zottola said in an interview. "All my income for the next 10 years is spoken for."
Meanwhile, complaints about marketing of private loans — like ads promising to approve loans worth $50,000 in just minutes — are on the rise. The complaints have made their way to lawmakers, who see a need to regulate the highly profitable and diverse group of companies and the loans they make to college students.
In August, the Senate Banking Committee approved a bill that would mandate clearer disclosure of rates and terms on private student loans. The bill also would require a 30-day comparison shopping period after loan approval, during which time the offer terms could not be altered.
New York Attorney General Andrew Cuomo said many graduates who borrowed owe as much if not more than most homeowners owe on mortgages. Unlike mortgages with clear consumer disclosure requirements — even from nonbank lenders, private lending is "the Wild West of the student loan industry," he said in a telephone interview.
Critics say what happened in the mortgage market could happen in the student loan market. Cuomo, who conducted a nationwide investigation, said the parallels between the two markets are "provocative."
Demand for bundled student loans sold to institutional investors worldwide fueled lending to students. The market for private student loan-backed securities leapt 76 percent last year, to $16.6 billion, from $9.4 billion in 2005, according to Moody's Investors Service.
The student loan-backed securities market has yet to suffer noticeable effects of a global credit squeeze that was triggered this summer by a mortgage meltdown of borrowers with risky credit.
"Once the economy starts to slow, you're going to see a large increase of these people in bankruptcy court," said Robert Manning, a professor at Rochester Institute of Technology who has written about college students and credit cards.
A 2005 change to bankruptcy law puts private student loans on par with child support and alimony payments: Lenders can garnish wages if someone doesn't pay.
Cuomo's probe revealed what he calls an "appalling pattern of favoritism" for student lenders that provided kickbacks, revenue-sharing plans and trips to college administrators in exchange for recommended lender status. Other critics allege widespread corrupt arrangements propelled a student loan boom.
Lenders deny such charges, arguing that industry growth resulted from surging education costs and that higher interest rates are justified for unsecured loans to borrowers with blemished or insufficient credit records.
"Lenders take 100 percent of the repayment risk on flexible private-education loans made to people with limited credit histories, on which they will not get repaid for several years," Barry Goulding, a Sallie Mae official, told Congress last spring.
New regulations could dry up access to education financing, he and other industry executives argue. Some experts are skeptical, predicting waves of student loan delinquencies and defaults on what is outstanding.
"Should private student loans suffer the same sort of failure as (subprime) mortgages, as students graduate or drop out and find themselves unable to pay, we will do serious damage not only to the lives of many students but also to the economic and social fabric of our country that depends on college graduates for its strength," said Luke Swarthout at the U.S. Public Interest Research Group.
http://sfgate.com/cgi-bin/article.cgi?f=/n/a/2007/09/30/financial/f111354D50.DTL
Student Loan Mess
Did Revolving Door Lead To Student Loan Mess?
Critics Blame Lax Oversight Resulting From Close Ties Of Industry, Government
By JOHN HECHINGER and ANNE MARIE CHAKER
Wall Street Journal April 13, 2007; Page B1
Four years ago, Sally Stroup, then an assistant secretary at the U.S. Education Department, got a memo from the agency's inspector general urging her to curb any "illegal inducements" lenders might be using to win college loan business.
Ms. Stroup, who had previously worked for a Pennsylvania loan company and a for-profit education concern dependent on student loans, didn't take the memo's advice.
At least eight top officials in the Education Department during the Bush administration either came from student-loan or related organizations or have taken lucrative jobs in that arena since leaving the agency. Former Education Department staffers say a revolving door between the department and industry has led to lax oversight of federal financial aid. Members of Congress -- including the Democrats who head committees overseeing education, Sen. Edward Kennedy of Massachusetts and Rep. George Miller of California -- say they are concerned about the industry ties. Mr. Miller plans to hold a hearing on student loan abuses this month.
Some Republicans are critical as well, including Rep. Tom Petri of Wisconsin. "It's hard for a program staffed mainly by folks in the industry to impartially conduct oversight of the industry," says Thomas Culligan, Mr. Petri's aide for education policy.
In recent years, department officials monitoring financial aid were informed about several questionable practices by lenders, yet they were slow to crack down. In addition to the current scandal over loan companies' grants of stock and other payments to college officials, lenders also breached a government database of student borrowers and made hundreds of millions of dollars in excess payments through a controversial loophole.
"I saw too much in the department that indicated that many of the people were too close to the lending industry and were making decisions that weren't in the public interest," says Jon Oberg, a former Education Department researcher.
Ms. Stroup says that until now, no one knew the extent of student loan abuses, and she says she took action when allegations could be proved. "We always wanted to run the agency right for students, families and schools," says Ms. Stroup, now a senior Republican aide on Capitol Hill.
Katherine McLane, a spokeswoman for Education Secretary Margaret Spellings, defends the department's record, saying that it taps private-sector experience to improve efficiency and provide "better service to students and families." She notes that student loan default rates have plummeted on the Republicans' watch and that, in 2005, the Government Accountability Office removed the department's student aid office from a list of government programs at high risk for "fraud, waste, abuse and mismanagement."
Last week, the Education Department put Matteo Fontana, a senior financial aid official, on leave after it was disclosed that in 2003 he held $100,000 of stock in the parent company of Student Loan Xpress Inc. That firm, a unit of financial-services company CIT Group Inc., has been at the center of a widening investigation by New York Attorney General Andrew Cuomo. Before joining the Education Department, Mr. Fontana worked at the nation's biggest student lender, SLM Corp., better known as Sallie Mae.
One of Mr. Fontana's early responsibilities at the Education Department was safeguarding the National Student Loan Data System, which has detailed information about borrowers that isn't supposed to be used for commercial purposes. In 2005, Cathy Lewis, the department's assistant inspector general, sent a memo to Theresa S. Shaw, chief operating officer of the department's student aid office, about security problems with the database, which was being tapped by lenders to get customers. Ms. Shaw, who previously worked for Sallie Mae, rising to chief information officer, and Mr. Fontana couldn't be reached to comment. Ms. McLane says the department has "rigorous" database monitoring and has spent $650,000 since 2003 to improve information security.
In another example of close industry ties, William Hansen, a former deputy secretary, worked for an industry trade group before taking the department post. When he left in 2003, he joined Affiliated Computer Services Inc., an information-technology company that won a contract that year -- with a value of at least $1 billion -- to administer student loans. Mr. Hansen says he recused himself at the Education Department when the project came up and didn't work on higher education matters while he was at ACS.
Mr. Cuomo's investigation has already led eight colleges, including the University of Pennsylvania, New York University and Syracuse University, to settle allegations concerning payments from lenders that the state considers kickbacks. Six financial-aid officials, including those at Columbia University, Johns Hopkins University and the University of Texas, are under scrutiny for accepting stock or other payments from Student Loan Xpress. Sallie Mae and Citigroup Inc.'s Citibank have reached agreements with Mr. Cuomo over allegedly deceptive practices.
In Ms. Lewis's memo to Ms. Stroup in 2003 about improper inducements, she said the inspector general's office had found evidence that Sallie Mae had negotiated with a school to offer private loans to students there if that school placed Sallie Mae on its preferred-lender list. Ms. Lewis was concerned that the agreement might have constituted an improper inducement by Sallie Mae for preferred status. Sallie Mae notes that the government never took action against the company.
Ms. Lewis also complained in her memo that the department had done nothing since 1995 to update its interpretation of agency rules for lenders despite a student loan marketplace that had changed "significantly." Also in 2003, Mr. Oberg wrote an internal, widely distributed memo warning that lenders were exploiting a legal provision that guaranteed lenders a minimum 9.5% rate of return no matter how low the prevailing rate might be. The 9.5% guarantee was supposed to apply only to loans funded by tax-exempt bonds. Congress eliminated the guarantee in 1993 but grandfathered in the existing arrangement, thinking the high-rate guarantees would disappear. Mr. Oberg warned that the proliferation of these loans could cost taxpayers billions of dollars in excess subsidies.
A later report by the inspector general confirmed Mr. Oberg's findings. It focused on student loan company Nelnet Inc., which figured out a complicated strategy to collect about $278 million in what the report said were excessive payments from the government from January 2003 through June 30, 2005. The report recommended that the department require Nelnet to "return the ... overpayments received and exclude ineligible loans from future billings." In securities filings addressing the issue, Nelnet said it had received verbal approval from the department to collect the higher rate.
Despite the inspector general's report, the Education Department announced this past January that it would let Nelnet keep the bonanza, though not future payments. In a statement, Nelnet spokesman Ben Kiser said the company's receipt of those payments conformed to department regulations. Ms. McLane says the settlement was in "the best interests of taxpayers and students" because seeking repayment could have jeopardized a source of aid in some markets.
Jeffrey R. Andrade, former deputy assistant secretary for postsecondary education until 2003, says he opposed the lucrative loans at a time when the department was examining the issue but that the department couldn't stop the practice because it was hamstrung by pre-existing rules. "I wanted to call" Nelnet "and say if you guys do this, we're going to audit you to death, and in hindsight that would have been the better strategy," says Mr. Andrade. He is now an executive vice president of U.S. Education Finance Group, a student loan company.
Write to John Hechinger at john.hechinger@wsj.com5 and Anne Marie Chaker at anne-marie.chaker@wsj.com6
URL for this article:
http://online.wsj.com/article/SB117642836964868636.html
Hyperlinks in this Article:
(1) http://online.wsj.com/article/SB117625662602665883.html
(2) http://online.wsj.com/article/SB117612303875863972.html
(3) http://online.wsj.com/article/SB117573094292160341.html
(4) http://online.wsj.com/article/SB117556353994157752.html
(5) mailto:john.hechinger@wsj.com
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Copyright 2007 Dow Jones & Company, Inc. All Rights Reserved
Critics Blame Lax Oversight Resulting From Close Ties Of Industry, Government
By JOHN HECHINGER and ANNE MARIE CHAKER
Wall Street Journal April 13, 2007; Page B1
Four years ago, Sally Stroup, then an assistant secretary at the U.S. Education Department, got a memo from the agency's inspector general urging her to curb any "illegal inducements" lenders might be using to win college loan business.
Ms. Stroup, who had previously worked for a Pennsylvania loan company and a for-profit education concern dependent on student loans, didn't take the memo's advice.
At least eight top officials in the Education Department during the Bush administration either came from student-loan or related organizations or have taken lucrative jobs in that arena since leaving the agency. Former Education Department staffers say a revolving door between the department and industry has led to lax oversight of federal financial aid. Members of Congress -- including the Democrats who head committees overseeing education, Sen. Edward Kennedy of Massachusetts and Rep. George Miller of California -- say they are concerned about the industry ties. Mr. Miller plans to hold a hearing on student loan abuses this month.
Some Republicans are critical as well, including Rep. Tom Petri of Wisconsin. "It's hard for a program staffed mainly by folks in the industry to impartially conduct oversight of the industry," says Thomas Culligan, Mr. Petri's aide for education policy.
In recent years, department officials monitoring financial aid were informed about several questionable practices by lenders, yet they were slow to crack down. In addition to the current scandal over loan companies' grants of stock and other payments to college officials, lenders also breached a government database of student borrowers and made hundreds of millions of dollars in excess payments through a controversial loophole.
"I saw too much in the department that indicated that many of the people were too close to the lending industry and were making decisions that weren't in the public interest," says Jon Oberg, a former Education Department researcher.
Ms. Stroup says that until now, no one knew the extent of student loan abuses, and she says she took action when allegations could be proved. "We always wanted to run the agency right for students, families and schools," says Ms. Stroup, now a senior Republican aide on Capitol Hill.
Katherine McLane, a spokeswoman for Education Secretary Margaret Spellings, defends the department's record, saying that it taps private-sector experience to improve efficiency and provide "better service to students and families." She notes that student loan default rates have plummeted on the Republicans' watch and that, in 2005, the Government Accountability Office removed the department's student aid office from a list of government programs at high risk for "fraud, waste, abuse and mismanagement."
Last week, the Education Department put Matteo Fontana, a senior financial aid official, on leave after it was disclosed that in 2003 he held $100,000 of stock in the parent company of Student Loan Xpress Inc. That firm, a unit of financial-services company CIT Group Inc., has been at the center of a widening investigation by New York Attorney General Andrew Cuomo. Before joining the Education Department, Mr. Fontana worked at the nation's biggest student lender, SLM Corp., better known as Sallie Mae.
One of Mr. Fontana's early responsibilities at the Education Department was safeguarding the National Student Loan Data System, which has detailed information about borrowers that isn't supposed to be used for commercial purposes. In 2005, Cathy Lewis, the department's assistant inspector general, sent a memo to Theresa S. Shaw, chief operating officer of the department's student aid office, about security problems with the database, which was being tapped by lenders to get customers. Ms. Shaw, who previously worked for Sallie Mae, rising to chief information officer, and Mr. Fontana couldn't be reached to comment. Ms. McLane says the department has "rigorous" database monitoring and has spent $650,000 since 2003 to improve information security.
In another example of close industry ties, William Hansen, a former deputy secretary, worked for an industry trade group before taking the department post. When he left in 2003, he joined Affiliated Computer Services Inc., an information-technology company that won a contract that year -- with a value of at least $1 billion -- to administer student loans. Mr. Hansen says he recused himself at the Education Department when the project came up and didn't work on higher education matters while he was at ACS.
Mr. Cuomo's investigation has already led eight colleges, including the University of Pennsylvania, New York University and Syracuse University, to settle allegations concerning payments from lenders that the state considers kickbacks. Six financial-aid officials, including those at Columbia University, Johns Hopkins University and the University of Texas, are under scrutiny for accepting stock or other payments from Student Loan Xpress. Sallie Mae and Citigroup Inc.'s Citibank have reached agreements with Mr. Cuomo over allegedly deceptive practices.
In Ms. Lewis's memo to Ms. Stroup in 2003 about improper inducements, she said the inspector general's office had found evidence that Sallie Mae had negotiated with a school to offer private loans to students there if that school placed Sallie Mae on its preferred-lender list. Ms. Lewis was concerned that the agreement might have constituted an improper inducement by Sallie Mae for preferred status. Sallie Mae notes that the government never took action against the company.
Ms. Lewis also complained in her memo that the department had done nothing since 1995 to update its interpretation of agency rules for lenders despite a student loan marketplace that had changed "significantly." Also in 2003, Mr. Oberg wrote an internal, widely distributed memo warning that lenders were exploiting a legal provision that guaranteed lenders a minimum 9.5% rate of return no matter how low the prevailing rate might be. The 9.5% guarantee was supposed to apply only to loans funded by tax-exempt bonds. Congress eliminated the guarantee in 1993 but grandfathered in the existing arrangement, thinking the high-rate guarantees would disappear. Mr. Oberg warned that the proliferation of these loans could cost taxpayers billions of dollars in excess subsidies.
A later report by the inspector general confirmed Mr. Oberg's findings. It focused on student loan company Nelnet Inc., which figured out a complicated strategy to collect about $278 million in what the report said were excessive payments from the government from January 2003 through June 30, 2005. The report recommended that the department require Nelnet to "return the ... overpayments received and exclude ineligible loans from future billings." In securities filings addressing the issue, Nelnet said it had received verbal approval from the department to collect the higher rate.
Despite the inspector general's report, the Education Department announced this past January that it would let Nelnet keep the bonanza, though not future payments. In a statement, Nelnet spokesman Ben Kiser said the company's receipt of those payments conformed to department regulations. Ms. McLane says the settlement was in "the best interests of taxpayers and students" because seeking repayment could have jeopardized a source of aid in some markets.
Jeffrey R. Andrade, former deputy assistant secretary for postsecondary education until 2003, says he opposed the lucrative loans at a time when the department was examining the issue but that the department couldn't stop the practice because it was hamstrung by pre-existing rules. "I wanted to call" Nelnet "and say if you guys do this, we're going to audit you to death, and in hindsight that would have been the better strategy," says Mr. Andrade. He is now an executive vice president of U.S. Education Finance Group, a student loan company.
Write to John Hechinger at john.hechinger@wsj.com5 and Anne Marie Chaker at anne-marie.chaker@wsj.com6
URL for this article:
http://online.wsj.com/article/SB117642836964868636.html
Hyperlinks in this Article:
(1) http://online.wsj.com/article/SB117625662602665883.html
(2) http://online.wsj.com/article/SB117612303875863972.html
(3) http://online.wsj.com/article/SB117573094292160341.html
(4) http://online.wsj.com/article/SB117556353994157752.html
(5) mailto:john.hechinger@wsj.com
(6) mailto:anne-marie.chaker@wsj.com
Copyright 2007 Dow Jones & Company, Inc. All Rights Reserved
Sunday, February 3, 2008
The Minsky Moment
by John Cassidy February 4, 2008
- The New Yorker
Twenty-five years ago, when most economists were extolling the virtues of financial deregulation and innovation, a maverick named Hyman P. Minsky maintained a more negative view of Wall Street; in fact, he noted that bankers, traders, and other financiers periodically played the role of arsonists, setting the entire economy ablaze. Wall Street encouraged businesses and individuals to take on too much risk, he believed, generating ruinous boom-and-bust cycles. The only way to break this pattern was for the government to step in and regulate the moneymen.
Many of Minsky’s colleagues regarded his “financial-instability hypothesis,” which he first developed in the nineteen-sixties, as radical, if not crackpot. Today, with the subprime crisis seemingly on the verge of metamorphosing into a recession, references to it have become commonplace on financial Web sites and in the reports of Wall Street analysts. Minsky’s hypothesis is well worth revisiting. In trying to revive the economy, President Bush and the House have already agreed on the outlines of a “stimulus package,” but the first stage in curing any malady is making a correct diagnosis.
Minsky, who died in 1996, at the age of seventy-seven, earned a Ph.D. from Harvard and taught at Brown, Berkeley, and Washington University. He didn’t have anything against financial institutions—for many years, he served as a director of the Mark Twain Bank, in St. Louis—but he knew more about how they worked than most deskbound economists. There are basically five stages in Minsky’s model of the credit cycle: displacement, boom, euphoria, profit taking, and panic. A displacement occurs when investors get excited about something—an invention, such as the Internet, or a war, or an abrupt change of economic policy. The current cycle began in 2003, with the Fed chief Alan Greenspan’s decision to reduce short-term interest rates to one per cent, and an unexpected influx of foreign money, particularly Chinese money, into U.S. Treasury bonds. With the cost of borrowing—mortgage rates, in particular—at historic lows, a speculative real-estate boom quickly developed that was much bigger, in terms of over-all valuation, than the previous bubble in technology stocks.
As a boom leads to euphoria, Minsky said, banks and other commercial lenders extend credit to ever more dubious borrowers, often creating new financial instruments to do the job. During the nineteen-eighties, junk bonds played that role. More recently, it was the securitization of mortgages, which enabled banks to provide home loans without worrying if they would ever be repaid. (Investors who bought the newfangled securities would be left to deal with any defaults.) Then, at the top of the market (in this case, mid-2006), some smart traders start to cash in their profits.
The onset of panic is usually heralded by a dramatic effect: in July, two Bear Stearns hedge funds that had invested heavily in mortgage securities collapsed. Six months and four interest-rate cuts later, Ben Bernanke and his colleagues at the Fed are struggling to contain the bust. Despite last week’s rebound, the outlook remains grim. According to Dean Baker, the co-director of the Center for Economic and Policy Research, average house prices are falling nationwide at an annual rate of more than ten per cent, something not seen since before the Second World War. This means that American households are getting poorer at a rate of more than two trillion dollars a year.
It’s hard to say exactly how falling house prices will affect the economy, but recent computer simulations carried out by Frederic Mishkin, a governor at the Fed, suggest that, for every dollar the typical American family’s housing wealth drops in a year, that family may cut its spending by up to seven cents. Nationwide, that adds up to roughly a hundred and fifty-five billion dollars, which is bigger than President Bush’s stimulus package. And it doesn’t take into account plunging stock prices, collapsing confidence, and the belated imposition of tighter lending practices—all of which will further restrict economic activity.
In an election year, politicians can’t be expected to acknowledge their powerlessness. Nonetheless, it was disheartening to see the Republicans exploiting the current crisis to try to make the President’s tax cuts permanent, and the Democrats attempting to pin the economic downturn on the White House. For once, Bush is not to blame. His tax cuts were irresponsible and callously regressive, but they didn’t play a significant role in the housing bubble.
If anybody is at fault it is Greenspan, who kept interest rates too low for too long and ignored warnings, some from his own colleagues, about what was happening in the mortgage market. But he wasn’t the only one. Between 2003 and 2007, most Americans didn’t want to hear about the downside of funds that invest in mortgage-backed securities, or of mortgages that allow lenders to make monthly payments so low that their loan balances sometimes increase. They were busy wondering how much their neighbors had made selling their apartment, scouting real-estate Web sites and going to open houses, and calling up Washington Mutual or Countrywide to see if they could get another home-equity loan. That’s the nature of speculative manias: eventually, they draw in almost all of us.
You might think that the best solution is to prevent manias from developing at all, but that requires vigilance. Since the nineteen-eighties, Congress and the executive branch have been conspiring to weaken federal supervision of Wall Street. Perhaps the most fateful step came when, during the Clinton Administration, Greenspan and Robert Rubin, then the Treasury Secretary, championed the abolition of the Glass-Steagall Act of 1933, which was meant to prevent a recurrence of the rampant speculation that preceded the Depression.
The greatest need is for intellectual reappraisal, and a good place to begin is with a statement from a paper co-authored by Minsky that “apt intervention and institutional structures are necessary for market economies to be successful.” Rather than waging old debates about tax cuts versus spending increases, policymakers ought to be discussing how to reform the financial system so that it serves the rest of the economy, instead of feeding off it and destabilizing it. Among the problems at hand: how to restructure Wall Street remuneration packages that encourage excessive risk-taking; restrict irresponsible lending without shutting out creditworthy borrowers; help victims of predatory practices without bailing out irresponsible lenders; and hold ratings agencies accountable for their assessments. These are complex issues, with few easy solutions, but that’s what makes them interesting. As Minsky believed, “Economies evolve, and so, too, must economic policy.”
Department of disempowerment
BUREAUCRATS MOVE TO SILENCE SOUTH L.A. BLACK NEIGHBORHOOD GROUP
BY STEVEN LEIGH MORRIS
LA Weekly, Wednesday, January 23, 2008 - 6:29 pm
ON JANUARY 14, AT A SPECIAL meeting of the city of Los Angeles' Board of Neighborhood Commissioners in a middle-school auditorium in South Los Angeles, the board voted 4-1 to put the Vernon/Main Neighborhood Council out of business.
Rena Kosnett
It was a curious night in the annals of community empowerment, as the commission appointed by Mayor Antonio Villaraigosa gave the local residents, who have been meeting regularly for years to improve their community, just five days to shut down operations and return all city-owned office equipment.
In the past several months, some neighborhood members of the Vernon/Main council have crossed swords with City Council Member Jan Perry. In one instance, President Donald Barnett showed up at a South Park gymnasium for a meeting about an Environmental Impact Report for a "wetlands park" at Avalon Boulevard and 54th Street.
Barnett publicly raised several questions that annoyed Perry, who is advocating the park: Can you really call it a wetland, when the plan is to gather filthy storm-drain water and let it seep into the earth? Is this the best land use in an area desperate for development? Could the $19 million slated for the storm-drain purification project be used for homeless housing instead?
According to Barnett, Perry became so vexed that she abruptly ended the meeting. Perry denies his allegation, telling the Weekly that she allowed the meeting to "finish"— but won't say how.
Perry's influence aside, "BONC"— as the board of seven Villaraigosa political appointees is called, is starting to earn a reputation for trying to silence boisterous neighborhood councils — with help from the Department of Neighborhood Empowerment (which people actually do call "DONE").
Barnett and Vernon/Main board member Deacon Alexander say they believe their neighborhood council was shuttered on Perry's orders — a suggestion Perry dismisses as "silly."
Yet several days ago, appalled neighborhood residents and business owners looked on as BONC board President Linda Lucks condescendingly lectured the South Los Angeles group, informing them that even though she was going to shut the group down against its will, they could see it as "a positive thing"— because now they can petition BONC to "recertify and make a fresh start" without the current highly activist local leaders.
The BONC board determined that the neighborhood council violated its own bylaws, and some officials at DONE also claim that the mostly black group has engaged in racist behavior. Rather than trying to untangle a thorny bramble of neighborhood politics, BONC voted to wipe out the group, prompting questions about the city's failure to follow any written standards for how and why a neighborhood council gets the boot.
NEIGHBORHOOD COUNCILS WERE CREATED in order to appease angry Hollywood and Valley secessionists so fed up with City Hall's neglect and diversion of taxes that they tried to break the city apart — and scared then-Mayor James Hahn and other city leaders into believing they just might pull it off.
Although Los Angeles voters chose not to break up Los Angeles, the movement against downtown and its powerful interests gave voice to far-flung neighborhoods. Chastened, city leaders created neighborhood councils to work in "partnership" with city agencies, and to receive stipends and administrative support.
Unlike in homeowners associations, city leaders deemed that the membership of neighborhood councils could be anybody who does business in a neighborhood, or is just a patron of a business in a neighborhood, or who merely declares an interest in the neighborhood. All were defined as "stakeholders."
Critics point out that the broad definition of who is a "neighbor" has opened the doors to outside interference and lobbying. It has also left City Hall more firmly in charge of deciding who gets to continue to exist as a neighborhood council, and who does not.
The January 14 vote to dismantle the South Los Angeles group came after the city's manhandling of a much different neighborhood council called North Hills West. This group of activist suburbanites in the West Valley had successfully defeated a series of city-supported, residential developments on its rustic fields and meadows — the very sort of interest in local issues a neighborhood council is supposed to engage in.
But instead of thanks for its grassroots democracy, the group suddenly faced decertification by City Hall — thanks to anonymous charges by unnamed "stakeholders" who claimed the group was involved in financial impropriety and "hate language."
Then, in an embarrassing about-face, DONE Project Coordinator Manuel Durazo was forced to admit in December that none of the anonymous charges could be substantiated. In January, DONE Acting General Manager BongHwan Kim publicly conceded, "I told [North Hills West Neighborhood Council] it's much better that they be the problem solvers, and the city should not be defining their agenda... I've come to learn that a policing role is not appropriate for DONE."
But a number of BONC's board members don't see it that way. "I take offense!" Commissioner Tsilah Burman shot back at Kim. "I would ask that you not use the language of 'policing' — I would say that what we're trying to do is be a place of last resort when a neighborhood council feels they can't get their problems resolved."
When the West Valley group learned that BONC was now attacking a neighborhood council in South L.A., the president and two board members traveled from the Valley south to attend the January 14 meeting — and to show solidarity with their embattled, cityside peers.
It didn't help. By night's end, Burman joined three other commissioners — Lucks, Daniel Gatica and Michele Siqueiro — to decertify the Vernon/Main council, even after the group refuted, with detailed documentation, a litany of thin charges by DONE.
Among other things, DONE Project Coordinator Mark Lewis accused the South Los Angeles group of failing to hold timely elections. In fact, Lewis blocked those elections until he approved the group's petition for election-prerequisite changes to its bylaws. DONE must respond to such petitions within 10 days, but made the group wait four months, then rejected its petition due to "insufficient paperwork."
Lewis also wrongly testified that the South Los Angeles group regularly failed to gather a quorum of "nine" board members. In fact, Vernon/Main's council needs only seven members for a quorum. The neighborhood council turned over to the Weekly a complete set of minutes dating back to 2005 that plainly show that its meetings were held with a quorum and according to its bylaws.
Barnett says he also made repeated requests to Lewis to provide a Spanish-language translator at its meetings, which Lewis often failed to do. (An e-mail from Lewis dated November 7, 2007, apologizes for one such failure.) DONE also blocked Barnett's efforts to hire a "nonauthorized" translator — a hiring policy confirmed by General Manager Kim.
Former executive director of DONE Greg Nelson describes what his erstwhile department is doing to the neighborhood council as the "bleeding of an organization to death with a thousand paper cuts." The petty demands have perplexed him. "I just don't see why DONE would need to approve a translator," Nelson told the Weekly.
This is not what the framers of the City Charter had in mind when they created the rules that spell out how Los Angeles governance works. City Hall is required to conduct "exhaustive efforts" to resolve problems within the neighborhood councils.
Nelson says DONE "is required to make exhaustive efforts to resolve a neighborhood council's problems, prior to decertification." While he accepts the complaint by the neighborhood council that it got "prejudicial and disparate treatment," he also says that DONE was trying to meet the standard of "exhaustive efforts" by asking the BONC board for permission to hold a new election — rather than completely decertify the neighborhood group.
But Commissioner Burman says the BONC commission "didn't feel that taking over the elections was going to solve that problem," so it disbanded the group.
In light of the requirement for "exhaustive efforts," that's a strange position for BONC to take — giving rise to the rumor that Jan Perry ordered the dismantling of the South L.A. neighborhood council. As Nelson points out, his department successfully organized new neighborhood council elections in Venice, and also in Van Nuys. To jump straight to decertification in South L.A. "was clearly a bad decision... Sounds like the decision was already made to decertify them, then everybody just looked for reasons."
BY STEVEN LEIGH MORRIS
LA Weekly, Wednesday, January 23, 2008 - 6:29 pm
ON JANUARY 14, AT A SPECIAL meeting of the city of Los Angeles' Board of Neighborhood Commissioners in a middle-school auditorium in South Los Angeles, the board voted 4-1 to put the Vernon/Main Neighborhood Council out of business.
Rena Kosnett
It was a curious night in the annals of community empowerment, as the commission appointed by Mayor Antonio Villaraigosa gave the local residents, who have been meeting regularly for years to improve their community, just five days to shut down operations and return all city-owned office equipment.
In the past several months, some neighborhood members of the Vernon/Main council have crossed swords with City Council Member Jan Perry. In one instance, President Donald Barnett showed up at a South Park gymnasium for a meeting about an Environmental Impact Report for a "wetlands park" at Avalon Boulevard and 54th Street.
Barnett publicly raised several questions that annoyed Perry, who is advocating the park: Can you really call it a wetland, when the plan is to gather filthy storm-drain water and let it seep into the earth? Is this the best land use in an area desperate for development? Could the $19 million slated for the storm-drain purification project be used for homeless housing instead?
According to Barnett, Perry became so vexed that she abruptly ended the meeting. Perry denies his allegation, telling the Weekly that she allowed the meeting to "finish"— but won't say how.
Perry's influence aside, "BONC"— as the board of seven Villaraigosa political appointees is called, is starting to earn a reputation for trying to silence boisterous neighborhood councils — with help from the Department of Neighborhood Empowerment (which people actually do call "DONE").
Barnett and Vernon/Main board member Deacon Alexander say they believe their neighborhood council was shuttered on Perry's orders — a suggestion Perry dismisses as "silly."
Yet several days ago, appalled neighborhood residents and business owners looked on as BONC board President Linda Lucks condescendingly lectured the South Los Angeles group, informing them that even though she was going to shut the group down against its will, they could see it as "a positive thing"— because now they can petition BONC to "recertify and make a fresh start" without the current highly activist local leaders.
The BONC board determined that the neighborhood council violated its own bylaws, and some officials at DONE also claim that the mostly black group has engaged in racist behavior. Rather than trying to untangle a thorny bramble of neighborhood politics, BONC voted to wipe out the group, prompting questions about the city's failure to follow any written standards for how and why a neighborhood council gets the boot.
NEIGHBORHOOD COUNCILS WERE CREATED in order to appease angry Hollywood and Valley secessionists so fed up with City Hall's neglect and diversion of taxes that they tried to break the city apart — and scared then-Mayor James Hahn and other city leaders into believing they just might pull it off.
Although Los Angeles voters chose not to break up Los Angeles, the movement against downtown and its powerful interests gave voice to far-flung neighborhoods. Chastened, city leaders created neighborhood councils to work in "partnership" with city agencies, and to receive stipends and administrative support.
Unlike in homeowners associations, city leaders deemed that the membership of neighborhood councils could be anybody who does business in a neighborhood, or is just a patron of a business in a neighborhood, or who merely declares an interest in the neighborhood. All were defined as "stakeholders."
Critics point out that the broad definition of who is a "neighbor" has opened the doors to outside interference and lobbying. It has also left City Hall more firmly in charge of deciding who gets to continue to exist as a neighborhood council, and who does not.
The January 14 vote to dismantle the South Los Angeles group came after the city's manhandling of a much different neighborhood council called North Hills West. This group of activist suburbanites in the West Valley had successfully defeated a series of city-supported, residential developments on its rustic fields and meadows — the very sort of interest in local issues a neighborhood council is supposed to engage in.
But instead of thanks for its grassroots democracy, the group suddenly faced decertification by City Hall — thanks to anonymous charges by unnamed "stakeholders" who claimed the group was involved in financial impropriety and "hate language."
Then, in an embarrassing about-face, DONE Project Coordinator Manuel Durazo was forced to admit in December that none of the anonymous charges could be substantiated. In January, DONE Acting General Manager BongHwan Kim publicly conceded, "I told [North Hills West Neighborhood Council] it's much better that they be the problem solvers, and the city should not be defining their agenda... I've come to learn that a policing role is not appropriate for DONE."
But a number of BONC's board members don't see it that way. "I take offense!" Commissioner Tsilah Burman shot back at Kim. "I would ask that you not use the language of 'policing' — I would say that what we're trying to do is be a place of last resort when a neighborhood council feels they can't get their problems resolved."
When the West Valley group learned that BONC was now attacking a neighborhood council in South L.A., the president and two board members traveled from the Valley south to attend the January 14 meeting — and to show solidarity with their embattled, cityside peers.
It didn't help. By night's end, Burman joined three other commissioners — Lucks, Daniel Gatica and Michele Siqueiro — to decertify the Vernon/Main council, even after the group refuted, with detailed documentation, a litany of thin charges by DONE.
Among other things, DONE Project Coordinator Mark Lewis accused the South Los Angeles group of failing to hold timely elections. In fact, Lewis blocked those elections until he approved the group's petition for election-prerequisite changes to its bylaws. DONE must respond to such petitions within 10 days, but made the group wait four months, then rejected its petition due to "insufficient paperwork."
Lewis also wrongly testified that the South Los Angeles group regularly failed to gather a quorum of "nine" board members. In fact, Vernon/Main's council needs only seven members for a quorum. The neighborhood council turned over to the Weekly a complete set of minutes dating back to 2005 that plainly show that its meetings were held with a quorum and according to its bylaws.
Barnett says he also made repeated requests to Lewis to provide a Spanish-language translator at its meetings, which Lewis often failed to do. (An e-mail from Lewis dated November 7, 2007, apologizes for one such failure.) DONE also blocked Barnett's efforts to hire a "nonauthorized" translator — a hiring policy confirmed by General Manager Kim.
Former executive director of DONE Greg Nelson describes what his erstwhile department is doing to the neighborhood council as the "bleeding of an organization to death with a thousand paper cuts." The petty demands have perplexed him. "I just don't see why DONE would need to approve a translator," Nelson told the Weekly.
This is not what the framers of the City Charter had in mind when they created the rules that spell out how Los Angeles governance works. City Hall is required to conduct "exhaustive efforts" to resolve problems within the neighborhood councils.
Nelson says DONE "is required to make exhaustive efforts to resolve a neighborhood council's problems, prior to decertification." While he accepts the complaint by the neighborhood council that it got "prejudicial and disparate treatment," he also says that DONE was trying to meet the standard of "exhaustive efforts" by asking the BONC board for permission to hold a new election — rather than completely decertify the neighborhood group.
But Commissioner Burman says the BONC commission "didn't feel that taking over the elections was going to solve that problem," so it disbanded the group.
In light of the requirement for "exhaustive efforts," that's a strange position for BONC to take — giving rise to the rumor that Jan Perry ordered the dismantling of the South L.A. neighborhood council. As Nelson points out, his department successfully organized new neighborhood council elections in Venice, and also in Van Nuys. To jump straight to decertification in South L.A. "was clearly a bad decision... Sounds like the decision was already made to decertify them, then everybody just looked for reasons."
Saturday, February 2, 2008
Oil Sources of Financial Crisis
Something Had to Give: How Oil Burst the American Bubble
by Michael T. Klare
Published on Friday, February 1, 2008 by TomDispatch.com
The economic bubble that lifted the stock market to dizzying heights was sustained as much by cheap oil as by cheap (often fraudulent) mortgages. Likewise, the collapse of the bubble was caused as much by costly (often imported) oil as by record defaults on those improvident mortgages. Oil, in fact, has played a critical, if little commented upon, role in America’s current economic enfeeblement — and it will continue to drain the economy of wealth and vigor for years to come.
The great economic mega-bubble arose in the late 1990s, when oil was cheap, times were good, and millions of middle-class families aspired to realize the “American dream” by buying a three (or more) bedroom house on a decent piece of property in a nice, safe suburb with good schools and various other amenities. The hitch: Few such affordable homes were available for sale — or being built — within easy commuting range of major metropolitan areas or near public transportation. In the Los Angeles metropolitan area, for example, the median sale price of existing homes rose from $290,000 in 2002 to $446,400 in 2004; similar increases were posted in other major cities and in their older, more desirable suburbs.
This left home buyers with two unappealing choices: Take out larger mortgages than they could readily afford, often borrowing from unscrupulous lenders who overlooked their overstretched finances (that is, their “subprime” qualifications); or buy cheaper homes far from their places of work, which ensured long commutes, while hoping that the price of gasoline remained relatively low. Many first-time home buyers wound up doing both — signing up for crushing mortgages on homes far from their places of work.
The result was metastasizing exurban home developments along the beltways that surround major American cities and along the new feeder roads that now stretched into the distant countryside beyond. In some cases, those new homeowners found themselves 30, 40, even 50 miles or more from the urban centers in which their only hope of employment lay. Data released by the U.S. Census Bureau in 2004 showed that virtually all of the fastest growing counties in the country — those with growth rates of 10% or more — were located in exurban areas like Loudoun County, Virginia (35 miles west of Washington, D.C.) or Henry County, Georgia (30 miles south of Atlanta).
At the same time, cheap oil and changing consumer tastes — pushed along by relentless advertising campaigns — led many of the same Americans to trade in their smaller, lighter cars for heavy SUVs or pickup trucks, which, of course, meant only one thing — a significant increase in oil consumption. According to the Department of Energy, total petroleum use rose from an average of 17 million barrels per day in 1990 to 21 million barrels in 2004, an increase of 24% — most of it being burned up on American roads.
Let the Good Times Roll (into the Exurbs)
In 1998, when the bubble was taking shape, crude oil cost about $11 a barrel and the United States produced half of the petroleum it consumed; but that was the last year in which the fundamentals were so positive. American reliance on imported petroleum crossed the 50% threshold that very year and has been rising ever since, while the cost of imported oil hit the $100 per barrel mark this January 2 for the first time, an all-time record (though the price was once briefly higher, as measured in older, less inflated dollars).
When that steady price climb, combined with growing dependence on imported petroleum, was translated into the new exurban landscape the economic bubble began to shudder. As a start, there was that ever-increasing outflow of dollars needed just to pay for all those barrels of crude and the resulting surge in America’s foreign-trade deficit.
Consider this: In 1998, the United States paid approximately $45 billion for its imported oil; in 2007, that bill is likely to have reached $400 billion or more. That constitutes the single largest contribution to America’s balance-of-payments deficit and a substantial transfer of wealth from the U.S. economy to those of oil-producing nations. This, in turn, helped weaken the value of the dollar in relation to key foreign currencies, especially the euro and the Japanese yen, boosting the cost of other imported foreign goods and so threatening to fuel inflation at home.
Meanwhile, two critical developments kept the cost of oil rising: a dramatic increase in global demand, largely driven by the emergence of China and India as major consuming nations; and a pronounced slowdown in the expansion of global supply, due mainly to a dearth of new discoveries and recurring political disorder in key oil fields already in production. This meant that American energy consumers — including all those long-distance commuters with crippling mortgages and gas-guzzling SUVs — had to compete with newly-affluent Chinese and Indian consumers for access to ever more costly supplies of imported petroleum. Something had to give.
As the oil import bill kept rising, the value of the dollar kept falling, and inflationary pressures kept building, the country’s central bankers responded in classic fashion by raising interest rates. This naturally resulted in substantially higher monthly payments for homeowners with variable-rate mortgages. For many families already stretched to the limit, this would prove the final blow. Forced to default on their mortgages, they then precipitated the subprime crisis by, in effect, puncturing the bubble.
Even then, the economy might have had a chance had that crisis not come in tandem with the $100 barrel of oil. By December, consumers were cutting back on nonessential purchases, producing the most disappointing holiday retail season since 2001. When questioned, many indicated that the high cost of gasoline and home-heating fuel had forced them to economize on Christmas gifts, winter vacations, and other indulgences. “If gasoline prices go up, that means there’s less to spend on everything else,” said David Greenlaw, chief U.S. fixed-income analyst at Morgan Stanley.
The high price of gasoline was bad news for another pillar of the economy as well: the auto industry. While Japanese companies were busy rolling out hybrid vehicles and small, fuel-efficient conventional cars, Detroit stuck doggedly to its now-obsolete business model of producing large SUVs and light trucks, which had, in recent years, been the source of most of its profits. Once the price of oil went stratospheric, of course, Americans predictably stopped buying the gas guzzlers, signing what looked like an instant death certificate for an improvident industry. In 1999, for example, Ford sold more than 428,000 mid-sized Explorer SUVs; in the first 11 months of 2007, the equivalent number was 126,930 Explorers (and even that puts a gloss on the corpse, as November was one of the worst months in recent automotive history). An auto industry in decline naturally means that many ancillary industries will be facing contraction, if not disaster.
Popping the Bubble
Then came January 2. Although oil retreated from the $100 mark by the end of that day on the New York Mercantile Exchange, the damage had been done. Stocks on the New York Stock Exchange plummeted, suffering their worst loss on a New Year debut since 1983. Gold, meanwhile, soared to an all-time high — a sure indication of international anxiety about the vigor of the U.S. economy.
Since then, stock market panics have hit major financial centers around the world. Only a dramatic last-minute decision by the Federal Reserve to reduce overnight lending rates by three-quarters of a point before the markets opened on January 22 averted a further, potentially catastrophic slide in stock prices. Many analysts now believe that a recession is inevitable — possibly a long and especially painful one. A few are even mentioning the “D” word, for depression.
Whatever happens, the American economy will eventually emerge from this crisis significantly weaker, largely because of its now-inescapable dependence on imported oil. Over the past decade, this country has squandered approximately one and a half trillion dollars on imported oil, much of which has been poured down the tanks of grotesquely fuel-inefficient vehicles that were conveying drivers on ever lengthening commutes from the exurbs to employment in center cities.
Today, a large share of this money is deposited in so-called sovereign-wealth funds (SWFs). Americans should get used to that phrase. It stands for giant pools of wealth that are under the control of government agencies like the Kuwait Investment Authority and the Abu Dhabi Investment Authority. These SWFs now control approximately $3 trillion in assets, and, with more petrodollars pouring into the petro-states every day, they are projected to hit the $12 trillion mark by 2015.
What are those who control the sovereign-wealth funds doing with all this money? For one thing, buying up choice U.S. assets at bargain-basement prices. In the past few months, Persian Gulf SWFs have acquired a significant stake in a number of prominent American firms, giving them a potential say in the future management of these companies. The Kuwait Investment Authority, for example, recently took a $12 billion stake in Citigroup and a $6.5 billion share in Merrill Lynch; the Abu Dhabi Investment Authority acquired a $7.5 billion stake in Citigroup; and Mubadala Development of Abu Dhabi purchased a $1.5 billion share in the privately-held Carlyle Group.
These acquisitions are just a small indication of a massive, irreversible shift in wealth and power from the United States to the petro-states of the Middle East and energy-rich Russia. These countries, notes the International Monetary Fund, are believed to have raked in $750 billion in 2007 and are expected to do even better this year — and each year thereafter. What this means is not just the continuing enfeeblement of the American economy, but an accompanying decline in global political leverage.
Nothing better captures the debilitating nature of America’s dependence on imported oil than President Bush’s humiliating recent performance in Riyadh, Saudi Arabia. He quite literally begged Saudi King Abdullah to increase the kingdom’s output of crude oil in order to lower the domestic price of gasoline. “My point to His Majesty is going to be, when consumers have less purchasing power because of high prices of gasoline — in other words, when it affects their families, it could cause this economy to slow down,” he told an interviewer before his royal audience. “If the economy slows down, there will be less barrels of [Saudi] oil purchased.”
Needless to say, the Saudi leadership dismissed this implied threat for the pathetic bathos it was. The Saudis, indicated Oil Minister Ali al-Naimi, would raise production only “when the market justifies it.” With that, they made clear what the whole world now knows: The American bubble has burst — and it was oil that popped it. Thus are those with an “oil addiction” (as President Bush once termed it) forced to grovel before the select few who can supply the needed fix.
Michael Klare, author of Resource Wars and Blood and Oil, is a professor of peace and world security studies at Hampshire College. His newest book, Rising Powers, Shrinking Planet: The New Geopolitics of Energy, will be published by Metropolitan Books in April 2008.
Copyright 2008 Michael T. Klare
by Michael T. Klare
Published on Friday, February 1, 2008 by TomDispatch.com
The economic bubble that lifted the stock market to dizzying heights was sustained as much by cheap oil as by cheap (often fraudulent) mortgages. Likewise, the collapse of the bubble was caused as much by costly (often imported) oil as by record defaults on those improvident mortgages. Oil, in fact, has played a critical, if little commented upon, role in America’s current economic enfeeblement — and it will continue to drain the economy of wealth and vigor for years to come.
The great economic mega-bubble arose in the late 1990s, when oil was cheap, times were good, and millions of middle-class families aspired to realize the “American dream” by buying a three (or more) bedroom house on a decent piece of property in a nice, safe suburb with good schools and various other amenities. The hitch: Few such affordable homes were available for sale — or being built — within easy commuting range of major metropolitan areas or near public transportation. In the Los Angeles metropolitan area, for example, the median sale price of existing homes rose from $290,000 in 2002 to $446,400 in 2004; similar increases were posted in other major cities and in their older, more desirable suburbs.
This left home buyers with two unappealing choices: Take out larger mortgages than they could readily afford, often borrowing from unscrupulous lenders who overlooked their overstretched finances (that is, their “subprime” qualifications); or buy cheaper homes far from their places of work, which ensured long commutes, while hoping that the price of gasoline remained relatively low. Many first-time home buyers wound up doing both — signing up for crushing mortgages on homes far from their places of work.
The result was metastasizing exurban home developments along the beltways that surround major American cities and along the new feeder roads that now stretched into the distant countryside beyond. In some cases, those new homeowners found themselves 30, 40, even 50 miles or more from the urban centers in which their only hope of employment lay. Data released by the U.S. Census Bureau in 2004 showed that virtually all of the fastest growing counties in the country — those with growth rates of 10% or more — were located in exurban areas like Loudoun County, Virginia (35 miles west of Washington, D.C.) or Henry County, Georgia (30 miles south of Atlanta).
At the same time, cheap oil and changing consumer tastes — pushed along by relentless advertising campaigns — led many of the same Americans to trade in their smaller, lighter cars for heavy SUVs or pickup trucks, which, of course, meant only one thing — a significant increase in oil consumption. According to the Department of Energy, total petroleum use rose from an average of 17 million barrels per day in 1990 to 21 million barrels in 2004, an increase of 24% — most of it being burned up on American roads.
Let the Good Times Roll (into the Exurbs)
In 1998, when the bubble was taking shape, crude oil cost about $11 a barrel and the United States produced half of the petroleum it consumed; but that was the last year in which the fundamentals were so positive. American reliance on imported petroleum crossed the 50% threshold that very year and has been rising ever since, while the cost of imported oil hit the $100 per barrel mark this January 2 for the first time, an all-time record (though the price was once briefly higher, as measured in older, less inflated dollars).
When that steady price climb, combined with growing dependence on imported petroleum, was translated into the new exurban landscape the economic bubble began to shudder. As a start, there was that ever-increasing outflow of dollars needed just to pay for all those barrels of crude and the resulting surge in America’s foreign-trade deficit.
Consider this: In 1998, the United States paid approximately $45 billion for its imported oil; in 2007, that bill is likely to have reached $400 billion or more. That constitutes the single largest contribution to America’s balance-of-payments deficit and a substantial transfer of wealth from the U.S. economy to those of oil-producing nations. This, in turn, helped weaken the value of the dollar in relation to key foreign currencies, especially the euro and the Japanese yen, boosting the cost of other imported foreign goods and so threatening to fuel inflation at home.
Meanwhile, two critical developments kept the cost of oil rising: a dramatic increase in global demand, largely driven by the emergence of China and India as major consuming nations; and a pronounced slowdown in the expansion of global supply, due mainly to a dearth of new discoveries and recurring political disorder in key oil fields already in production. This meant that American energy consumers — including all those long-distance commuters with crippling mortgages and gas-guzzling SUVs — had to compete with newly-affluent Chinese and Indian consumers for access to ever more costly supplies of imported petroleum. Something had to give.
As the oil import bill kept rising, the value of the dollar kept falling, and inflationary pressures kept building, the country’s central bankers responded in classic fashion by raising interest rates. This naturally resulted in substantially higher monthly payments for homeowners with variable-rate mortgages. For many families already stretched to the limit, this would prove the final blow. Forced to default on their mortgages, they then precipitated the subprime crisis by, in effect, puncturing the bubble.
Even then, the economy might have had a chance had that crisis not come in tandem with the $100 barrel of oil. By December, consumers were cutting back on nonessential purchases, producing the most disappointing holiday retail season since 2001. When questioned, many indicated that the high cost of gasoline and home-heating fuel had forced them to economize on Christmas gifts, winter vacations, and other indulgences. “If gasoline prices go up, that means there’s less to spend on everything else,” said David Greenlaw, chief U.S. fixed-income analyst at Morgan Stanley.
The high price of gasoline was bad news for another pillar of the economy as well: the auto industry. While Japanese companies were busy rolling out hybrid vehicles and small, fuel-efficient conventional cars, Detroit stuck doggedly to its now-obsolete business model of producing large SUVs and light trucks, which had, in recent years, been the source of most of its profits. Once the price of oil went stratospheric, of course, Americans predictably stopped buying the gas guzzlers, signing what looked like an instant death certificate for an improvident industry. In 1999, for example, Ford sold more than 428,000 mid-sized Explorer SUVs; in the first 11 months of 2007, the equivalent number was 126,930 Explorers (and even that puts a gloss on the corpse, as November was one of the worst months in recent automotive history). An auto industry in decline naturally means that many ancillary industries will be facing contraction, if not disaster.
Popping the Bubble
Then came January 2. Although oil retreated from the $100 mark by the end of that day on the New York Mercantile Exchange, the damage had been done. Stocks on the New York Stock Exchange plummeted, suffering their worst loss on a New Year debut since 1983. Gold, meanwhile, soared to an all-time high — a sure indication of international anxiety about the vigor of the U.S. economy.
Since then, stock market panics have hit major financial centers around the world. Only a dramatic last-minute decision by the Federal Reserve to reduce overnight lending rates by three-quarters of a point before the markets opened on January 22 averted a further, potentially catastrophic slide in stock prices. Many analysts now believe that a recession is inevitable — possibly a long and especially painful one. A few are even mentioning the “D” word, for depression.
Whatever happens, the American economy will eventually emerge from this crisis significantly weaker, largely because of its now-inescapable dependence on imported oil. Over the past decade, this country has squandered approximately one and a half trillion dollars on imported oil, much of which has been poured down the tanks of grotesquely fuel-inefficient vehicles that were conveying drivers on ever lengthening commutes from the exurbs to employment in center cities.
Today, a large share of this money is deposited in so-called sovereign-wealth funds (SWFs). Americans should get used to that phrase. It stands for giant pools of wealth that are under the control of government agencies like the Kuwait Investment Authority and the Abu Dhabi Investment Authority. These SWFs now control approximately $3 trillion in assets, and, with more petrodollars pouring into the petro-states every day, they are projected to hit the $12 trillion mark by 2015.
What are those who control the sovereign-wealth funds doing with all this money? For one thing, buying up choice U.S. assets at bargain-basement prices. In the past few months, Persian Gulf SWFs have acquired a significant stake in a number of prominent American firms, giving them a potential say in the future management of these companies. The Kuwait Investment Authority, for example, recently took a $12 billion stake in Citigroup and a $6.5 billion share in Merrill Lynch; the Abu Dhabi Investment Authority acquired a $7.5 billion stake in Citigroup; and Mubadala Development of Abu Dhabi purchased a $1.5 billion share in the privately-held Carlyle Group.
These acquisitions are just a small indication of a massive, irreversible shift in wealth and power from the United States to the petro-states of the Middle East and energy-rich Russia. These countries, notes the International Monetary Fund, are believed to have raked in $750 billion in 2007 and are expected to do even better this year — and each year thereafter. What this means is not just the continuing enfeeblement of the American economy, but an accompanying decline in global political leverage.
Nothing better captures the debilitating nature of America’s dependence on imported oil than President Bush’s humiliating recent performance in Riyadh, Saudi Arabia. He quite literally begged Saudi King Abdullah to increase the kingdom’s output of crude oil in order to lower the domestic price of gasoline. “My point to His Majesty is going to be, when consumers have less purchasing power because of high prices of gasoline — in other words, when it affects their families, it could cause this economy to slow down,” he told an interviewer before his royal audience. “If the economy slows down, there will be less barrels of [Saudi] oil purchased.”
Needless to say, the Saudi leadership dismissed this implied threat for the pathetic bathos it was. The Saudis, indicated Oil Minister Ali al-Naimi, would raise production only “when the market justifies it.” With that, they made clear what the whole world now knows: The American bubble has burst — and it was oil that popped it. Thus are those with an “oil addiction” (as President Bush once termed it) forced to grovel before the select few who can supply the needed fix.
Michael Klare, author of Resource Wars and Blood and Oil, is a professor of peace and world security studies at Hampshire College. His newest book, Rising Powers, Shrinking Planet: The New Geopolitics of Energy, will be published by Metropolitan Books in April 2008.
Copyright 2008 Michael T. Klare
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