Posted Thursday, May 21, 2009

In the late 1960s, two separate groups—the Diggers in San Francisco and the Yippies in New York—began operating
“free stores.” These were places where people could come to get things they needed—food, medicine, clothes, and, in some cases, cash—for free. These were designed simultaneously as parodies of, and alternatives to, the usual American consumer materialism. The stores were not around for very long because (at least in New York) people would come in and simply take everything they could put their hands on. Such predictable incursions were contrary to the spirit of the enterprise, but people who set themselves against market principles are ill-positioned to enforce “limit one per customer.”

Now, four decades later, comes Chris Anderson, editor of Wired and author of The Long Tail, whose new book proclaims that giving things away for free is the “radical” new business model of the future. According to Anderson, there are a variety of ways businesses can and should do this, and once they do, they can charge for other goods and services to make their money. Readers can decide whether they think the model is radical; certainly, Anderson does not claim that it is new, although he does propose applying it in a number of ways that seem unprecedented. Which is odd, since if he followed his own advice he’d be out of a job.

The problem is that—outside of a handful of examples, almost all of which are Internet- or digital-based—giving things away for free does not work, or does not work in any significant way. Here’s why: Just about any activity that merits the title “business” has a cost of producing its goods or services. Take, as a particularly rapacious example, the oil-and-gas business. It costs a huge amount of money to extract petroleum from the ground (in many places, more now than it used to), as well as refining the stuff, storing it, shipping it, and so on. Those costs may or may not justify the price of a barrel of oil or a gallon of gas, but neither do they justify a price of zero.

It’s exceedingly difficult to envision a way in which the oil industry—which, by the way, is fairly large—could recoup its expenses without charging the people who use its product. Presumably, if oil companies owned all the car companies, they could give you a car for free as long as they charged you a lot to fill it up: Although wildly impractical and undesirable in this instance, it is a version of Gillette’s old razor-for-free, charge-you-for-the-blades model. Or gas stations could give you a free plate when you fill up your tank. Neither of those is original or terribly interesting or necessarily very effective. Interestingly, as Anderson notes, Gillette mostly did charge for razors; these days it sells especially expensive razors. Come to think of it, gas stations don’t give away plates anymore, either.

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Apply this lens to almost any nondigital business—pharmaceuticals, manufacturing, law, banking—and the same problem emerges. Businesses need to recover labor and capital costs, and giving things away for free doesn’t meet that need very well. Anderson makes much of a supposed distinction between an “atoms economy” (you know, stuff) and a “bits economy,” but it really doesn’t help, because “bits” don’t run the economy. Even as Wall Street felt the need to ask Congress for hundreds of billions of dollars in bailouts, you didn’t see investment banks offering their services for free, and I don’t think that free toasters were going to save Wachovia’s business.

Actually, even in the digital world, there are plenty of cases in which “free” hasn’t worked. Back in the dot-com boom, the Internet services provider NetZero promised “free Internet forever.” The company is still around, sort of, in the form of United Online (UNTD), except that it doesn’t really provide free Internet access anymore, and it doesn’t make money. (Note: UNTD lost money in 2008; as a reader points out below, it had a profitable first quarter in 2009.) Ditto Vonage (VG), a “freemium” voice-over-Internet-protocol phone company that also loses money.

Wikipedia defines foreclosure as the legal and professional proceeding in which a mortgagee, or other lienholder, usually a lender, obtains a court ordered termination of a mortgagor’s equitable right of redemption. Usually a lender obtains a security interest from a borrower who mortgages or pledges an asset like a house to secure the loan. If the borrower defaults and the lender tries to repossess the property, courts of equity can grant the borrower the equitable right of redemption if the borrower repays the debt. While this equitable right exists, the lender cannot be sure that it can successfully repossess the property, thus the lender seeks to foreclose the equitable right of redemption. Other lienholders can also foreclose the owner’s right of redemption for other debts, such as for overdue taxes, unpaid contractors’ bills or overdue HOA dues or assessments.

Unfortunately, the current housing crisis has greatly increased the number of foreclosures in many of the bubble states.  California, Nevada, Las Vegas and Florida have all seen steady increases in the amount of foreclosures.  When an individual or family cannot find a way to make their mortgage payment for several months, foreclosure is almost inevitable.  I think we all have friends and family who have been through this troubling time and it is not a pretty sight.

Is there anything you can do to stop foreclosure?  There are numerous resources on the internet to help stop foreclosure.  Ultimately, the best thing anyone can do is educate themselves on what their options are.  I have several close friends who would rather pay off credit card debt than make their mortgage payment.  This is a VERY bad idea.  If you default on your mortgage payment, it is going to be extremely hard to ever build your credit to a respectable level.  If you cannot pay a credit card, your credit score will get hit but not nearly as much as with a foreclosure.

Therefore, your number one financial priority should be to make your mortgage payment each and every month.  What if I don’t make enough money to make my mortgage payment?  This is all to often the case with the amount of salary reductions and layoffs during the current recession.  If you do not make enough money to pay for your mortgage you can look into the Making Home Affordable Plan and see what the government can do to help you out.

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No matter what you may think, the government wants to keep you in your home.  The more homes that are foreclosed on the worse the economy is going to get.  That is the exact reason that President Obama created the Making Home Affordable plan.  He wants you to stay in your home, make your mortgage payments and live happily ever after.  With that being said, you must find a way to budget your money to make your mortgage payments.

The Making Home Affordable Plan mandates that your mortgage is only 31% of your monthly salary.  This is the case if your mortgage loan is backed by Fannie Mae or Freddie Mac.  Almost 70% of home loans in America are backed by these two companies.  If only 31% of your monthly salary is going towards your home loan then you should definitely have enough money to pay for it.  One of the hardest things you may have to do is to sit down and write out all the money you actually spend.  I mean write down every single penny you spend for a month’s period.  If you buy a $1.49 pack of chewing gum before work every Monday, you need to write it down.  You do not realize how bad you get nickel and dimed until you actually write down every single purchase.

After you have figured out how much money you spend in a month, you are likely going to need to cut out some habits.  Do you really need to buy three drinks every time you go out to eat.  For that matter, do you need to go out to eat as much as you do?  Is it mandatory that you get your nails done at the most luxurious spa?  These are questions you need to ask yourself and be honest.  There is a fine line between being happy and being wasteful.  If something makes you extremely happy and you can afford it, by all means continue to do it.  If you cannot pay for your mortgage, you might want to reconsider some of the things you feel makes you happy.

Another way to get through this troubling time is a home loan modification.  This has been extremely important with stopping foreclosures.  If you can find a way to get a lower mortgage rate then you are going to pay much less in a monthly mortgage payment.  With this, you will also pay much less over the entire lifetime of your home loan.  If you can save just $50 a month, that could lead a long way to stopping foreclosure on your home.

Getting a home loan modification is also all about educating yourself on what your options are.  There are an unlimited amount of resources available on the internet to research home loan modification or mortgage refinance.  Make sure to get information from relevant sites as there are a great deal of spam sites out there.  If you need any help, just do a quick google search for mortgage refinance or stop foreclosure and I am sure you will get some great resources.

Ultimately home loan modification will help stop foreclosure.  This is exactly what the President wanted and he will make sure it happens.  Hopefully the number of foreclosures greatly declines through the next several months as this has been a hinder on the recovery of the economy.  Having lower mortgage payments and more money to stimulate the economy will help us on the road to recovery.  For more information on home loan modification and stopping foreclosure, make sure to come back to Subprime Blogger for future articles.

How do you measure wealth generation?

1) Average annual gains?

2) Gains relative to an underlying index (the S&P 500)?

3) Gains relative to inflation?

Of these three, the last is the only real means of gauging wealth creation or destruction. Commentators have been going bananas over the fact that stocks are up 20%+ since their bottom of 666. No one mentions that this rally may actually be induced by the Federal Reserve pumping trillions of dollars into the financial system.

Similarly, no one mentions that adjusted for inflation, stocks are still WAY down from their peak during the Tech bubble.

As you can see, stocks entered a bear market in earnest following the Tech Crash. Yes, in number or nominal terms, the Dow has risen. But you have to remember the dollar lost roughly a third of its value from 2001 to today. Measuring stocks or anything in dollars between now and then was like measuring with a ruler that was continually shrinking.

Also, bear in mind that the above chart is using the Government’s phony measure of inflation: the Consumer Price Index [CPI] which DOESN’T include food or energy prices. Using accurate inflationary data, stocks are down even more in real terms.

My main point is this: inflation is an ever-present reality in the post WWII era. Investors need to be protecting themselves from this beast at all costs. You can do this by:

• Buying gold
• Buying commodities or real assets
• Buying companies that can offset inflationary costs by raising the price of their products
  

I suggest having some money in all three. It’s the only certain way to protect your wealth from inflation. The Feds are cooking up an inflationary storm of epic proportions, pumping TRILLIONS of dollars into the financial system. Stocks may rally like a rocket-ship from here. But in real terms they’re still tanking.

After all, if the Dow hits 30,000, but you’re celebrating by drinking a $150.00 coke… are you really any richer?

Vienna, Austria: New light has been thrown on how humans choose their partners, a scientist will tell the annual conference of the European Society of Human Genetics today (Monday May 25). Professor Maria da Graça Bicalho, head of the Immunogenetics and Histocompatibility Laboratory at the University of Parana, Brazil, says that her research had shown that people with diverse major histocompatibility complexes (MHCs) were more likely to choose each other as mates than those whose MHCs were similar, and that this was likely to be an evolutionary strategy to ensure healthy reproduction.

Females’ preference for MHC dissimilar mates has been shown in many vertebrate species, including humans, and it is also known that MHC influences mating selection by preferences for particular body odours. The Brazilian team has been working in this field since 1998, and decided to investigate mate selection in the Brazilian population, while trying to uncover the biological significance of MHC diversity.

The scientists studied MHC data from 90 married couples, and compared them with 152 randomly-generated control couples. They counted the number of MHC dissimilarities among those who were real couples, and compared them with those in the randomly-generated ‘virtual couples’. “If MHC genes did not influence mate selection”, says Professor Bicalho, “we would have expected to see similar results from both sets of couples. But we found that the real partners had significantly more MHC dissimilarities than we could have expected to find simply by chance.”

Within MHC-dissimilar couples the partners will be genetically different, and such a pattern of mate choice decreases the danger of endogamy (mating among relatives) and increases the genetic variability of offspring. Genetic variability is known to be an advantage for offspring, and the MHC effect could be an evolutionary strategy underlying incest avoidance in humans and also improving the efficiency of the immune system, the scientists say.

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The MHC is a large genetic region situated on chromosome 6, and found in most vertebrates. It plays an important role in the immune system and also in reproductive success. Apart from being a large region, it is also an extraordinarily diverse one.

“Although it may be tempting to think that humans choose their partners because of their similarities”, says Professor Bicalho, “our research has shown clearly that it is differences that make for successful reproduction, and that the subconscious drive to have healthy children is important when choosing a mate.”

The scientists believe that their findings will help understanding of conception, fertility, and gestational failures. Research has already shown that couples with similar MHC genes had longer intervals between births, which could imply early, unperceived miscarriages. “We intend to follow up this work by looking at social and cultural influences as well as biological ones in mate choice, and relating these to the genetic diversity of the extended MHC region”, says Professor Bicalho.

“We expect to find that cultural aspects play an important role in mate choice, and certainly do not subscribe to the theory that if a person bears a particular genetic variant it will determine his or her behaviour. But we also think that the unconscious evolutionary aspect of partner choice should not be overlooked. We believe our research shows that this has an important role to play in ensuring healthy reproduction, by helping to ensure that children are born with a strong immune system better able to cope with infection.”

YOKOHAMA, Japan — Jose Canseco is pumped up for his debut in mixed martial arts even though he’s not sure what he’s getting into.

The former Oakland A’s slugger is fighting seven-foot-two 330-pound super heavyweight Hong Man Choi of South Korea on the Dream 9 card Tuesday night at Yokohama Arena.

“I’m not gonna lie to you: I’m scared. This guy is huge,” Canseco said Monday at a news conference to promote the fight. “I’m a 44-year-old rookie and have had a lot of challenges in my baseball career and hopefully, I can do well tomorrow.”

Canseco, who hit 462 home runs over 17 seasons in the major leagues, has had several fights inside the ring since leaving baseball but has never taken on professional fighters like Choi, who has a 1-2 record in MMA.

“I have a lot of respect for these guys,” said Canseco, who stands 6-foot-4 and weighs 240 pounds. “A lot of baseball players are fans of mixed martial arts and so am I.”

He boxed Danny Bonaduce, a former “Partridge Family” child star, to a draw in a celebrity match in January. The 1988 AL MVP, who named alleged steroid abusers like himself in his two books, lost to former Philadelphia Eagle Vai Sikahema in his first foray into celebrity boxing.

Mixed martial arts is hugely popular in Japan and organizers are expecting a sellout crowd for Tuesday’s event. Former NFL lineman Bob Sapp is also on the card.

By his acknowledgment, the baseball outcast needs the money. It’s one reason why Canseco has accepted a wide variety of offbeat jobs to make ends meet.

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Service Pack 2 (SP2) for Windows Vista and Server 2008, which was finished one month ago, is now available to download. SP2 is also available as a stand-alone package. It can be used to update the English, French, German, Japanese and Spanish language versions of Vista and Server 2008 and is available for x86, x64 and ia64 systems. All three packages can also be downloaded together as an ISO image.

Currently, SP2 is not yet being distributed via Windows Update, however, Microsoft intends to start doing so “within the next few weeks”.

Service Pack 1 must be installed prior to installing SP2. SP1 was included in Server 2008 out of the box, but Vista users will need to have installed it separately. SP1 synchronised the code bases of Vista and Server 2008, which is why SP2 is now updating both operating systems.

SP2 includes all patches Microsoft has released since the last Service Pack (overview). In addition to patches, SP2 also includes a number of additional features, such as Windows Search 4.0, Windows Vista Feature Pack for Wireless (including Bluetooth 2.1 support) and Blu-ray support. An overview can be found on Technet.

Microsoft has published a list of applications which will no longer work or will have limited functionality following SP2 installation. Compared to Service Pack 2 for Windows XP, the list appears to be fairly modest.

Applications do not run faster under Vista with SP2 and indeed boot-time is even a little longer. Copying data will also continue to be slower under Vista with SP2 than under XP or Windows 7. By contrast, with SP2 installed Vista now reacts to user actions such as launching the start menu, Windows Explorer or the system settings window noticeably faster, approaching the speeds achieved under XP and Windows 7. On modern desktop PCs, the speed of the operating systems feels more or less the same. However the amount of disk space it requires continues to rule out Vista as an operating system for netbooks.

The above chart shows the projected sources of funding (receipts) for the U.S. Government for 2009.  Borrowing (the federal budget deficit) is projected to account for nearly half of all funding.  If you read yesterday’s post, you also know that the amount of borrowing in 2009 is likely to increase (because the Obama administration’s budget assumptions are too optimistic).

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By Dr Housing

Let me be abundantly clear.  We still have a Pay Option ARM and Alt-A mortgage problem.  This will hit in full force in 2010 and we are already seeing many mortgage holders having trouble with actual recasts brought on by negative amortization.  Yet there is a crew of people saying that Alt-A mortgage products will not bring any trouble because of the low interest rate environment.  Unfortunately the low rate misses the bigger issue.  Low rates are helping but the problem that we will be seeing is the massive onslaught of recasts, not resets that will be occurring over the next few years.  This is a big reason why we won’t see a housing bottom in California until 2011 at the earliest.  Many of these loans were made to supposedly better qualified borrowers in mid to upper priced areas.  These areas will begin to crack like an egg dropped on the floor late in 2009.  The Notice of Default tsunami will guarantee this much.

I’m am stunned that some people are actually saying that Alt-A mortgages or Pay Option ARMs will create little problems in the market.  Okay.  Then how about we remove the public-private investment program that conveniently has a cap with the FDIC of $500 billion?  After all, if there isn’t any problem with toxic mortgages why should we have a toxic mortgage program that has the design to eat up $1 trillion in loans.  Exactly.  Let me break down the latest figures from data by none other than the Federal Reserve:

California

At the end of March 2009

Subprime loans active:  $119 billion

Alt-A loans active:            $288 billion

U.S.

Alt-A active:       $469 billion

When we talk about the $500 billion in Alt-A mortgages this is what we are talking about.  Last time I checked $469 billion does not mean the problem has gone away.  Businessweek came out with a chart only last month showing how Pay Option ARMs will be recasting over the next few years:

Click for sharper image

I’ve added a reference point for all those people who seem to think that Option ARMs and Alt-A loans have somehow disappeared from the market.  The game is just starting.  Currently, we are seeing less than $2 billion per month of these loans recasting.  However, in 2010 we are going to start seeing $8 to $10 billion per month recast, nearly 5 times the current rate.  The chart states “months to 1^st reset” but they are referring to recasts brought on by negative amortization.  And as you will see, since the majority of these loans are in California the bulk are underwater Jacque Cousteau style.

Wachovia in their infinite wisdom swallowed up Golden West at the height of the lending insanity.  This cratered the bank which was taken over by Wells Fargo.  Just because you eat a bank doesn’t mean the toxic waste suddenly disappears.  In fact, there is still well over $100 billion in Pick-A-Pay mortgages in their portfolio.  Wells Fargo has written off a portion of the portfolio but there is still a significant amount remaining:

This is from their most recent 10-Q.  Wells Fargo alone has $42 billion in unpaid principal linked to Pick-A-Pay mortgages here in California.  The Pick-A-Pay was basically the Pay Option ARM World Savings Style.  Here were the terms:

Source:  Mortgage X

These are the crappiest loans in the world.  World Savings which was owned by Golden West thought that by simply having a little more collateral and looking at FICO scores that handing out toxic waste would be smart.  Some of these insane loans don’t have the first adjustment until 10 years later!  Of course, if Wells Fargo had any sense they would look at that absurd 152% LTV and freaking recast the entire lot.  Somehow I doubt they are doing this since they are too busy sucking up taxpayer money through the crony bailout and pretending everything is fine through manufactured stress tests.  Look at the LTV on some of the toxic foursome.  Arizona actually beats California out with a 161% LTV which is astonishing in itself.  But again, out of this little section of $61 billion in Pick-A-Pay loans $42 billion are in California, a state that has seen the median price drop by 50% in one year.

Wells Fargo seems to have the biggest amount of this crap on their books.  Yet Bank of America and JP Morgan now have a lot since they acquired toxic mortgage experts Countrywide Financial and WaMu.  Let us first look at Bank of America:

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Bank of America has $20 billion in Pay Option ARMs courtesy of Countrywide.  But keep in mind Countrywide was a toxic mortgage expert and other Alt-A crap producer.  They are the 31-Flavors of toxic waste.  We can find some of that junk in the whopping $261 billion residential mortgage portfolio.  If you haven’t realized it yet, if you lose your job any mortgage becomes toxic if you are underwater and can’t make the payment.  So many of these “prime” loans are equally bad.  The only difference is these Pay Option ARMs are monstrosities of epic proportions born in the laboratory of financial meth labs.  Take a look at what the California Attorney General shows through one glorious example of a Countrywide Pay Option ARM:

Here we get a firsthand look of a toxic mortgage product in action.  This is for a $460,000 loan which is what is sitting in many of those mid to upper priced areas in California.  Initially, the first year payment is $1,479 which of course is absurdly low.  But by the time we hit the first 5 year adjustment our payment jumps up to $3,747!  The payment more than doubles.  These craptastic loans were made throughout the bubble from 2004 to 2008 (yes, 2008 with freaking Wachoiva).  A large number of these will have major adjustments in 5 years (that is why we are seeing the first batch now) while some like the idiotic Pick-A-Pay loans can go on for 10 years.  Like I stated before, I highly doubt that Wells or BofA are going to push to recast many of these loans since they are going to fold the minute they do it.  Most people in these loans can’t sell and are basically renters.  That is until they hit recast and you will be seeing some massive moonwalking from homes.  Yet buyers are walking because they are not building equity (aka, renting).  If you bought a place for $500,000 and now know it is worth $250,000, you might make that $1,500 a month payment but are you going to make the payment once it goes up to $3,700?  Heck no!  You are out.  These banks are praying the market will recover.  It will not.  At least not under their delusional expectations and V-shaped bubble recovery plans.

Let us look at JP Morgan who ended up swallowing up WaMu, another Pay Option ARM fanatic.  Before WaMu went under like the titanic they had a gigantic amount of Pay Option ARMs:

Right before WaMu bit the banking dust, it had $52 billion in Pay Option ARMs.  And where were the bulk of these loans?  If you guessed California you win a prize:

Now JP Morgan wrote down a large part of this portfolio.  But how much of it?  That is the real question.  If we are to take the stress test as any guide, banks are still insanely optimistic of potential losses.  Let us pull up the latest 10-Q for JP Morgan:

According to the above, they still have $40.2 billion in Option ARMs and $21 billion in subprime loans.  But another major issue that I won’t address here but should be obvious is that massive “home equity” line item.  JP Morgan has $140 billion in these loans.  Many times, these loans are combined with Pay Option ARMs which makes for a dynamic duo of crap.  These loans are secured by home equity which doesn’t even exist anymore!  These will implode simultaneously as things get worse with these loans.  In the Pick-A-Pay portfolio with Wells, the majority of people make the minimum payment meaning negative amortization.  Meaning, the bank most likely will recast the product based on the appraised price at time of sale.  Many will say otherwise but this is the only logical conclusion.  If we are to appraise those loans in today’s current market, the vast majority of the portfolio would shatter the 110% or 125% (insane) caps and all these mortgages would hit recast oblivion.  I doubt that since banks are waiting for the PPIP so the taxpayer can assume the position at the worst time.  And that is why this problem hasn’t been solved.  I’ve heard a few misguided pundits say that most of these loans have been refinanced.  Sorry, the data above doesn’t show that.  Most of these are still out there.  The only refinancing going on with these toxic mortgages occurs in the foreclosure process.

So why has refinancing activity picked up?  Because buyers in no financial trouble have taken advantage of the low mortgage rate environment and this is smart.  But don’t think all the activity was because of subprime and Alt-A borrowers running to get new government backed mortgages.  They don’t qualify!

I’ll leave you with the most recent graph from Credit Suisse:

The big hit is going to be in 2010.  With 135,000 Notice of Defaults in California for Q1 of 2009, the second half of the year is going to expose the eye of the hurricane we are currently in.  The pundits who say these loans have been taken care mistake silence with a problem being solved.  The data does not back them up but since when do we expect pundits to pay attention to data?

May 21 (Bloomberg) — The odds on the dollar, Treasury bonds and the U.S. government’s AAA grade all heading for the dumpster are shortening.

While currency forecasting is a mug’s game and bond yields can’t quite decide whether to dive toward deflation or surge in anticipation of inflation, every time I think about that credit rating, I hear what Agent Smith in the “Matrix” movies called “the sound of inevitability.”

Several policy missteps suggest that investors should stop trusting — and lending to — the U.S. government. These include the state’s pressure on Bank of America Corp. to buy Merrill Lynch & Co.; the priority given to Chrysler LLC’s unions over the automaker’s secured creditors; and the freedom that some banks will regain to supersize executive bonuses by giving back part of the government money bolstering their balance sheets.

Currency markets have been in a weird state of what looks almost like equilibrium for the past couple of months. What’s really going on is something akin to an evenly matched tug of war that fails to move the ribbon tied around the center of the rope, giving the impression of harmony while powerful forces do silent battle until someone slips.

“All currencies are being debased dramatically by their central banks at extraordinary speeds and so in relative terms it appears there is no currency problem,” Lee Quaintance and Paul Brodsky of QB Asset Management said in a research note earlier this month. “In reality, however, paper money is highly vulnerable to a public catalyst that serves to acknowledge it is all merely vapor money.”

Flesh Wounds

Why pick on the dollar, though? Well, not necessarily because the U.S. economy is in worse shape than those of the euro area, the U.K. or Japan. The biggest problem is that external investors — particularly China — have more skin in the dollar game than in euros, yen or pounds, which makes the U.S. currency the most likely candidate to meet the cleaver in a crisis of confidence about post-crunch government finances.

China owns about $744 billion of U.S. Treasury bonds in its $2 trillion of foreign-exchange reserves.

Chinese exports, though, are dropping as the global economy weakens, with overseas shipments declining 23 percent in April from a year earlier, leaving a nation that has already expressed concern about its U.S. investments with less to spend in future.

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‘Heavy Hand of Government’

Those kinds of concerns are starting to surface in a steepening of the U.S. yield curve, driven by an increase in 10- and 30-year U.S. Treasury yields. The 10-year note currently yields 3.23 percent, about 235 basis points more than the two- year security, which marks a near doubling of the spread since the end of last year.

“When the government parks its tanks on capitalism’s lawns, that spells trouble for those who invest, add value and create jobs,” says Tim Price, director of investments at PFP Wealth Management in London. “Trillion-dollar bailouts do not only leave massive public-sector deficits in their wake, they also leave the presence of the heavy hand of government all over industry and markets, so the outlook for government bonds is less promising than the economic textbooks on deflation would have us believe.”

Earlier this month, the U.S. reported the first budget deficit for April in 26 years, with spending exceeding revenue by $20.9 billion, even though that’s the month when taxpayers have to stump up to the Internal Revenue Service and the government’s coffers should be overflowing. So far this fiscal year, the U.S. shortfall is $802.3 billion, more than five times the $153.5 billion gap in the year-earlier period.

Deathly Deficit

For the fiscal year ending Sept. 30, the Congressional Budget Office forecasts a record deficit of $1.75 trillion, almost four times the previous year’s $454.8 billion shortfall and about 13 percent of gross domestic product. Bear in mind that the target demanded of European nations wanting to join the euro was a deficit no greater than 3 percent of GDP.

David Walker, a former U.S. comptroller general, wrote in the Financial Times on May 12 that the U.S.’s top credit rating looks incompatible with “an accumulated negative net worth” of more than $11 trillion and “additional off-balance-sheet obligations” of $45 trillion. “One could even argue that our government does not deserve a triple A credit rating based on our current financial condition, structural fiscal imbalances and political stalemate,” he wrote.

No Default

It is undeniable that the U.S. government’s ability to finance its borrowing commitments has deteriorated as its deficit has ballooned. Dropping the U.S. from the top rating grade, though, wouldn’t mean the nation is about to default on its debt obligations; there’s a subtle distinction between ability to pay and propensity to fail to pay. There’s also a compelling argument that no government should be enjoying the benefits of a top credit grade in the current financial climate.

Using the definitions outlined by Standard & Poor’s, a one- step cut into the AA rated category would nudge the U.S.’s creditworthiness into a “very strong” capacity to fulfill its commitments, just weaker than the “extremely strong” capabilities demanded of AAA rated borrowers. That seems an appropriately nuanced sanction — albeit one that the rating companies might turn out to be too cowardly to impose.

(Mark Gilbert is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: Mark Gilbert in London at magilbert@bloomberg.net