From Volume 6, Issue 29 of EIR Online, Published July 17, 2007

U.S. Economic/Financial News

Candidates Weigh In on Hedge Fund Tax Loophole

July 14 (EIRNS)—The push to fix a Federal Tax Code loophole that benefits financiers at the expense of ordinary workers, is gathering steam, as Democratic Presidential candidates weigh in on the side of reform.

Following former Sen. John Edwards' endorsement on July 8 of tax reform legislation introduced last month by Sens. Max Baucus (D-Mont.) and Charles Grassley (R-Iowa), other candidates have decided to follow suit. On July 12, Sen. Barack Obama (D-Ill.) signed on to the Baucus-Grassley bill as a co-sponsor, while Sen. Hillary Clinton (D-N.Y.) jumped on board the very next day, blasting the tax loophole which allowed "an investment manager making $50 million" to "pay a lower tax rate on her earned income than a teacher making $50,000 pays on her income," according to Reuters, July 13.

The bill as introduced focuses on one loophole which allows hedge-fund managers and similar partnerships which go public, to only pay 15% capital gains tax on a large portion of their earnings defined as passive investments, instead of the normal 35%; but Senator Baucus says of the legislation, "I'm looking at it all. This is all very preliminary. I'm nowhere close to knowing what we should do and should not do."

Dam Breaking on Subprime Mortgage-and-Securities Bubble

July 10 (EIRNS)—After the markets closed July 10 (well down), Moody's Investors Service announced that it was cutting the credit ratings on $5.2 billion in bonds backed by subprime mortgages. The move affects 399 CDO (collateralized debt obligation) bonds, all of which were issued just last year.

This announcement followed a similar one made this morning by Standard & Poors, that they are set to cut credit ratings on $12 billion worth of bonds, and are considering a much larger re-rating of their portfolio. The bonds under review by S&P represent a mere 2.1% of the $565.3 billion of similar bonds rated by them during 2006, but is four times the $3 million worth of bonds which they have already subjected to downgrading. In addition, S&P has put the entire class of CDO bonds, representing 612 classes of residential mortgage-backed securities, on a "Credit Watch" with negative implications. S&P, Moody's, and other "respected" ratings agencies, such as Fitch, have come under fire recently for underestimating the actual risk potential of these bonds, some of which are now selling for 50 cents on the dollar.

Two of the biggest market losers today were Lehman Brothers and Bear Stearns, both "leaders" in underwriting these bonds. CNNMoney reported July 10 that, in the month of October alone, $50 billion of adjustable rate (subprime) mortgages will reset to higher interest rates, resulting in mortgage rate increases of 30-40% for consumers.

Congress Grills 'Plunge Protection Committee'

July 11 (EIRNS)—Democratic Reps. Maxine Waters (Calif.) and Barney Frank (Mass.) acknowledged the growing risk of a financial crash, at a hearing June 11 on "Hedge Funds and Systemic Risk," in the House Financial Services Committee. All the principals of the "Plunge Protection Committee" (officially, the President's Working Group on Financial Markets)—Treasury, Federal Reserve, SEC, and Commodity Futures Trading Commission—were before Frank's committee; all denied that any systemic risk existed in the current mortgage-bubble meltdown, and opposed any regulation or even registration of hedge funds.

Waters was blunt in her questioning of Treasury Undersecretary Robert Steele: "What can you tell me about other hedge funds that may be in trouble, and about to fail like these [Bear Stearns hedge funds] from excessive investment in these mortgage-based securities?" Waters asked. "Can we expect, as some are predicting, a collapse in financial markets as a result of these developments?"

Earlier, in opening the hearing, Frank had said, regarding hedge funds and financial markets: "There is a problem here, that we wish we were sure how to approach.... There is a potential for systemic risk." Frank added, "There is a great deal of potential for pension funds to get involved [in hedge funds] beyond what they can handle," a warning repeated by several other committee members. Republican Rep. Richard Baker (La.) warned, "Another Amaranth matter might lead to an avalanche of pension fund losses, because their managers don't understand the risks. This is no casual warning...."

This was one of four Congressional hearings on July 11-12 alone, dealing with private equity funds, hedge funds, and growing risks to the financial system from repeated failures of these speculative funds.

Troubled Texas Teacher Pension Fund Gambles on Hedge Funds

July 14 (EIRNS)—T. Britton Harris IV, CEO of the Teacher Retirement System of Texas (TRS), formerly CEO at Bridgewater Associates hedge fund, is planning to put one-third of the pension fund's $112 billion in assets into "alternative assets" (hedge funds, private equity funds, and real estate) to diversify its portfolio, according to the July 14 Wall Street Journal. The Texas pension fund currently has under 5% of its assets in such funds.

"Investments in alternative assets has not hurt returns at other pension funds. They have helped returns," according to Harris. California's San Diego County Employees Retirement Association would disagree with that assessment by Harris. They are suing the failed hedge fund Amaranth for $150 million for failing to properly guard against risk in managing their portfolio. The Texas State Legislature, fearful for the health of the huge pension fund, passed legislation recently, capping the amount of hedge fund investments allowed to 5% of its total portfolio. TRS was pushing for a 10% cap.

The TRS fund has been trying to find ways to beef up shortfalls in its fund by moving into higher-return investments, but one of the reasons for the shortfall, according to Public Capital, a pension blog for the Austin American-Statesman online, is that the state contribution into the fund is the lowest allowed by the Texas Constitution—just 6%. It was lowered in the 1990s during the heyday of high returns.

According to Frederick Rowe, chairman of the Texas Pension Review Board, "An experienced investor might suspect that TRS is coming late to the alternatives game; ... that may dig an even deeper hole for the fund." Rowe characterized the TRS move into hedge funds as a "panic attack."

Mortgage Foreclosures Rose 87% in June

July 12 (EIRNS)— reported today 12 a statement made by RealtyTrac (which sells foreclosure data), that mortgage foreclosures rose 87% in June, over the number for June 2006, and that foreclosures for the first half of 2007 are 56% higher than the figures for that period in 2006. Total numbers of disclosures were highest in California, Florida, Ohio, and Michigan.

In terms of rate of foreclosures, Nevada had the highest in June, with one filing for every 175 households, four times the national average of one for every 704 households. Following Nevada, were California (1 per 315), Colorado (1 per 317), Florida (1 per 347), Arizona (1 per 383), Ohio (1 per 403), and Michigan (1 per 420).

RealtyTrac further reports that 58% of properties that are in the disclosure process are linked to borrowers with subprime loans, and that they expect U.S. foreclosures to reach 1.8 million by the end of the year.

Meanwhile, Bloomberg reports, the National Association of Realtors said that the supply of unsold homes hit a record 4.43 million in May. In a press release yesterday, the NAR said that home prices will drop by 1.4% this year, and housing starts will drop in 2008 due to higher mortgage rates and a glut of properties available. NAR also projected 865,000 new-home sales this year and 878,000 in 2008, compared to 1.05 million in 2006.

Delphi To Cut 90% of 2005 UAW Workforce

July 9 (EIRNS)—Auto-parts maker Delphi Corp. expects to have as few as 2,300 United Auto Workers union members at its four remaining UAW plants by 2012, the company said in a U.S. Bankruptcy Court filing in New York last week. That would be less than one-tenth of the 24,000 UAW members it employed when it filed for Chapter 11 bankruptcy protection in 2005, AP reports.

Chalk it up to the failure of the U.S. Congress to support Lyndon LaRouche's plan to save the auto industry in 2005.

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