The Community Reinvestment Act of 1977 is often tossed around these days as the source of the economic collapse we are still experiencing in this country. If you think it sounds a little strange that an act passed in 1977 caused an economic collapse in 2008 you are correct. It would be strange if that is what happened but the truth of the matter is that it isn’t that strange because that is not what caused the recent collapse no matter what Sean Hannity and Rush Limbaugh would have you to believe. In my last post, I pointed out that the actual numbers concerning the real estate mortgage industry didn’t add up to the collapse we experienced and I will go further into what actually happened in later posts on this subject but I thought it would be worthwhile to look at what actually did happen to the real estate market first.
The Community Reinvestment Act was passed with the express intent of eliminating unfair lending practices in inner cities. As far back as the thirties when the government became involved in assistance for home mortgages the mortgage industry has discriminated against one factor, perceived risk. In the early years of government involvement there were maps drawn up wherein were lined off with colored lines based upon the projected amount of risk associated with mortgages in different areas. Historically, the inner cities which were largely populated by minorities were “redlined” or outlined in red as the highest risk areas to loan money. Up until the early sixties such maps were the rule in the industry and it was very hard to convince mortgage companies and banks to loan money in these areas for the simple reason that there were plenty of other areas considered less risky in which to loan their money.
In 1968 the Fair Housing Act was passed to fight this problem. This act prohibited the policy of redlining areas based upon race, religion, gender, familial status, or ethnic origin. While the act was aimed at specifically limiting the ability of lending institutions to discriminate based upon these criteria the industry continued to be slanted away from lending in these areas because of perceived risk. While the Fair Housing Act specifically made it illegal to discriminate based upon these factors the lending institutions simply had to avoid having it proved that their bias was based upon these factors to fall outside of the control of this act.
The Community Reinvestment Act was passed to encourage investment in these areas. What the act does in effect is to require banks under the FDIC to maintain equal opportunity for loans in all areas where they are chartered to do business including lower income areas. In other words, if a bank has depositors in low income areas it is required to offer equal opportunity for loans in these same areas. There were no specific requirements to how this was to be effected but it was to be enforced by the same FDIC auditors who take care of making sure that such banks do safe and legal business under the protection of the FDIC. The Act specifically states that all such banks are to maintain due diligence and follow accepted criteria for determining that loans made under this act are fiscally sound. As with the other constraints in the act, these decisions are to be audited and enforced by the FDIC auditors.
The teeth of the enforcement of the act came from the FDIC’s recommendations as to how member institutions were graded according to their compliance with the provisions of the act. In other words, the FDIC would either give thumbs up or thumbs down to member institutions who applied for mergers and acquisitions with other banks based upon their compliance with the CRA. A good rating for compliance was the carrot on the end of the stick and member banks were to respond accordingly. The specific regulatory agencies who made these judgments were the Office of the Comptroller of Currency, the Office of Thrift Supervision, and the FDIC. The Federal Financial Institution Examinations Council was charged with coordinating these reports and publishing the findings for a bank’s compliance with CRA regulations.
While that Act itself was aimed at increasing the ability of people in lower income areas to attain financing for buying homes in these areas it was not very successful in changing the status quo. The Act itself was continuously modified to make it more effective. Changes in 1989, 1992, 1994, 1995, 1999, and 2005 were made to the Act to make it more effective in increasing this ability by giving the regulatory agencies more teeth in enforcing the act. Still, as late as 2007 there were conversations in government about further strengthening the Act to increase the amount of access to such loans for the simple reason that it never successfully impacted the markets in large numbers.
According to independent studies by the Cato Institute, and the Competitive Enterprise Institute the Act itself could never be shown to improve home ownership in low income areas. There are those who disagree of course but the reality is that the Act itself played a very small part in the growth of loans in low income areas. The overwhelming consensus of such studies is that the loans that were made under the CRA were loans that to a large extent held to term and were much less likely to threats of foreclosure than those made by private entities which were not under the jurisdiction of the CRA. As a matter of fact, some 80% of the loans that came into foreclosure during the 2007 crisis and later were made by private mortgage companies that were not in any way associated with the Community Reinvestment Act because they were not under its jurisdiction in any form.
Sub Prime Mortgages and other exotic entities that actually led to the housing bubble collapse were the overwhelmingly the creation of private enterprise mortgage companies. Why? For the same reason that all such schemes are hatched; PROFIT.
In the recent past in this country the overwhelming majority of home mortgages that were made were simple financial agreements wherein one party made a loan and the other party held onto the loan as an investment. The profit was in collecting the interest rate over a long term and it was a pretty handsome profit at that. The standard rule of thumb for such mortgages is that a 30 year note usually pays off some 300% over the term of the loan. As most homeowners understand this means that a $50,000 dollar mortgage usually costs some $150,000 by the time it is paid off if it goes the full term of the loan. Obviously, a loan that defaulted was bad business for everyone. The homeowner lost his home and the money he had invested up to the point of foreclosure and the mortgage holder lost the projected profits of the long term interest payments so it was in no one’s best interest to make bad loans.
Securitization changed the whole industry in a drastic way in the late 1990’s. Just as the Dot Com collapse of the late 90’s started to crash the financial markets securitization of mortgages began to take over these markets which is basically the way we avoided an economic collapse at that time. I will go more into the details of Securitization and how it works in a later post but for now I will give the short version explanation.
Basically, Securitization involves bundling groups of mortgages into bond type instruments that are traded on the market as assets. In other words, it is a little bit of hocus pocus magic whereby a Debt in the form of a mortgage is changed into an Asset in the form of a Collaterized Mortgage Obligation (CMO). Of course the rules and regulations for this little bit of magic are hazy and open ended which is exactly why such regulations are needed but for now it is worth noting that this industry grew at an astronomical rate in the late 1990’s and early 2000’s.
Securitization instantaneously created a market for mortgages, lots of mortgages. The people producing the mortgages sold them immediately after creating them to a group who would bundle them into CMO’s and sell them again. Each transaction created a profit margin so that such mortgage bundles often actually increased in value with each trade, sometimes in margins that ended up being in the range of 50 to 100 times over the initial value. It was magic. A debt instantaneously becomes an asset and then multiplies in value and everyone was making lots of money. Of course there is really no such thing as magic. A debt is still a debt, no matter how you bundle it or what you name it but that is something we still don’t seem to recognize as a nation and another point for another post later on.
As Securitization grew mortgage companies became more and more creative with the types of loans they created. They also pushed harder for approval of higher risk loans. After all, the mortgage company wasn’t going to hold the loan to maturity and the next person in line who was doing the securitization wasn’t either. Instead of long term profit on sound loans the real money was now in short term profits on large volumes of loans and no one really cared how safe the loans themselves were. After all, as the market boomed the home values increased so that a person could always just refinance if they couldn’t pay the mortgage. It was the classic case of paying the piper later and the US economy boomed.
The Housing industry became a pyramid scheme and as long as the home values kept increasing there was no end in sight. As in most such schemes the jig is eventually up. Someone notices that the emperor isn’t actually wearing any clothes and reality starts to set in. As in all pyramid schemes that inevitably collapse the people on the bottom lose and we are seeing the effects of this one now. It wasn’t the fact that the government forced banks to make bad loans it was the fact that banks found a way to make it profitable to make bad loans. Through control of Congress and the gradual dismantling of the regulations put in effect after the last great collapse in 1929 from rampant speculation greed found a way to create even more rampant speculation in the last 15 years.
Casinos make a lot of money off of people’s belief that they can beat statistical certainty but at least most people who play in Casinos have to use their own money. The banking industry in the US has created their own Casino but they are using our money to gamble with. As long as the general public doesn’t understand what just happened to our economy we have no way to prevent it from happening again. It doesn’t really matter if the economy comes back or not if we don’t fix the problems that caused it to collapse in the first place and we simply have not done that so far.
We have allowed a system to be created where it was profitable to make bad loans and it was the pursuit of these profits that crashed the economy. Don’t expect the people who made all the money to abandon the system that was so profitable for them any time soon. It is fairly easy to just buy media outlets if you have a lot of money and spread propaganda that blames everyone but the people who created the problem. After all, most Americans are so stupid that they can be convinced that poor people buying homes they couldn’t afford crashed the world economy. Oh how those poor bankers must have anguished over being forced to make loans to people they knew couldn’t pay them back by the big bad government. As my dad used to say, “they must have cried all the way to the bank.”
Monday, November 29, 2010
Monday, November 15, 2010
Economic Collapse Part I
What happened to the economy in 2008? Obviously, we went into a recession or maybe even a depression but what happened to cause this to happen? Lots of people want to know the answer to that but I am afraid that for the most part we are listening to the wrong sources to figure it out. What we really need to do is understand what kind of economy we actually have in the US today to be able to understand what just went wrong with it. Unfortunately, I don’t see a lot of people taking this approach as it is always easier to continue a bad policy than to understand what is wrong with it in the first place.
Maybe we should start with some of the currently accepted ideas as to what went wrong with the economy. If you listen to Rush Limbaugh or Sean Hannity or any of their carefully cloned copies currently filling the talk radio airwaves you will hear that government is at fault. In their view, the government began to interfere with the free market and this caused a lot of loans to be made that were not secure loans. When these loans inevitably went into default, the market began to collapse and voila; we have a recession on our hands. Big government, in its infinite ignorance of the free market, basically caused the whole thing. To be even more explicit, liberal politicians in their effort to take care of their entitled voter base began to force the free market to loan money to people who couldn’t afford to pay it back.
If this sounds familiar, it is because we have heard it before. Ronald Reagan used similar logic to get himself elected in 1980. We had a recession during that time too. Jimmy Carter, the incumbent president went on TV and began asking Americans to cut back, to conserve, to consider the possibility that we might all have to do things differently to continue to lead the free world in economic growth. Self sacrifice and a calling to a greater good were his solution to the problems we were facing at the time. Reagan took the opposite tact and began excoriating government as the source of the problem. In Reagan’s view it was the government and its entitlements programs to those undeserving that were dragging the economy down. Welfare queens who lived better than the average working man were the topic he continually wanted to dote upon whether it actually had anything to do with the problems we were facing or not.
Reagan knew what we really needed. A scapegoat to blame all our problems on; especially one that would resonate so thoroughly with working class Americans and he found it in the welfare queens and the liberals in government who fostered them. Unfortunately, this recipe for fixing the problem didn’t work then and it won’t work this time either. In point of fact, the government might have been part of the problem in that it has blindly supported the corporate entities that have been feeding it money for the last half of the 20th century but that is like blaming the cow for giving bad milk when you feed it onions all day.
Let’s take a look at the actual numbers of what was going on in 2008 when the government publicly admitted that it was going to have to bail out the private banking concerns in this country. On September 18, 2008 Ben Bernanke (head of the Federal Reserve) and Treasury Secretary Henry Paulsen met with key Congressional legislators with the message that they needed 700 Billion dollars to avoid a financial catastrophe. This wasn’t some cry in the wilderness from a lunatic fringe; this was the head of the Federal Reserve and the head of the US Treasury telling US congressmen that they had to do something quick. In Bernanke’s words,
“If we don’t do this, we may not have an economy on Monday.”
In order to understand the magnitude of this statement it is necessary to look back a little bit. The George W. Bush administration, the Bill Clinton administration, the George H. W. Bush administration, and the Ronald Reagan administration have been in power in Washington since 1980. There is little doubt that they have been the most business friendly, corporate sponsored administrations in the history of this country. With the exception of the first term of the Clinton presidency we had seen 28 years of pro business government without respite. They have gradually dismantled or defanged every financial regulatory agency, every economic control that was put in place after the Great Depression. These agencies and laws were put in place after the Great Depression for the express reason that some very bright men took a look at what happened then and decided they needed regulations to keep from having a repeat performance. Not surprisingly, we are now getting that repeat performance and for many of the same reasons that the last collapse happened.
The George W. Bush administration was arguably the friendliest to corporate interests and de-regulation of the industry. Imagine what it took to convince a president extraordinarily concerned with his public image and how he would be viewed by history to completely reverse his field on how free markets are supposed to work in his last 4 months in office. I would like to have been a fly on the wall in the meeting when Bernanke and Paulsen proposed to him that in order to stave off total economic collapse; he was going to have to nationalize the US banking system by doing a government bailout. I wonder what it took to convince him that his whole laissez-faire approach to economics was wrong; that he was going to have to socialize the US financial system to avoid a worldwide economic collapse. Everyone seems to miss that this occurred; that a notoriously stubborn and self serving US President who had built his whole career around the idea that we need less government suddenly decided the government was the only solution. What did they actually show him in that meeting?
Let’s look at some numbers to see if the current ideas about home mortgage defaults explain the problem. In September of 2008 there were some 760,000 homes in danger of foreclosure according to data released by the US Foreclosure Market report. While this is a high number it doesn’t explain the collapse. In 2008 the average home mortgage total value was 167,000 dollars. If you multiply 760,000 by 167,000 which is the worst possible scenario because it assumes that each and every house in danger of foreclosure instantly becomes a total loss you come up with a little less than 127 billion dollars. Keep in mind that this is the worst possible case in that most home foreclosures actually result in much lower losses after all the paperwork is done and the lawyers are paid. According to most estimates I have found the highest average is quote by Freddie Mac officials as 60,000 dollars. Using this number which is actually quite a bit higher than most estimates and multiplying it by 760,000 we come up with somewhat less than 46 billion dollars. In other words, if worse came to worse and every single home that was in danger of foreclosure in September of 2008 actually occurred all at once the industry would be looking at a 45.6 billion dollar loss. Remember, this is the worst case scenario and assumes that all these homes were foreclosed upon at once. Where did the 700 Billion dollar numbers that Paulsen and Bernanke were talking about come from? Clearly, there is something else going on that we aren’t discussing on a public level and I will get back to that in a later post but for now I just wanted to point out that if the foreclosure market was the problem we could have completely solved that with a 46 billion dollar injection into the market and I heard no one in power making that suggestion.
In my next post on this subject I will begin to explore the Community Reinvestment Act and how it supposedly led to the collapse of the housing bubble.
Maybe we should start with some of the currently accepted ideas as to what went wrong with the economy. If you listen to Rush Limbaugh or Sean Hannity or any of their carefully cloned copies currently filling the talk radio airwaves you will hear that government is at fault. In their view, the government began to interfere with the free market and this caused a lot of loans to be made that were not secure loans. When these loans inevitably went into default, the market began to collapse and voila; we have a recession on our hands. Big government, in its infinite ignorance of the free market, basically caused the whole thing. To be even more explicit, liberal politicians in their effort to take care of their entitled voter base began to force the free market to loan money to people who couldn’t afford to pay it back.
If this sounds familiar, it is because we have heard it before. Ronald Reagan used similar logic to get himself elected in 1980. We had a recession during that time too. Jimmy Carter, the incumbent president went on TV and began asking Americans to cut back, to conserve, to consider the possibility that we might all have to do things differently to continue to lead the free world in economic growth. Self sacrifice and a calling to a greater good were his solution to the problems we were facing at the time. Reagan took the opposite tact and began excoriating government as the source of the problem. In Reagan’s view it was the government and its entitlements programs to those undeserving that were dragging the economy down. Welfare queens who lived better than the average working man were the topic he continually wanted to dote upon whether it actually had anything to do with the problems we were facing or not.
Reagan knew what we really needed. A scapegoat to blame all our problems on; especially one that would resonate so thoroughly with working class Americans and he found it in the welfare queens and the liberals in government who fostered them. Unfortunately, this recipe for fixing the problem didn’t work then and it won’t work this time either. In point of fact, the government might have been part of the problem in that it has blindly supported the corporate entities that have been feeding it money for the last half of the 20th century but that is like blaming the cow for giving bad milk when you feed it onions all day.
Let’s take a look at the actual numbers of what was going on in 2008 when the government publicly admitted that it was going to have to bail out the private banking concerns in this country. On September 18, 2008 Ben Bernanke (head of the Federal Reserve) and Treasury Secretary Henry Paulsen met with key Congressional legislators with the message that they needed 700 Billion dollars to avoid a financial catastrophe. This wasn’t some cry in the wilderness from a lunatic fringe; this was the head of the Federal Reserve and the head of the US Treasury telling US congressmen that they had to do something quick. In Bernanke’s words,
“If we don’t do this, we may not have an economy on Monday.”
In order to understand the magnitude of this statement it is necessary to look back a little bit. The George W. Bush administration, the Bill Clinton administration, the George H. W. Bush administration, and the Ronald Reagan administration have been in power in Washington since 1980. There is little doubt that they have been the most business friendly, corporate sponsored administrations in the history of this country. With the exception of the first term of the Clinton presidency we had seen 28 years of pro business government without respite. They have gradually dismantled or defanged every financial regulatory agency, every economic control that was put in place after the Great Depression. These agencies and laws were put in place after the Great Depression for the express reason that some very bright men took a look at what happened then and decided they needed regulations to keep from having a repeat performance. Not surprisingly, we are now getting that repeat performance and for many of the same reasons that the last collapse happened.
The George W. Bush administration was arguably the friendliest to corporate interests and de-regulation of the industry. Imagine what it took to convince a president extraordinarily concerned with his public image and how he would be viewed by history to completely reverse his field on how free markets are supposed to work in his last 4 months in office. I would like to have been a fly on the wall in the meeting when Bernanke and Paulsen proposed to him that in order to stave off total economic collapse; he was going to have to nationalize the US banking system by doing a government bailout. I wonder what it took to convince him that his whole laissez-faire approach to economics was wrong; that he was going to have to socialize the US financial system to avoid a worldwide economic collapse. Everyone seems to miss that this occurred; that a notoriously stubborn and self serving US President who had built his whole career around the idea that we need less government suddenly decided the government was the only solution. What did they actually show him in that meeting?
Let’s look at some numbers to see if the current ideas about home mortgage defaults explain the problem. In September of 2008 there were some 760,000 homes in danger of foreclosure according to data released by the US Foreclosure Market report. While this is a high number it doesn’t explain the collapse. In 2008 the average home mortgage total value was 167,000 dollars. If you multiply 760,000 by 167,000 which is the worst possible scenario because it assumes that each and every house in danger of foreclosure instantly becomes a total loss you come up with a little less than 127 billion dollars. Keep in mind that this is the worst possible case in that most home foreclosures actually result in much lower losses after all the paperwork is done and the lawyers are paid. According to most estimates I have found the highest average is quote by Freddie Mac officials as 60,000 dollars. Using this number which is actually quite a bit higher than most estimates and multiplying it by 760,000 we come up with somewhat less than 46 billion dollars. In other words, if worse came to worse and every single home that was in danger of foreclosure in September of 2008 actually occurred all at once the industry would be looking at a 45.6 billion dollar loss. Remember, this is the worst case scenario and assumes that all these homes were foreclosed upon at once. Where did the 700 Billion dollar numbers that Paulsen and Bernanke were talking about come from? Clearly, there is something else going on that we aren’t discussing on a public level and I will get back to that in a later post but for now I just wanted to point out that if the foreclosure market was the problem we could have completely solved that with a 46 billion dollar injection into the market and I heard no one in power making that suggestion.
In my next post on this subject I will begin to explore the Community Reinvestment Act and how it supposedly led to the collapse of the housing bubble.
Friday, November 5, 2010
Drill baby, Drill!
Drill baby drill! The last presidential election this was one of the mantras of the imbecilic Sarah Palin who somehow managed to get on the ballet as the Republican Vice Presidential candidate. While hardly anyone mistakes Palin for an intelligent politician with actual ideas for how to solve some of our problems as a nation she is from Alaska where some of the biggest oil reserves that the US owns exist. Unfortunately, this reserve is now past its peak production and the supply curve on the way down is pretty steep. However, Alaska as a state has done very well with oil as a source of income with Alaskan citizens receiving a rebate check from the state every year from the profits that the State sees from oil drilling. Unfortunately, the rest of the nation doesn’t get one of those checks so the idea that more oil drilling in Alaska will somehow help the rest of us requires a suspension of the fact that oil reserves there are dwindling as well.
Behind Palin’s rhetoric is a growing number of conservative talk show hosts and politicians who seem to think that we can remove our dependence on foreign oil by simply drilling enough of it here to make up for it. Similar to most cures for our ills that the far right comes up with, it makes some sense in a very simple minded way. After all, if we own oil reserves why should we be buying oil from overseas? Let’s take a look at this in a little more detail and see if it actually makes any sense.
Oil, like any other commodity, is bought and sold in the market place according to the laws of supply and demand with few exceptions. In other words, the cost of finding, harvesting, and transporting the oil to the market all combine to make up the expense required in selling it. As long as all of these costs can be met and the product is sold a little higher than these costs a profit is made. These are the basic rules of any such market and since oil is bought and sold all over the world any oil that is harvested here is in direct competition with oil that is harvested anywhere else. The US is a large producer of oil but the fact of the matter is that we passed our peak production levels in the late 1960’s for the simple reason that oil reserves are not unlimited and we had by that time depleted the amount of oil in the existing wells. It isn’t a matter of simply drilling more wells as the oil reserves themselves are depleted. In other words, the oil we have remaining is harder to find, in smaller fields, and much more expensive to get out of the ground.
In the oil industry there is a term for the costs associated with oil production. “Lifting costs” include all of the costs associated with harvesting oil. These include buying the property the oil reserve is situated underneath, the exploration costs expended locating the oil in the first place, and the actual production costs of removing the oil from its reserve. As our supplies grow smaller and smaller the exploration costs grow in the opposite direction at roughly the same rate and oil in smaller fields is less economical to harvest. Since we have depleted all the reserves that are easily removed from the ground first, we are left with oil reserves that are technically more expensive to harvest. This has been the reality for many years in this country and it is not a picture that is getting rosier as time passes. The largest reserves the US has left are in offshore deposits. Over the last 20 years the US has been forced to turn to more expensive drilling projects on the ocean floor because it is where the vast majority of our remaining oil reserves are.
The world average for lifting costs is around 25 dollars a barrel. In the largest and most available oil reserves in the world in the middle east this number drops even more; to around 14 dollars a barrel. In the US in shallow water oil drilling the price is somewhere in the neighborhood of 40 dollars a barrel depending on the field, where it is and what kind of weather and climate conditions prevail. It isn’t hard to figure out that when we are spending 40 dollars a barrel it precludes the possibility of competing with someone who is spending 14 dollars a barrel unless they are taking a very large markup due to market conditions such as a shortage. This is the position that US oil companies have been in for quite a few years now which is exactly why they are not drilling enough wells to meet our demand; they can simply buy the oil cheaper than they can harvest it. This sounds bad but the situation is actually worse than what I have covered so far. Most of the shallow water offshore reservoirs have already peaked in production; they are now on the steep downside of the supply curve. This means that we are now looking at even steeper lifting costs to tap into the remaining reserves in deeper waters. Most estimates put these numbers in the 65-75 dollar a barrel range. This is the little secret that never enters into the political discussions wherein conservatives respond to alternate energy requests by insisting that we just need to release the oil companies to tap into our reserves. It is economically unfeasible and the oil companies know it.
Let’s look at the economical reality of the situation. The only way US oil companies can invest the large amounts of capital in specialized rigs and new technology drilling equipment needed to do more deep water drilling they have to either know the oil prices are going to stay at ranges around 90-100 dollars a barrel or else they are spending money harvesting a product they can’t make a profit selling. Any time the owners of larger and therefore cheaper oil reserves to harvest decide to flood the market with this oil the US companies heavily invested in expensive technologies to harvest deep water oil will take a huge loss and oil companies are fond of profit. Since the whole thing is an economic pariah it is worth taking notice who is pushing the argument that we should simply drill more and why.
Oil companies are like any other large bureaucratic entity; they are mainly interested in their own survival. Presently, the oil companies own the distribution of the energy source our country depends on. I won’t bother to explain why cornering the market on any commodity is profitable but I will point out that US oil companies have owned the energy market in this country for much of this century and they are not anxious to give it up now. Since they own or are leasing these deep water reservoirs which they bought with the understanding that their monopoly would continue, they are not willing to see it threatened from any quarter; whether it makes economic sense or not. Every time the government starts making noises about alternate energy and subsidizing infrastructure to make such ideas feasible the oil companies see this as a direct threat to these investments. Oil company lobbyist in Washington are pushing very hard for increased government support to subsidize the costs of deep water drilling, shale oil removal projects and other economically unfeasible ideas because any other alternative is a threat to their control of energy policy in this country.
Two things are key part to the oil company’s strategy; maintaining high demand and maintaining high prices. Without the high demand they can’t maintain the high prices and without the high prices they can’t even make the argument that higher lifting costs are in any way economically feasible. It is a little amazing that such supposed supporters of free markets don’t understand the logical fallacy of the position they are in. As prices go up demand decreases; it is one of the basic laws of economics. This has happened several times in the last few years in this country. When supposed shortages raised prices so high in 2008 people cut back on their consumption which is why the prices came back down. The oil companies can’t make the argument that more expensive technologies to harvest oil make any sense whatsoever if the demand for oil starts to dip which is why they are so adamantly opposed to alternative energy of any kind; it will necessarily lessen demand.
In short, energy policy in this country like most everything else is built around money. I won’t bother to go into environmental costs associated with these more expensive harvesting methods but as we saw this last summer in the Gulf they are not minor. The people who have the money set the policy and right now that is oil companies. Never mind that the reality of the situation is that an oil based energy policy is completely unsustainable. Never mind that this is true not only in the US but all over the world as well. Demand for energy is outpacing the world’s supply of oil and all signs are that the emergence of industrialization all over the world promises to increase this demand in the next century.
We are faced with a clear cut choice in this country. We can continue to support an industry that is doomed to inevitable failure because we simply don’t own the oil that we need for energy and it is getting more expensive in every possible way to get it; or we can use our resources to get ahead of the curve and be the leader in finding an alternative.
The US has been the leader in innovation for much of this century. It is amongst our greatest strengths as a nation, both technological and intellectual innovation. We are now faced with a clear cut choice as to whether we will squander everything we have worked for maintaining an industry doomed to inevitable collapse or find a better way. Reality is knocking at the door and no matter how many oil company lobbyists funnel money into congressmen’s pockets in Washington the message it has for us about our dependence on oil will be delivered.
Behind Palin’s rhetoric is a growing number of conservative talk show hosts and politicians who seem to think that we can remove our dependence on foreign oil by simply drilling enough of it here to make up for it. Similar to most cures for our ills that the far right comes up with, it makes some sense in a very simple minded way. After all, if we own oil reserves why should we be buying oil from overseas? Let’s take a look at this in a little more detail and see if it actually makes any sense.
Oil, like any other commodity, is bought and sold in the market place according to the laws of supply and demand with few exceptions. In other words, the cost of finding, harvesting, and transporting the oil to the market all combine to make up the expense required in selling it. As long as all of these costs can be met and the product is sold a little higher than these costs a profit is made. These are the basic rules of any such market and since oil is bought and sold all over the world any oil that is harvested here is in direct competition with oil that is harvested anywhere else. The US is a large producer of oil but the fact of the matter is that we passed our peak production levels in the late 1960’s for the simple reason that oil reserves are not unlimited and we had by that time depleted the amount of oil in the existing wells. It isn’t a matter of simply drilling more wells as the oil reserves themselves are depleted. In other words, the oil we have remaining is harder to find, in smaller fields, and much more expensive to get out of the ground.
In the oil industry there is a term for the costs associated with oil production. “Lifting costs” include all of the costs associated with harvesting oil. These include buying the property the oil reserve is situated underneath, the exploration costs expended locating the oil in the first place, and the actual production costs of removing the oil from its reserve. As our supplies grow smaller and smaller the exploration costs grow in the opposite direction at roughly the same rate and oil in smaller fields is less economical to harvest. Since we have depleted all the reserves that are easily removed from the ground first, we are left with oil reserves that are technically more expensive to harvest. This has been the reality for many years in this country and it is not a picture that is getting rosier as time passes. The largest reserves the US has left are in offshore deposits. Over the last 20 years the US has been forced to turn to more expensive drilling projects on the ocean floor because it is where the vast majority of our remaining oil reserves are.
The world average for lifting costs is around 25 dollars a barrel. In the largest and most available oil reserves in the world in the middle east this number drops even more; to around 14 dollars a barrel. In the US in shallow water oil drilling the price is somewhere in the neighborhood of 40 dollars a barrel depending on the field, where it is and what kind of weather and climate conditions prevail. It isn’t hard to figure out that when we are spending 40 dollars a barrel it precludes the possibility of competing with someone who is spending 14 dollars a barrel unless they are taking a very large markup due to market conditions such as a shortage. This is the position that US oil companies have been in for quite a few years now which is exactly why they are not drilling enough wells to meet our demand; they can simply buy the oil cheaper than they can harvest it. This sounds bad but the situation is actually worse than what I have covered so far. Most of the shallow water offshore reservoirs have already peaked in production; they are now on the steep downside of the supply curve. This means that we are now looking at even steeper lifting costs to tap into the remaining reserves in deeper waters. Most estimates put these numbers in the 65-75 dollar a barrel range. This is the little secret that never enters into the political discussions wherein conservatives respond to alternate energy requests by insisting that we just need to release the oil companies to tap into our reserves. It is economically unfeasible and the oil companies know it.
Let’s look at the economical reality of the situation. The only way US oil companies can invest the large amounts of capital in specialized rigs and new technology drilling equipment needed to do more deep water drilling they have to either know the oil prices are going to stay at ranges around 90-100 dollars a barrel or else they are spending money harvesting a product they can’t make a profit selling. Any time the owners of larger and therefore cheaper oil reserves to harvest decide to flood the market with this oil the US companies heavily invested in expensive technologies to harvest deep water oil will take a huge loss and oil companies are fond of profit. Since the whole thing is an economic pariah it is worth taking notice who is pushing the argument that we should simply drill more and why.
Oil companies are like any other large bureaucratic entity; they are mainly interested in their own survival. Presently, the oil companies own the distribution of the energy source our country depends on. I won’t bother to explain why cornering the market on any commodity is profitable but I will point out that US oil companies have owned the energy market in this country for much of this century and they are not anxious to give it up now. Since they own or are leasing these deep water reservoirs which they bought with the understanding that their monopoly would continue, they are not willing to see it threatened from any quarter; whether it makes economic sense or not. Every time the government starts making noises about alternate energy and subsidizing infrastructure to make such ideas feasible the oil companies see this as a direct threat to these investments. Oil company lobbyist in Washington are pushing very hard for increased government support to subsidize the costs of deep water drilling, shale oil removal projects and other economically unfeasible ideas because any other alternative is a threat to their control of energy policy in this country.
Two things are key part to the oil company’s strategy; maintaining high demand and maintaining high prices. Without the high demand they can’t maintain the high prices and without the high prices they can’t even make the argument that higher lifting costs are in any way economically feasible. It is a little amazing that such supposed supporters of free markets don’t understand the logical fallacy of the position they are in. As prices go up demand decreases; it is one of the basic laws of economics. This has happened several times in the last few years in this country. When supposed shortages raised prices so high in 2008 people cut back on their consumption which is why the prices came back down. The oil companies can’t make the argument that more expensive technologies to harvest oil make any sense whatsoever if the demand for oil starts to dip which is why they are so adamantly opposed to alternative energy of any kind; it will necessarily lessen demand.
In short, energy policy in this country like most everything else is built around money. I won’t bother to go into environmental costs associated with these more expensive harvesting methods but as we saw this last summer in the Gulf they are not minor. The people who have the money set the policy and right now that is oil companies. Never mind that the reality of the situation is that an oil based energy policy is completely unsustainable. Never mind that this is true not only in the US but all over the world as well. Demand for energy is outpacing the world’s supply of oil and all signs are that the emergence of industrialization all over the world promises to increase this demand in the next century.
We are faced with a clear cut choice in this country. We can continue to support an industry that is doomed to inevitable failure because we simply don’t own the oil that we need for energy and it is getting more expensive in every possible way to get it; or we can use our resources to get ahead of the curve and be the leader in finding an alternative.
The US has been the leader in innovation for much of this century. It is amongst our greatest strengths as a nation, both technological and intellectual innovation. We are now faced with a clear cut choice as to whether we will squander everything we have worked for maintaining an industry doomed to inevitable collapse or find a better way. Reality is knocking at the door and no matter how many oil company lobbyists funnel money into congressmen’s pockets in Washington the message it has for us about our dependence on oil will be delivered.
Wednesday, November 3, 2010
The Energy Policy of Oil
It is always a little amazing to me to realize how little Americans understand about energy policy and how it is orchestrated in this country. The fact of the matter is that our country is in danger of becoming a third world country in terms of economic development and much of the reason for this fall can be traced to our energy policy. The rise of American power during and after WWII is closely related to the fact that we utilized and owned the most efficient energy source in the world at the time; Oil. It is worth remembering that our actual involvement in the war itself came about as a direct result of our energy policy.
In the early months of 1941 the United States was trying to steer clear of conflicts in Europe while at the same time keeping a wary eye on developments. At the same time Japan, still incensed over what it considered to be slights at the end of WWI, was steadily striving to increase its security in the Far East and the Pacific Rim. Japan had been one of the Allies during WWI but at the end of the war had initially been denied the gains that it had made in China and other areas of the Pacific Rim. When Japan threatened to walk out of talks with the Allies as they were dividing up the spoils of the war, Britain had intervened on her behalf. Still, the American contingent under Wilson was not happy with the whole scenario and steadily pressured Britain after the war to drop support for Japan as a partner. Japan saw American opposition as very threatening, more especially since Japan had earned the enmity of some powerful enemies in supporting the Allies in WWI. China and the Soviet Union were very close and very powerful in Japan’s eyes and without allied support as trading partners and suppliers of raw materials needed to keep building up their defensive powers Japan felt ever more exposed with each effort by Americans to isolate them.
Unlike the United States, Japan was wholly without the raw materials of steel and iron needed to build a navy or an army. It was also completely without the oil that it needed to keep its basic economy going without importing it from outside sources. American efforts to isolate Japan were seen by the Japanese as threats to its very existence and it reacted accordingly. As the rest of the world became enthralled with watching the exploits of Nazi Germany in Europe, Japan began expanding her borders and subsidizing her military buildup by colonizing the far east just as Western powers had done for much of the preceding century. Japan saw it not in the light of economic development but in the light of survival of their nation. As Japan began to invade Manchuria and then later China itself, the western powers became more concerned with Japanese ambitions. These concerns were sharpened further by the abject brutality of Japanese invasions which often included the wholesale slaughter of civilians.
By early 1941 relations with Japan had reached a crucial stage with Roosevelt and the American government determined to discourage further Japanese military expansion and Japan just as determined to continue what it considered to be tactics necessary for its survival as a nation. The American government decided to set up an embargo on industrial products that Japanese needed to continue their expansion. These included steel and other raw materials but even more critically, they included oil. The Japanese were dependent on foreign sources for fully 80% of their oil supply. This oil supply not only powered the Japanese military but also the whole Japanese economy. Without this critical oil supply the whole economy would collapse internally and Japan would no longer be able to feed or clothe its people.
Naturally, the Japanese reacted to this oil embargo with great alarm. They first tried to cut a deal with the American government. Japan offered to give up part of its expansion plans in return for American support of many of it conquests already achieved. With publicity of Japanese atrocities in the Pacific Rim and China getting more exposure daily these requests for compromise fell on deaf ears with the United State government insisting that all expansion activities cease as well as the return of lands the Japanese had already conquered. Facing the prospect of a total collapse and realizing that there was no compromise position that the US would agree to that would be palatable to the Japanese public the war hawks in Japan took over the government and began making plans of how to neutralize American power in the Pacific Rim until Japan could seize control of the supplies that it needed from the region.
Pearl Harbor was the almost inevitable result of this oil embargo. Japan had no delusion of being able to conquer the United States but it did believe it could cripple American power in the Pacific Rim long enough to seize control of the area and assure Japan’s access to oil and other raw materials it needed to survive. With the choice between collapse and war, Japan chose war and the United States was involuntarily dragged into the middle of WWII. With hindsight it is easy to see the chain of events that led to Japan attacking Pearl Harbor. In 1941 of course, this chain of events was much harder to see and very few people believed that events would lead to such an attack. However, it is without question that it was the Japanese need for oil that was at the core of the reasons for the attack. Japanese sources within the government at the time point this out repeatedly in their explanations for the attack. A country dependent upon foreign oil for its very survival will often be forced to make decisions that are antithetical to its basic moral views and the United States is no exception.
In 1940 the US was one of the main producers of oil in the industrial world. US oil companies operated in the world market with great freedom and the US still owned a large portion of the world’s known supply of oil. However, since that time with the exponential growth of the usage of oil for agricultural production and an industrial sector that was the envy of the rest of the world the US gradually used up its own supply of oil and began being more dependent on other sources of oil. Along with this change, smaller third world countries that had up to this point welcomed US expertise and US oil companies into partnerships to produce oil in their countries began taking over ownership of their own oil reserves. This is a pattern that repeated itself in South America, Indochina, and the Middle East with unerring accuracy.
By the late 1960’s the US found itself in the unenviable position of being the biggest consumer of oil while its own reserves were steadily being used up. By 1970 most US sources of oil were peaking in production with a sharp downside to the supply curve that spelled major economic problems for an economy completely dependent on oil for survival. While this was not unpredictable and the US had foreseen the necessity of maintaining a presence in the largest oil reserve area of the world after WWII, it soon became obvious that even minor disruptions in this supply would cause major upheavals in the US economy. The Oil Embargo of OPEC nations of the Middle East in the early seventies were a precursor to what the US government understood to be a deadly source of destruction for US economic concerns.
After WWII the Allied powers basically split up and reordered the landscape in the Middle East based upon their own individual needs for oil and the fact that this area of the world happened to be the largest known supply of the commodity. Almost all political decisions in the Middle East since that time have been based upon the underlying fact that western economies are dependent on a steady supply of these reserves of oil. The US found itself forced to deal with governments in the region that were both antithetical to our moral values and some of the worst violators of their own people that the world has ever seen. How else can one justify America’s undeniable support of regimes in Saudi Arabia, Iran, Iraq, Afghanistan, Jordan, Syria, and Egypt that were both brutal violators of basic human rights and at different times dangerous and tribal based aggressors in both internal and external wars that have consumed the area for much of the last seventy years. We have installed dictators, fomented wars, and supported brutality in the area since WWII that is as bad as has ever been seen on the planet. Even today, we lament the brutality of Saddam Hussein while forgetting that we helped put him in power to act as a buffer against radical Islamic groups in Iran. We support brutal dictatorships in Kuwait and Saudi Arabia who regularly fund terrorist organizations that mindlessly attack innocents all over the world. We rage against Iran for her own abuses while at the same time that we support governments in Jordan, Pakistan, and Egypt with equally appalling records of human right violations against their own people.
Any real accounting of the cost of this oil dependency has to include the military costs that we have expended in the region in 3 separate wars in the last 20 years. If we add the cost of these wars to the cost in dollars per gallon in oil that we import; is oil still the most efficient energy? I don’t understand why Americans would continue to insist that we have no energy alternative when faced with the real costs in military incursions and increased national security measures that became necessary after 9-11. We must remember that it was our need for oil that got us involved in the area to begin with. It is our need for oil that keeps us embroiled in political issues in the area that should be reprehensible to every American. Without oil we have no need to have a presence in Saudi Arabia, Iraq, Iran, or Afghanistan. Since we are the biggest consumer of oil in the world we have the ability to bring about the collapse of these regimes. We can easily remove their ability to afford war by simply removing ourselves from the equation. We cannot do away with demand for oil in the rest of the world but we can devastate the demand markets by simply finding other sources of energy; sources that don’t force us to support brutal dictatorships or tribal based hatreds.
All of this leads us to the place where I started this post. We are now in the same position that Japan found itself in previous to WWII. We are completely dependent on oil from foreign sources. The only difference is that we are dependent not upon the United States or Great Britain, we are dependent upon brutal regimes that we would not otherwise do business with for any amount of money. While we don’t import 80% of the oil that we use, we do import 55% of the oil that we use from outside sources. What that means of course is that we are extremely dependent on outside sources for the well being of our economy and that in itself should be enough to convince Americans that we need to find a better solution without even bringing up the fact that many of these outside sources are diametrically opposed to our moral viewpoints. There was a commercial on TV when the government was trying to drum up support for the war against terrorism that suggested that Americans buying drugs were inadvertently and indirectly supporting terrorism. A more accurate statement would be that Americans support terrorism by directly funding its sponsors every time we fill up our SUV at the gas pump.
In the early months of 1941 the United States was trying to steer clear of conflicts in Europe while at the same time keeping a wary eye on developments. At the same time Japan, still incensed over what it considered to be slights at the end of WWI, was steadily striving to increase its security in the Far East and the Pacific Rim. Japan had been one of the Allies during WWI but at the end of the war had initially been denied the gains that it had made in China and other areas of the Pacific Rim. When Japan threatened to walk out of talks with the Allies as they were dividing up the spoils of the war, Britain had intervened on her behalf. Still, the American contingent under Wilson was not happy with the whole scenario and steadily pressured Britain after the war to drop support for Japan as a partner. Japan saw American opposition as very threatening, more especially since Japan had earned the enmity of some powerful enemies in supporting the Allies in WWI. China and the Soviet Union were very close and very powerful in Japan’s eyes and without allied support as trading partners and suppliers of raw materials needed to keep building up their defensive powers Japan felt ever more exposed with each effort by Americans to isolate them.
Unlike the United States, Japan was wholly without the raw materials of steel and iron needed to build a navy or an army. It was also completely without the oil that it needed to keep its basic economy going without importing it from outside sources. American efforts to isolate Japan were seen by the Japanese as threats to its very existence and it reacted accordingly. As the rest of the world became enthralled with watching the exploits of Nazi Germany in Europe, Japan began expanding her borders and subsidizing her military buildup by colonizing the far east just as Western powers had done for much of the preceding century. Japan saw it not in the light of economic development but in the light of survival of their nation. As Japan began to invade Manchuria and then later China itself, the western powers became more concerned with Japanese ambitions. These concerns were sharpened further by the abject brutality of Japanese invasions which often included the wholesale slaughter of civilians.
By early 1941 relations with Japan had reached a crucial stage with Roosevelt and the American government determined to discourage further Japanese military expansion and Japan just as determined to continue what it considered to be tactics necessary for its survival as a nation. The American government decided to set up an embargo on industrial products that Japanese needed to continue their expansion. These included steel and other raw materials but even more critically, they included oil. The Japanese were dependent on foreign sources for fully 80% of their oil supply. This oil supply not only powered the Japanese military but also the whole Japanese economy. Without this critical oil supply the whole economy would collapse internally and Japan would no longer be able to feed or clothe its people.
Naturally, the Japanese reacted to this oil embargo with great alarm. They first tried to cut a deal with the American government. Japan offered to give up part of its expansion plans in return for American support of many of it conquests already achieved. With publicity of Japanese atrocities in the Pacific Rim and China getting more exposure daily these requests for compromise fell on deaf ears with the United State government insisting that all expansion activities cease as well as the return of lands the Japanese had already conquered. Facing the prospect of a total collapse and realizing that there was no compromise position that the US would agree to that would be palatable to the Japanese public the war hawks in Japan took over the government and began making plans of how to neutralize American power in the Pacific Rim until Japan could seize control of the supplies that it needed from the region.
Pearl Harbor was the almost inevitable result of this oil embargo. Japan had no delusion of being able to conquer the United States but it did believe it could cripple American power in the Pacific Rim long enough to seize control of the area and assure Japan’s access to oil and other raw materials it needed to survive. With the choice between collapse and war, Japan chose war and the United States was involuntarily dragged into the middle of WWII. With hindsight it is easy to see the chain of events that led to Japan attacking Pearl Harbor. In 1941 of course, this chain of events was much harder to see and very few people believed that events would lead to such an attack. However, it is without question that it was the Japanese need for oil that was at the core of the reasons for the attack. Japanese sources within the government at the time point this out repeatedly in their explanations for the attack. A country dependent upon foreign oil for its very survival will often be forced to make decisions that are antithetical to its basic moral views and the United States is no exception.
In 1940 the US was one of the main producers of oil in the industrial world. US oil companies operated in the world market with great freedom and the US still owned a large portion of the world’s known supply of oil. However, since that time with the exponential growth of the usage of oil for agricultural production and an industrial sector that was the envy of the rest of the world the US gradually used up its own supply of oil and began being more dependent on other sources of oil. Along with this change, smaller third world countries that had up to this point welcomed US expertise and US oil companies into partnerships to produce oil in their countries began taking over ownership of their own oil reserves. This is a pattern that repeated itself in South America, Indochina, and the Middle East with unerring accuracy.
By the late 1960’s the US found itself in the unenviable position of being the biggest consumer of oil while its own reserves were steadily being used up. By 1970 most US sources of oil were peaking in production with a sharp downside to the supply curve that spelled major economic problems for an economy completely dependent on oil for survival. While this was not unpredictable and the US had foreseen the necessity of maintaining a presence in the largest oil reserve area of the world after WWII, it soon became obvious that even minor disruptions in this supply would cause major upheavals in the US economy. The Oil Embargo of OPEC nations of the Middle East in the early seventies were a precursor to what the US government understood to be a deadly source of destruction for US economic concerns.
After WWII the Allied powers basically split up and reordered the landscape in the Middle East based upon their own individual needs for oil and the fact that this area of the world happened to be the largest known supply of the commodity. Almost all political decisions in the Middle East since that time have been based upon the underlying fact that western economies are dependent on a steady supply of these reserves of oil. The US found itself forced to deal with governments in the region that were both antithetical to our moral values and some of the worst violators of their own people that the world has ever seen. How else can one justify America’s undeniable support of regimes in Saudi Arabia, Iran, Iraq, Afghanistan, Jordan, Syria, and Egypt that were both brutal violators of basic human rights and at different times dangerous and tribal based aggressors in both internal and external wars that have consumed the area for much of the last seventy years. We have installed dictators, fomented wars, and supported brutality in the area since WWII that is as bad as has ever been seen on the planet. Even today, we lament the brutality of Saddam Hussein while forgetting that we helped put him in power to act as a buffer against radical Islamic groups in Iran. We support brutal dictatorships in Kuwait and Saudi Arabia who regularly fund terrorist organizations that mindlessly attack innocents all over the world. We rage against Iran for her own abuses while at the same time that we support governments in Jordan, Pakistan, and Egypt with equally appalling records of human right violations against their own people.
Any real accounting of the cost of this oil dependency has to include the military costs that we have expended in the region in 3 separate wars in the last 20 years. If we add the cost of these wars to the cost in dollars per gallon in oil that we import; is oil still the most efficient energy? I don’t understand why Americans would continue to insist that we have no energy alternative when faced with the real costs in military incursions and increased national security measures that became necessary after 9-11. We must remember that it was our need for oil that got us involved in the area to begin with. It is our need for oil that keeps us embroiled in political issues in the area that should be reprehensible to every American. Without oil we have no need to have a presence in Saudi Arabia, Iraq, Iran, or Afghanistan. Since we are the biggest consumer of oil in the world we have the ability to bring about the collapse of these regimes. We can easily remove their ability to afford war by simply removing ourselves from the equation. We cannot do away with demand for oil in the rest of the world but we can devastate the demand markets by simply finding other sources of energy; sources that don’t force us to support brutal dictatorships or tribal based hatreds.
All of this leads us to the place where I started this post. We are now in the same position that Japan found itself in previous to WWII. We are completely dependent on oil from foreign sources. The only difference is that we are dependent not upon the United States or Great Britain, we are dependent upon brutal regimes that we would not otherwise do business with for any amount of money. While we don’t import 80% of the oil that we use, we do import 55% of the oil that we use from outside sources. What that means of course is that we are extremely dependent on outside sources for the well being of our economy and that in itself should be enough to convince Americans that we need to find a better solution without even bringing up the fact that many of these outside sources are diametrically opposed to our moral viewpoints. There was a commercial on TV when the government was trying to drum up support for the war against terrorism that suggested that Americans buying drugs were inadvertently and indirectly supporting terrorism. A more accurate statement would be that Americans support terrorism by directly funding its sponsors every time we fill up our SUV at the gas pump.
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