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In a federal budget filled with mind-boggling statistics, two numbers stand out as particularly stunning, for the way they may change American politics and American power.

The first is the projected deficit in the coming year, nearly 11 percent of the country’s entire economic output. That is not unprecedented: During the Civil War, World War I and World War II, the United States ran soaring deficits, but usually with the expectation that they would come back down once peace was restored and war spending abated.

But the second number, buried deeper in the budget’s projections, is the one that really commands attention: By President Obama’s own optimistic projections, American deficits will not return to what are widely considered sustainable levels over the next 10 years. In fact, in 2019 and 2020 ”” years after Mr. Obama has left the political scene, even if he serves two terms ”” they start rising again sharply, to more than 5 percent of gross domestic product. His budget draws a picture of a nation that like many American homeowners simply cannot get above water.

For Mr. Obama and his successors, the effect of those projections is clear: Unless miraculous growth, or miraculous political compromises, creates some unforeseen change over the next decade, there is virtually no room for new domestic initiatives for Mr. Obama or his successors. Beyond that lies the possibility that the United States could begin to suffer the same disease that has afflicted Japan over the past decade. As debt grew more rapidly than income, that country’s influence around the world eroded.

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I understand that positioning for the next election, partisan politics and lobbying money are a deadly combination to any possible reform. But its so obvious to me watching these folks push and shove good ideas away that they: 1) are utterly clueless how all of this (credit crisis, recession, housing bust) happened; b) have absolutely no idea how to fix any of it; iii) are primarily concerned with getting re-elected.

—Barry Ritholtz

The Obama administration projects rosier economic-growth prospects than most mainstream economists do but a sobering jobless recovery, according to documents released Monday about underlying assumptions in the government’s $3.83 trillion federal budget for 2011.

Other documents outlining proposed tax cuts and hikes reveal that the administration, concerned about growing income inequality, seeks to pay for a number of programs to help the middle class by taxing the wealthiest Americans and imposing new taxes on corporations, especially those with international operations.

The administration created a public relations nightmare for itself last year when it came into power forecasting an optimistic 8 percent unemployment rate. Policymakers then watched in horror as the jobless rate climbed to 10.2 percent before dipping back to 10 percent in December.

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President Obama was forced to concede today that the US deficit will soar to record levels this year as he unveiled a $3.8 trillion annual budget that faces a perilous passage on Capitol Hill and could decide the fate of his presidency.

Blaming the extraordinary levels of government debt on the profligacy of his predecessor George W. Bush, Mr Obama said that the deficit would reach nearly $1.6 trillion this year, far more than the White House predicted last year and a staggering level that is alienating voters.

Mr Obama, facing a difficult political landscape and an economy where one in ten Americans is still unemployed, sought to present a budget with dual priorities: bringing down the deficit while spending billions of additional dollars to create jobs.

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I do not know about you but I don’t have the ability to comprehend the magnitude of these figures. In any event, read all the links.

President Barack Obama will propose on Monday a $3.8 trillion budget for fiscal 2011 that projects the deficit will shoot up to a record $1.6 trillion this year, but would push the red ink down to about $700 billion, or 4% of the gross domestic product, by 2013, according to congressional aides.

The deficit for the current fiscal year, which ends on Sept. 30, would eclipse last year’s $1.4 trillion deficit, in part due to new spending on a proposed jobs package. The president also wants $25 billion for cash-strapped state governments, mainly to offset their funding of the Medicaid health program for the poor.

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It is payback time for Fannie Mae and Freddie Mac on some mortgages sold to the finance companies by lenders.

Stuck with about $300 billion in loans to borrowers at least 90 days behind on payments, Fannie and Freddie have unleashed armies of auditors and other employees to sift through mortgage files for proof of underwriting flaws. The two mortgage-finance companies are flexing their muscles to force banks to repurchase loans found to contain improper documentation about a borrower’s income or outright lies.

The result: Freddie Mac required lenders to buy back $2.7 billion of loans in the first nine months of 2009, a 125% jump from $1.2 billion a year earlier. Fannie Mae won’t disclose its figure, but trade publication Inside Mortgage Finance said Fannie made $4.3 billion in loan-repurchase requests in the first nine months of 2009.

“Because taxpayers are involved, we’re being very vigilant,” said Maria Brewster, who oversees Fannie’s repurchase team. “No taxpayer should have to pay for a business decision that caused a bad loan to be sold to Fannie Mae.”

Read it all from the weekend Wall Street Journal.

Will an 82-year-old veteran central banker be the man who finally stops the music for the bankers of Wall Street?

A Congressional hearing in Washington on Tuesday may well provide the answer.

A week ago, US President Barack Obama, appeared to be telling America that the ideas of Economic Recovery Advisory Board chairman Paul Volcker would be the centrepiece of his plan to make the global financial system safer, announcing that the “Volcker rule” would determine the future of the world’s banks.

But since then, there has been complete confusion as to exactly what the President and Mr Volcker have in mind.

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“Our immersion in the details of crises that have arisen over the past eight centuries and in data on them has led us to conclude that the most commonly repeated and most expensive investment advice ever given in the boom just before a financial crisis stems from the perception that ‘this time is different.’ That advice, that the old rules of valuation no longer apply, is usually followed up with vigor. Financial professionals and, all too often, government leaders explain that we are doing things better than before, we are smarter, and we have learned from past mistakes. Each time, society convinces itself that the current boom, unlike the many booms that preceded catastrophic collapses in the past, is built on sound fundamentals, structural reforms, technological innovation, and good policy.”

– This Time is Different (Carmen M. Reinhart and Kenneth Rogoff)

When does a potential crisis become an actual crisis, and how and why does it happen? Why did most everyone believe there were no problems in the US (or Japanese or European or British) economies in 2006? Yet now we are mired in a very difficult situation. “The subprime problem will be contained,” said now controversially confirmed Fed Chairman Bernanke, just months before the implosion and significant Fed intervention. I have just returned from Europe, and the discussion often turned to the potential of a crisis in the Eurozone if Greece defaults….
Greece is running a budget deficit of 12.5%. Under the Maastricht Treaty, they are supposed to keep it at 3%. Their GDP was $374 billion in 2008 (about €240 billion). If they can cut their budget deficit to 10% this year, that means they will need to go into the bond market for another €25 billion or so. But they already have a problem with rising debt. Look at the following graph on the debt of various countries….

When Russia defaulted on its debt and sent the world into crisis in 1998, they had total debt of only €51 billion. Greece now has €254 billion and added another €8 billion this week, and needs to add another €24 billion (or so) later this year. That’s a debt-to-GDP ratio of over 100%, well above the limit of the treaty, which is 60%.

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On the very day this week when the Congressional Budget Office warned that the succession of previously unimaginable trillion-dollar-plus budget deficits could inflict ruin on the United States, the Senate faced a moment of truth.

For the first time, a truly bipartisan proposal aimed at averting such a calamity came to a vote. By 53 to 46, the senators approved the measure officially described as a bill for “responsible fiscal action, to assure the long-term fiscal stability and economic security of the federal government of the United States, and to expand future prosperity and growth for all Americans.”

Of course, this being the 21st-century Senate, it meant defeat because of a failure to command the 60-vote supermajority the opposition now always requires.

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The Timpanogos Storytelling Festival in Utah was funded by a $150,000 2009 Federal Stimulus Package grant.

You can find more here.

As the CBO notes, Fannie and Freddie “purchase mortgages at above-market prices,” driving down interest rates and passing some of the savings to home buyers. That subsidy is felt right away, but the risks in providing it are stored up over time, and their real costs may not be felt for years or even decades””as was the case in the years leading up to their spectacular collapse in 2008.

Yet this is precisely the fiction that the Obama Administration seeks to preserve by keeping the cost of Fan and Fred off the government’s books. The Administration’s budget accounting assumes Fannie and Freddie are private companies. So under its preferred treatment, the only recognized cost to taxpayers is the money that is being pumped in to keep them afloat””$110 billion so far.

That’s plenty as it is, but in the wake of their government takeover, there is no justification for pretending that their risks aren’t taxpayer risks. This is all the more true with the likes of New York Senator Chuck Schumer giving the companies marching orders to rescue tenants in the Stuyvesant Town development in Manhattan.

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Embattled Federal Reserve Chairman Ben Bernanke won confirmation for a second term Thursday, but only by the closest vote ever for the crucial post and after withering criticism from lawmakers for bailing out Wall Street while other Americans suffered in recession.

The Senate confirmed Bernanke for a new four-year term by a 70-30 vote, a seemingly solid majority but 14 votes worse than the closest previous vote for a Fed chairman.

The battle over Bernanke’s confirmation has been a test of central bank independence, a crucial element if the Fed is to carry out unpopular but economically essential policies. Its decisions on interest rates can have immense consequences, from the success or failure of the largest companies to the typical home-buyer’s ability to get an affordable loan to the price of cereal at the grocery or gas at the corner station.

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Mr Zhu noted that investors are increasingly borrowing the cheap US dollar, and investing the borrowed funds in emerging markets, where interest rates are higher, and therefore generating a better return than saving in the dollars.

This phenomenon called carry trade in the US dollar is a “massive issue today,” said Mr Zhu.

“It’s bigger than the Japanese yen carry trade 12 years ago,” he said.

However, if the United States were to tighten its lax monetary policy, making borrowing more costly, funds could then flow out just as suddenly from emerging markets, back into the US market.

This could cause a collapse in emerging markets’ currencies, and spark a repeat of the 1997-1998 Asian financial crisis.

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1) Immediately vest the FDIC (or other regulator that has a strict consumer-protection mandate) with the authority to take receivership / conservatorship of distressed bank and non-bank financial institutions, including bank holding companies, in the event of insolvency….

2) Require a significant portion of the capital of bank and non-bank financial institutions to be in the form of convertible debt (contingent capital).

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Obama’s economic team could have raised the limits on how much mortgage securities Fannie and Freddie can buy, allowing those firms to replace the Fed’s purchasing program. But Barr said the administration thinks the mortgage business will stand on its own without such special assistance, similar to the way the nation’s biggest banks weaned themselves off federal bailout funds by raising private capital.

“The basic goal is to implement a gradual process where the government’s role in the economy goes down,” Barr said. “It has to be consistent with the basic goal of stability, but it is appropriate.”

Administration and Fed officials expressed confidence that rates will rise only modestly — perhaps a quarter of a percentage point. They attribute their optimism to the lengthy notice they have given the market. The markets already should have anticipated the government’s exit by adjusting interest rates higher. Yet mortgage rates have been falling slightly the past few weeks.

The optimism at the White House and the Fed, however, is not shared across the government. A few senior policymakers at the central bank view the economic recovery as still too fragile, suggesting that purchases perhaps should expand further. These dissenters also warn that mortgage rates could shoot up, perhaps to 6 percent or higher, because private investors buying securities would demand a greater rate of return than the Fed. To reach it, lenders may have to raise rates for consumers.

“Presumably, there is pent-up demand from the private sector, but the question is: At what rate are they going to be interested?” said Eric S. Rosengren, the president of the Federal Reserve Bank of Boston, who has indicated that he supports expanding the Fed’s mortgage securities purchase program.

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AIG and the Federal Reserve Bank of New York have become targets of an investigation into whether the overseer had instructed the troubled insurer not to disclose certain key information to the public.

Neil Barofsky, special inspector general for the $700 billion bailout, is set to tell the House Oversight Committee on Wednesday that he has initiated an investigation into whether the New York Fed instructed AIG (AIG, Fortune 500) not to disclose more than a dozen controversial counterparty transactions to the Securities and Exchange Commission.

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These recent events demonstrate how quickly the nation’s escalating cyberbattles have outpaced the rush to find a deterrent, something equivalent to the cold-war-era strategy of threatening nuclear retaliation.

So far, despite millions of dollars spent on studies, that quest has failed. Last week, Secretary of State Hillary Rodham Clinton made the most comprehensive effort yet to warn potential adversaries that cyberattacks would not be ignored, drawing on the language of nuclear deterrence.

“States, terrorists and those who would act as their proxies must know that the United States will protect our networks,” she declared in a speech on Thursday that drew an angry response from Beijing. “Those who disrupt the free flow of information in our society or any other pose a threat to our economy, our government and our civil society.”

But Mrs. Clinton did not say how the United States would respond, beyond suggesting that countries that knowingly permit cyberattacks to be launched from their territories would suffer damage to their reputations, and could be frozen out of the global economy.

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Obama should launch his own moon shot. What the country needs most now is not more government stimulus, but more stimulation. We need to get millions of American kids, not just the geniuses, excited about innovation and entrepreneurship again. We need to make 2010 what Obama should have made 2009: the year of innovation, the year of making our pie bigger, the year of “Start-Up America.”

Obama should make the centerpiece of his presidency mobilizing a million new start-up companies that won’t just give us temporary highway jobs, but lasting good jobs that keep America on the cutting edge. The best way to counter the Tea Party movement, which is all about stopping things, is with an Innovation Movement, which is all about starting things. Without inventing more new products and services that make people more productive, healthier or entertained ”” that we can sell around the world ”” we’ll never be able to afford the health care our people need, let alone pay off our debts.

Obama should bring together the country’s leading innovators and ask them: “What legislation, what tax incentives, do we need right now to replicate you all a million times over” ”” and make that his No. 1 priority. Inspiring, reviving and empowering Start-up America is his moon shot.

And to reignite his youth movement, he should make sure every American kid knows about two programs that he has already endorsed: The first is National Lab Day. Introduced last November by a coalition of educators and science and engineering associations, Lab Day aims to inspire a wave of future innovators, by pairing veteran scientists and engineers with students in grades K-12 to inspire thousands of hands-on science projects around the country.

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No matter how it plays out, Ben Bernanke’s bruising confirmation battle has damaged the U.S. Federal Reserve’s clout and perceived independence.

Mr. Bernanke is more than the Fed’s chief decision maker. Fed officials see him as their brand, a smart, honest and stoic voice best able to defend decisions of the past two years to a skeptical Congress and public. Even if the Senate backs Mr. Bernanke this week, he won’t speak with the same authority, and the Fed will have a harder time casting itself as above partisan politics.

Fortunately for the Fed, the hard call about when to raise interest rates doesn’t need to be made now. Fortunately for Mr. Bernanke, his support inside the Obama administration, and even more so inside the Fed, is solid. But the longer the battle drags on, the more it could interfere with the Fed’s ability to communicate convincingly. And no matter what, the Fed will have less sway as Congress debates whether to rein in its powers.

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In the aftermath of the Senate election in Massachusetts, the focus of attention is inevitably on what it means for Barack Obama. The impact on the Democratic president of the loss of the late Ted Kennedy’s seat to the Republicans will, no doubt, be significant (see article). Yet the result could be remembered as a message more profound than the disparate mutterings of a grumpy electorate that has lost faith in its leader””as a growl of hostility to the rising power of the state.

America’s most vibrant political force at the moment is the anti-tax tea-party movement. Even in leftish Massachusetts people are worried that Mr Obama’s spending splurge, notably his still-unpassed health-care bill, will send the deficit soaring. In Britain, where elections are usually spending competitions, the contest this year will be fought about where to cut. Even in regions as historically statist as Scandinavia and southern Europe debates are beginning to emerge about the size and effectiveness of government.

There are good reasons, as well as bad ones, why the state is growing; but the trend must be reversed. Doing so will prove exceedingly hard””not least because the bigger and more powerful the state gets, the more it tends to grow. But electorates, as in Massachusetts, eventually revolt; and such expressions of voters’ fury are likely to shape politics in the years to come.

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Washington spent months nursing the financial system back to health after the 2008 economic crisis, stabilizing then reviving battered markets and ultimately restoring trillions of dollars in investor losses. Wall Street’s political fortunes have not fared as well.

Now, an aggressive stance against the bankers, financiers and even government officials popularly blamed for causing the crisis is gaining political momentum, and there are signs it is eroding the very financial stability the government championed.

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U.S. President Barack Obama called lawmakers on Saturday to check that Federal Reserve Chairman Ben Bernanke had enough support for a second term and two key senators said the nomination was on track.

In a sign of how worried the White House is about a sudden recent surge in opposition to Bernanke’s renomination, Obama contacted the Democratic Senate leadership to make sure it had enough votes.

“(The) president made … calls to a few senators this afternoon including leadership to make sure everything on track and he has been assured that Bernanke is on track for confirmation,” a senior administration official said.

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Scott Brown has a lot to answer for. His stunning Senate victory for the Republicans in Massachusetts sent the White House into a spin. President Obama promptly decided on the populist gesture of targeting Wall Street with vague proposals to outlaw banks’ risky activities and limit their size. Though seemingly hastily wheeled out, the ideas were first floated a few months ago by Paul Volcker, former chairman of the Federal Reserve Board, a man widely regarded as the best US central banker of the modern era. As a result they have some credibility, though they are far from being a panacea.

Many believe the banks have brought this on their own heads. The return of big bonuses so soon after a crisis of their own making, for which ordinary people will be paying for years, showed crass insensitivity and greed. America’s banks rushed to pay off their obligations to taxpayers under the Tarp (troubled asset relief programme) precisely so that they could get back on the bonus gravy train. The behaviour of the banks, however, is no excuse for flawed policy. Nobody yet knows the detail of Mr Obama’s plans, probably not even the president. But from what we know so far, they suffer from two serious shortcomings.

The first is that they would not have stopped the current crisis….

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The confirmation of Ben S. Bernanke to a second four-year term as chairman of the Federal Reserve ran into further trouble on Friday as two more Democratic senators said they would vote against him.

The White House came to Mr. Bernanke’s defense, but the Senate majority leader, Harry Reid, appeared uncertain about whether there were the 60 votes necessary to confirm Mr. Bernanke before his term as chairman expires on Jan. 31. Mr. Reid said late Friday that while he planned to vote for Mr. Bernanke’s confirmation, his support was “not unconditional.”

Senator Christopher J. Dodd, Democrat of Connecticut and the chairman of the Banking Committee, warned Friday that a no vote would send the “worst signal to the market right now,” and could lead to an economic “tailspin.”

In a statement Friday morning, Senator Barbara Boxer, Democrat of California, came out against Mr. Bernanke, who was named to his post during the Bush administration. She said she had “a lot of respect” for him and praised him for preventing the economic crisis from getting even worse. “However, it is time for a change,” she said. “It is time for Main Street to have a champion at the Fed.”

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The economic pattern of the early 1980s may well be repeated. The US economy is likely to start to recover strongly, with a growth rate of more than 5 per cent expected this month.

But it looks increasingly doubtful that Mr Obama and the Democrats will enjoy the benefits. Having won Massachusetts, the Republicans will have no compunction in claiming that what saved the US economy was the conservative backlash. If the Democrats fail to challenge them, this is the version of reality that American voters will start to believe.

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According to e-mails released this month, AIG was asked to limit what the public knew about the Maiden Lane transactions. The payments have been called a “backdoor bailout” by lawmakers because banks, including Goldman Sachs Group Inc. and Societe Generale SA, were reimbursed at 100 cents on the dollar for mortgage-linked securities that had declined in value.

“This has been terribly mishandled,” said James D. Cox, a professor of corporate and securities law at Duke University School of Law. “There’s this pattern that emerges that the New York Fed, for a variety of reasons including not causing nervousness about who was an AIG counterparty, covered up its rather heavy-handed approach to the bailout.”

Absolutely sickening–read it all.

DJ reports Senate Democrats are to seek an increase to the federal government’s borrowing limit by $1.9 trillion lifting the total amount the U.S. government can owe to $14.294 trillion, several congressional aides said. The increase is forecast to support the federal government’s borrowing needs the end of 2010, one Senate Democratic aide said. The borrowing hike comes soon after a $290 billion increase to the debt ceiling agreed to by lawmakers at the end of 2009.

From here:

In many ways the campaign in Massachusetts became a referendum not only on health care reform but also on the openness and integrity of our government process. It is vital that we restore the respect of the American people in our system of government and in our leaders. To that end, I believe it would only be fair and prudent that we suspend further votes on health care legislation until Senator-elect Brown is seated.