TIME Economy

Banking Is for the 1%

Can’t get credit? You aren’t the only one. Why banks want to do business mainly with the rich

The rich are different, as F. Scott Fitzgerald famously wrote, and so are their banking services. While most of us struggle to keep our balances high enough to avoid a slew of extra fees for everything from writing checks to making ATM withdrawals, wealthy individuals enjoy the special extras provided by banks, which increasingly seem more like high-end concierges than financial institutions. If you are rich, your bank will happily arrange everything from Broadway tickets to spa trips.

Oh, and you’ll have an easier time getting a loan too. A recent report by the Goldman Sachs Global Markets Institute, the public-policy unit of the finance giant, found that while the rich have ample access to credit and banking services six years on from the financial crisis, low- and medium-income consumers do not. Instead, they pay more for everything from mortgages to credit cards, and generally, the majority of consumers have worse access to credit than they did before the crisis. As the Goldman report puts it, “For a near-minimum-wage worker who has maintained some access to bank credit (and it is important to note that many have not in the wake of the financial crisis), the added annual interest expenses associated with a typical level of debt would be roughly equivalent to one week’s wages.” Small and midsize businesses, meanwhile, have seen interest rates on their loans go up 1.75% relative to those for larger companies. This is a major problem because it dampens economic growth and slows job creation.

It’s Ironic (and admirable) that the report comes from Goldman Sachs, which like several other big banks–Morgan Stanley, UBS–is putting its future bets on wealth-management services catering to rich individuals rather than the masses. Banks would say this is because the cost of doing business with regular people has grown too high in the wake of Dodd-Frank regulation. It’s true that in one sense, new regulations dictating how much risk banks can take and how much capital they have to maintain make it easier to provide services to the rich. That’s one reason why, for example, the rates on jumbo mortgages–the kind the wealthy take out to buy expensive homes–have fallen relative to those of 30-year loans, which typically cater to the middle class. It also explains why access to credit cards is constrained for lower-income people compared with those higher up the economic ladder.

Regulation isn’t entirely to blame. For starters, banks are increasingly looking to wealthy individuals to make up for the profits they aren’t making by trading. Even without Dodd-Frank, it would have been difficult for banks to maintain their precrisis trading revenue in a market with the lowest volatility levels in decades. (Huge market shifts mean huge profits for banks on the right side of a trade.) The market calm is largely due to the Federal Reserve Bank’s unprecedented $4 trillion money dump, which is itself an effort to prop up an anemic recovery.

All of this leads to a self-perpetuating vicious cycle: the lack of access to banking services, loans and capital fuels America’s growing wealth divide, which is particularly stark when it comes to race. A May study by the Center for Global Policy Solutions, a Washington-based consultancy, and Duke University found that the median amount of liquid wealth (assets that can easily be turned into cash) held by African-American households was $200. For Latino households it was $340. The median for white households was $23,000. One reason for the difference is that a disproportionate number of minorities (along with women and younger workers of all races) have no access to formal retirement-savings plans. No surprise that asset management, the fastest-growing area of finance, is yet another area in which big banks focus mainly on serving the rich.

In lieu of forcing banks to lend to lower-income groups, something that’s being tried with mixed results in the U.K., what to do? Smarter housing policy would be a good place to start. The majority of Americans still keep most of their wealth in their homes. But so far, investors and rich buyers who can largely pay in cash have led the housing recovery. That’s partly why home sales are up but mortgage applications are down. Policymakers and banks need to rethink who is a “good” borrower. One 10-year study by the University of North Carolina, Chapel Hill, for example, found that poor buyers putting less than 5% down can be better-than-average credit risks if vetted by metrics aside from how much cash they have on hand. If banks won’t take the risk of lending to them, they may eventually find their own growth prospects in peril. After all, in a $17 trillion economy, catering to the 1% can take you only so far.

TIME Economy

Last Tango in Buenos Aires

Argentina’s debt snarl tells us how risky the global financial system still is

There’s a legal adage that goes, “Hard cases make bad law.” A recent U.S. court ruling against Argentina, which pushed the country into a new technical default on its sovereign debt, is a case in point. In 2001, Argentina defaulted on $80 billion worth of sovereign debt, the bonds that a country issues to raise money. It had to restructure, just as Greece had to more recently, and over the years, some 93% of creditors went along with the cut-rate deals, taking “exchange” bonds that paid 30¢ on the dollar. But some, like Elliott Management, the hedge fund started by Wall Street titan Paul Singer, held out. Tens of millions of dollars in legal fees later, Elliott won its case.

U.S. federal judge Thomas Griesa ruled earlier this summer that unless Argentina paid creditors like Elliott and other holdouts 100% of their claims, it couldn’t pay anybody else either. Paying Elliott in full would mean that, contractually, the country would also have to pay everyone else in full too–a $29 billion commitment. The case is full of gnarly legal and financial issues. But what it tells us is dead simple: the world financial order is still far too complex and opaque.

It’s tough to cry for Argentina–or the hedge funds. Elliott says Argentina’s claim that it has been victimized by “vulture funds” is a populist political strategy to drum up support for President Cristina Fernández de Kirchner’s flagging party. “Argentina isn’t a poor country. It’s a G-20 nation,” says Jay Newman, Elliott’s Argentina-portfolio manager. “It’s chosen for political reasons not to negotiate a fair settlement with us or more than 61,000 other bondholders.” Certainly no one would argue that the Argentine government is a paragon of best practices; Argentina, which had the same per capita GDP as Switzerland in the 1950s, has defaulted eight times.

Then again, the vultures haven’t done so badly either. Many bought bonds postdefault for pennies on the dollar. Now they are eschewing an already rich return for a regal one, while setting a precedent that could make creditors reluctant to cooperate when nations default in the future. “This has become a morality play which has given rise to a host of new legal problems,” says Jonathan Blackman, the Cleary Gottlieb partner defending Argentina. Both sides are waging an ugly media war complete with ad campaigns, as thousands of other creditors and financial institutions around the world nervously await the final result.

The Argentine crisis says three important things about the global economy. First, the balance between creditors and debtors has shifted. As data from the McKinsey Global Institute (MGI) show, there’s more debt globally than there was before the 2008 financial crisis. But now, the largest portion of it consists of public-sector debt. “Debt in the economy is like a balloon,” explains Susan Lund, a partner at MGI. “When you squeeze it out of one place, it grows in another.” With the rise in public debt comes a greater risk of sovereign defaults, which can wreak havoc on the global economy. (Remember the euro crisis?)

Second, the global economy is becoming more fragmented. The fact that a federal court in New York City ruled in favor of the holdouts is a sign that the global economy is splitting along national and ideological lines: British courts tend to go with majority rule in sovereign cases, and local markets have any number of other ways of handling sovereign-debt deals. The BRIC nations, aside from increasingly cutting their own trade deals, have set up a new development bank, which may become a source of capital for countries like Argentina if they remain shut out of the Western credit markets. That could give Russia and China more leverage over, for example, Argentina’s natural resources. (The country has the world’s second largest shale-gas deposit.)

Finally, the case shows how much work remains to be done in making our financial system more transparent. In addition to establishing a single standard for sovereign default, we desperately need to make complex security holdings more visible. Academics like Joseph Stiglitz say Elliott Management actually stands to benefit from an Argentine default, since nearly $1 billion worth of credit-default swaps exist on the country; that’s insurance that will pay out now that Argentina has defaulted. While the Elliott subsidiary that went to court against Buenos Aires says it holds no such swaps, the hedge-fund firm as a whole doesn’t disclose trading positions, and the swaps holdings of individual companies aren’t public record. They should be. Knowing exactly who stands to gain–or lose–from fiscal turmoil that can affect all of us could help make the right fixes at least a little more apparent.

TO READ MORE BY RANA FOROOHAR, GO TO time.com/foroohar

TIME mergers

Why Big Mergers Are Bad for Consumers

When big companies merge, it’s good for the bankers — but not so good for the rest of us

Rupert Murdoch’s 21st Century Fox wants to take over Time Warner. Comcast wants to buy Time Warner Cable. AT&T and DirecTV may hook up to compete against them. T-Mobile and Sprint are looking to connect, as are any number of other large communications firms, not to mention technology and pharma giants. We are in a new golden age of mergers and acquisitions–M&A activity was up sharply in 2014 and is already at pre-financial-crisis levels. Now bankers are salivating at the billions of dollars in fees such deals generate. The question is, Will the deals be any good for the rest of us?

Since the early 1980s, antitrust regulators like the Department of Justice and the Federal Trade Commission have tried to answer that question by asking another: Will a given merger bring down prices and improve services for consumers? If the answer was even remotely yes, then the merger–no matter how big–was likely to go through. But voices on all sides of the antitrust debate are beginning to question whether that rationale is actually working anymore.

Nobody would argue that the megamergers that have taken place over the past 30 years in pharmaceuticals, for example, have brought down drug prices. Or that the tie-ups between big airlines have made flying more enjoyable. Or that conglomerate banks have made our financial system more robust. “Merging companies always say that they’ll save money and bring down prices,” says Albert Foer, president of the American Antitrust Institute, a think tank devoted to studying competition. “But the reality is that they often end up with monopoly power that allows them to exert incredible pressure in whatever way they like.” That can include squeezing not only customers but also smaller suppliers way down the food chain.

Take the book business, for example. Though publishing is minuscule as a percentage of the economy, it has recently become a focal point in the debate over how our antitrust system works (or doesn’t), mostly because it illustrates the incredible power of one corporation: Amazon. In 2012, the Department of Justice went after tech giant Apple and a group of five major book publishers for collusion, winning a case against them for attempting to fix the prices of e-books. The publishers argued their actions were a response to anticompetitive monopoly pricing by Amazon. Apple is appealing.

Did the verdict serve the public? Many people, including star trial attorney David Boies, say no. Boies, who’s been representing large firms on both sides of the antitrust issue as well as the DOJ over the past several decades, says the verdict is “a failure of common sense and analysis.” Regulators often bring collusion cases, for example, because they are relatively easy to prove. Yet in this case, argues Boies, it led to an outcome in which the entrenched market participant, Amazon, was strengthened, and new participants–Apple and the book publishers–that hoped to create a competing platform in the e-book industry were shot down. “The result is that Amazon gets bigger, and eventually regulators will have to go after them,” says Boies. “We really need a more realistic, commonsense view of antitrust enforcement.” Amazon declined to comment.

The “Bigger Is Better” ethos of the 1980s and 1990s grew not only out of conservative, markets-know-best thinking. It was also fueled by a belief on the left that antitrust enforcement was wasteful and that regulating big companies was preferable to trying to stop them from becoming too big in the first place. Neither side got it right. Big companies aren’t always concerned first about the welfare of their customers–or particularly easy to regulate. The idea of letting companies do whatever they want as long as they can prove that they are decreasing prices may be far too simplistic a logic to serve the public–or even the corporate–good. Amazon shares have tumbled as investors worry about the future of a company that has so successfully compressed prices that it generates as much as $20 billion in revenue a quarter but no profit.

How to fix things? We need a rethink of antitrust logic that takes into consideration a more complex, global landscape in which megamergers have unpredictable ripple effects. We also need a new definition of consumer good that encompasses not only price but choice and the kind of marketplace diversity that encourages innovation and growth. Tech and communications firms today are like the railroads of old: it will take a strong hand to rein them in. That’s a task not for regulators but for Congress and a new Administration. Until then, with corporate coffers full and markets flying high, the big are only likely to get bigger.

TIME trade

It’s Time for Europe to Get Tough With Russia

European Union Foreign Ministers Meet On Ukraine Crisis
Flags of the European Union seen in front of the headquarters of the European Commission on March 03, 2014 in Brussels, Belgium. Michael Gottschalk—Photothek/Getty Images

Europe has a history of coming together in good times but not in bad. Think about the creation of the Eurozone, and the launch of the single currency, juxtaposed with the piecemeal policy reaction over the last few years to the Eurozone financial crisis. This tendency has been on tragic display recently, with the shooting down of a Malaysia Airlines jet that carried numerous European passengers. This event should have strengthened European resolve to put more and tougher sanctions on Russia. Instead, it’s led to half-hearted measures doled out on a country-by-country basis. France is even going ahead with big deal to supply warships to Russia.

The key issue, of course, is that Europe is in very deep with the Russians economically, much deeper than the U.S. Or China, for that matter; The recent Russia-China gas deal was small potatoes compared to the business that the Europeans do. Europeans get about 30 percent of their gas from Russia, and are dependent on other natural resources, like oil and minerals, from Russia too. Indeed, the Netherlands, which lost more people than any European country in the crash, took in the largest share of those exports from Russia last year. They aren’t alone—German banks and multinationals do lots of business with Russia, and countries like the UK are a big destination for oligarchs looking to stash cash outside their home country.

That’s why it’s so crucial that European foreign ministers come together at their meeting over the Ukraine situation and Russian sanctions in Brussels. Until they are on board with more serious sanctions, particularly in the energy sector, it’s unlikely that the current rounds are going to make a serious dent in the Russian economy, which, as a recently Capital Economics report pointed out, still has a strong international investment position.

The bottom line is that Europe needs a much smarter and less Russia-centric energy strategy. As I’ve explained before, that’s a need that’s unlikely to filled by the gas rich US anytime soon. Rather it’s something that will have to be driven internally within Europe. It’s an opportunity not only for Europe to become more secure, but to prove to the rest of the world that it can work together and live up to the promise of the EU itself—in both good times and bad.

TIME Economy

Murdoch’s Bid for Time Warner May Signal a Coming Crash

The media mogul has a habit of buying at the top of the market.

What do Rupert Murdoch’s $80 billion bid for Time Warner and Fed chair Janet Yellen’s mid-year report to Congress yesterday have in common? Both may well be signals of a market top.

Let’s start with the news Wednesday: Murdoch has a track record of making bids that mark the end of bull runs. As Peter Atwater, a behavioral economist who runs the firm Financial Insyghts, pointed out to me, Murdoch’s $5.3 billion acquisition of Chris Craft in 2000, his $5.6 billion acquisition of Dow Jones in 2007, and his $12 billion bid for the portion of BSkyB that he didn’t own back in 2011 all coincided with market peaks. Shortly after all these deals, stocks fell.

Likewise, Janet Yellen’s speech Tuesday on the state of the U.S. economy, in which she said she thought technology stocks (including biotech and social media in particular) were overvalued, was an important signal that valuations are stretched, and we may be in for a fall. Yellen tends to worry less about bubbles than some other economists, so when she starts to fret — and especially when she says so publicly — that’s telling.

It’s no wonder that all this is happening now. With more than $4 trillion of Fed money sloshing around in the markets, and jobs numbers looking better, there’s a vigorous central banker debate going on about how soon to raise interest rates (which inevitably dampens market sentiment). Likewise, it’s worth noting that the last five major merger manias in financial history happened at the peak of markets, and ended with a big drop in equities. That happens not only because companies have a lot of money to play with at the top of a market, but also because they have in many cases exhausted growth strategies, and mergers are an easy way to get a further quick-hit boost in stocks (see my column on that topic here). Mergers are often presented as the beginning of a corporate growth streak — more often than not, they signal the end.

TIME Economy

Wall Street’s Values Are Strangling American Business

When finance calls the shots, we all lose

It’s widely known that more than half of all corporate mergers and acquisitions end in failure. Like many marriages, they are often fraught with irreconcilable cultural and financial differences. Yet M&A activity was up sharply in 2013 and reached pre-recession levels this year. So why do companies keep at it? Because it’s an easy way to make a quick buck and please Wall Street. Increasingly, business is serving markets rather than markets serving business, as they were originally meant to do in our capitalist system.

For a particularly stark example, consider American pharmaceutical giant Pfizer’s recent bid to buy British drugmaker AstraZeneca. The deal made little strategic sense and would probably have destroyed thousands of jobs as well as slowed research at both companies. (Public outcry to that effect eventually helped scuttle the plan.) But it would have allowed Pfizer to shift its domicile to Britain, where companies pay less tax. That, in turn, would have boosted share prices in the short term, enriching the executives paid in stock and the bankers, lawyers and other financial intermediaries who stood to gain about half a billion dollars or so in fees from the deal.

Pfizer isn’t alone. Plenty of firms engage in such tax wizardry. This kind of short-term thinking is starting to dominate executive suites. Besides tax avoidance, Wall Street’s marching orders to corporate America include dividend payments and share buybacks, which sap long-term growth plans. It also demands ever more globalized supply chains, which make balance sheets look better by cutting costs but add complexity and risk. All of this hurts longer-term, more sustainable job and value creation. As a recent article on the topic by academic Gautam Mukunda in the Harvard Business Review noted, “The financial sector’s influence on management has become so powerful that a recent survey of chief financial officers showed that 78% would give up economic value and 55% would cancel a project with a positive net present value–that is, willingly harm their companies–to meet Wall Street’s targets and fulfill its desire for ‘smooth’ earnings.”

Some of this can be blamed on the sheer size of the financial sector. Many thought that the economic crisis and Great Recession would weaken the power of markets. In fact, it only strengthened finance’s grip on the economy. The largest banks are bigger than they were before the recession, while finance as a percentage of the economy is about the same size. Overall, the industry earns 30% of all corporate profit while creating just 6% of the country’s jobs. And financial institutions are still doing plenty of tricky things with our money. Legendary investor Warren Buffett recently told me he’s steering well clear of exposure to commercial securities like the complex derivatives being sliced and diced by major banks. He expects these “weapons of mass destruction” to cause problems for our economy again at some point.

There’s a less obvious but equally important way in which Wall Street distorts the economy: by defining “shareholder value” as short-term returns. If a CEO misses quarterly earnings by even a few cents per share, activist investors will push for that CEO to be fired. Yet the kinds of challenges companies face today–how to shift to entirely new digital business models, where to put operations when political risk is on the rise, how to anticipate the future costs of health, pensions and energy–are not quarterly problems. They are issues that will take years, if not decades, to resolve. Unfortunately, in a world in which the average holding period for a stock is about seven months, down from seven years four decades ago, CEOs grasp for the lowest-hanging fruit. They label tax-avoidance schemes as “strategic” and cut research and development in favor of sending those funds to investors in the form of share buybacks.

All of this will put American firms at a distinct disadvantage against global competitors with long-term mind-sets. McKinsey Global Institute data shows that between now and 2025, 7 out of 10 of the largest global firms are likely to come from emerging markets, and most will be family-owned businesses not beholden to the markets. Of course, there’s plenty we could do policy-wise to force companies and markets to think longer term–from corporate tax reform to bans on high-speed trading to shifts in corporate compensation. But just as Wall Street has captured corporate America, so has it captured Washington. Few mainstream politicians on either side of the aisle have much interest in fixing things, since they get so much of their financial backing from the Street. Unfortunately for them, the fringes of their parties–and voters–do care.

TIME Courts

American Corporations Are Powerful Enough Without a Conscience

Supreme Court Delivers Decisions Against Aereo And Rules In Favor Of Cellphone Privacy
The U.S. Supreme Court is shown on June 25, 2014 in Washington. Win McNamee—Getty Images

Corporations have more economic power than they’ve ever had in this country as measured by their share of overall U.S. GDP. Now, thanks to a new Supreme Court ruling, they have more religious freedom too. In the closely watched Sebelius versus Hobby Lobby case, the court decided in favor of Hobby Lobby, a craft retail store chain run by a family of Pentecostals who believe that offering up certain birth control options via employee insurance, which had been mandated under the Affordable Care Act, conflicted with their religious beliefs. The courts thought they had a point–and the ruling says that such “closely held” family companies are no longer required to provide contraception for workers, similar to religious non-profits, some of which already have the same exception.

The upshot? Companies can now officially have a conscience. Just as the Citizen’s United case allowed companies the rights of individuals when it came to political donations, this case is setting a big precedent for corporations to be treated as individuals when it comes to religious freedom.

There are all sorts of potential business implications. First and most immediately, you could see a difference in access to paid contraception for women who work in big publicly held firms versus privately held and/or family owned ones. That’s no small thing, given that private firms drive 50 percent of GDP and about 65 percent of new job creation in this country. It could also create a further divide in access to contraception between rich and poor women. The former tend to work in greater numbers for large, publicly held companies. The latter are more likely to be laboring in small, local firms–the town hairdresser, a restaurant, or a doctor’s office–than in bigger firms like Hobby Lobby.

The ruling could also open the door to all sorts of other challenges to workplace legislations based on notions of religious freedom. Take the Employment Non-Discrimination Act, for example, that would include sexual orientation amongst the protected characteristics in workplace discrimination suits. Could firms like Hobby Lobby challenge that, too?

Finally, and perhaps most profoundly, this ruling gives more power (economic and personal) to U.S. corporations, at the expense of individual human labor. That’s a shift that’s been happening for decades now (and interestingly, was forwarded by another anti-union ruling that came down from the Court today). And to me, it’s worrisome. At a time when corporations have more economic power than ever, pay the lowest share of taxes as a percentage of the total take in history, and are creating fewer jobs than in the past, do they really need more special treatment that compromises a public good (in this case, equal access to healthcare) and puts more of a burden on individuals? I don’t think so.

TIME Business

Coalition of the Unwilling

The far right and far left increasingly agree (to hate) Wall Street, tax rates and trade

Election results always have business impacts. But rarely are they as stark as the drop in Boeing stock that followed the defeat of Republican House majority leader Eric Cantor in the Virginia primary on June 10. Cantor, an ally of Big Business in Congress, was defeated by David Brat, an economics professor who has been called the Tea Party’s Elizabeth Warren, an outsider pledging to make capitalism fairer for the little guy. He’s also a proponent of cutting federal subsidies to firms like Boeing–hence the one-day stock drop that wiped out its gains for the year–as well as ending “special tax credits to billionaires.”

What Brat’s victory really highlights is a quirk in our politics that is bringing the far right and far left into a series of unexpected alignments. In addition to being anti-Establishment, Brat’s speeches are often anti-immigration and antiglobalization. But when it comes to such economic-policy issues as taxes, free trade and corporate welfare, a lot of Democrats are, more or less, in agreement with him. (Brat’s office did not respond to interview requests.)

Brat, along with many members of the Tea Party and plenty of people on the far left, would like to see some bankers thrown into jail for their role in the financial crisis. These critics argue that corporations benefit unfairly from government subsidies. (Cantor was a booster of the Export-Import Bank, which Boeing’s foreign customers can tap for U.S. taxpayer–subsidized loans.) They believe the rules of free trade are no longer working when China and others can flout them without consequence. And they’d like to see a tax code that doesn’t explicitly favor the superrich.

To be sure, the philosophical underpinnings of Brat and Warren are vastly different. Populists on the left are against measures like fast-track authority for President Obama–which would allow him to bypass Congress when negotiating trade deals–on policy grounds. They believe that such deals in the past sped the offshoring of America’s industrial base, which ultimately erodes our economic competitiveness. Some on both sides of the aisle argue that trade agreements that used to be about tariffs and quotas increasingly focus on domestic issues such as taxes, financial-services regulation, patents and food- and product-safety rules. Says Michael Stumo, who runs the Coalition for a Prosperous America, an advocacy group that represents agriculture and manufacturing businesses across the U.S.: “Modern trade deals are more about globalizing domestic policy and offshoring our jobs, our industries and our governance.”

On the right, members of the Tea Party are skeptical of free-trade deals because they see them as threats to national sovereignty. As Representatives Michele Bachmann and Walter Jones and a number of other conservatives in Congress put it to President Obama in a letter opposing fast track, “For 200 years of our nation’s history, Congress has led our nation’s trade policy,” and conservatives aren’t interested in giving up that privilege.

These aren’t extreme positions. A recent Gallup poll found that 38% of Americans see foreign trade as a “threat to the economy.” A majority of Americans also support tax reform, in particular higher taxes for the wealthy. Part of the momentum around that issue is, of course, driven by an American economy in which the rich have gotten ever richer since the financial crisis while everyone else has struggled. That’s another topic that the flanks in both parties largely agree on–the people who caused the pain of the past six years still haven’t paid for it. “Those guys [meaning financiers] should have gone to jail,” said Brat in the run-up to the Virginia primary. “Instead of going to jail, they went into Eric Cantor’s Rolodex.”

What could this unlikely alliance mean in political terms? Not much in the short term. In some ways, the coalition of Occupy Democrats and Tea Party Republicans is a Coalition of No. Bipartisan opposition has so far stalled fast-track authority for the President’s trans-Pacific trade deal. Coming up with a new trade agenda that could actually reshape policy is a (slow) work in progress. Republican Dave Camp’s tax-reform plan, reflecting popular anger over plutocrats, includes higher rates for hedge funders and private-equity titans, but it faces long to impossible odds against Big Business lobbyists and their lackeys on both sides of the aisle. Still, the Coalition of No is just getting started. If this year’s midterm elections put more Tea Party Republicans in office, it could increase the number of legislators, like Brat, who have something in common with the left: an anticorporate bias. That, in turn, would make for a very different 2016 presidential election than anybody currently imagines.

TIME Oil

Will the Iraqi Siege Cause Oil and Gasoline Prices to Spike?

Should we be worried about a major spike in oil prices—and summer gas prices—because of the sectarian conflict in Iraq? It’s an important question in the markets right now, because every $10 increase in the price of oil shaves 0.5 percent of global growth. I’m cautiously optimistic for the moment that the answer will be: no.

Oil, as I’ve written before, is amongst the most fear driven commodities. Supply and demand are supposed to rule markets, but every time there’s a major conflict in the oil rich Middle East—from the Iranian revolution to the Gulf War—prices go up about 30 percent higher than they should be, regardless of the facts on the ground. Even when supply isn’t interrupted, even when there’s plenty of oil to fuel world markets, the price of crude is typically driven by fear rather than reality.

So what are the facts on the ground right now in Iraq? The refinery that is currently under siege by militants is in the north and used mostly for domestic consumption. That’s not great news for Iraqis, but it has little bearing on international markets. The major oil fields that produce for the export market are in the south of the country, firmly in the hands of the government, and exports are actually increasing. The fact that big Western oil majors like BP and Exxon are pulling out staff isn’t great news, because developing countries like Iraq typically need outsider help to keep production efficient. I think it’s fair to say that if the conflict continues for months, Iraq may struggle to keep production levels high, but I don’t think we’re going to see a major supply disruption unless conflict moves South.

That said, I think there will be small to moderate price hikes in crude, because oil markets pivot so much around uncertainty. Gas prices were already higher than they should be for this time of year because of increased demand in the US, which is growing faster these days, and also maintenance being done on refineries in the South of the US. In terms of any potential supply disruption because of the Iraqi siege, it’s possible that Kurdish oil exports may be affected, but again, that has little bearing on the international market, since they were already down because of other issues — Turkey, ownership, a continuing fight with the central government, etc.

Long story short—any conflict in oil-producing country is bad news for prices. But I don’t think you’ll see the sort of 30 percent spikes you did in past conflicts unless things get a whole lot worse.

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