Debt Rattle, March 8 2008

Note: please also read our post earlier today: The Fed nationalizes the banks

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Ilargi: I called yesterday, March 7, The Day The Wheels Came Off. I was not joking. This first article spells it out loud and clear:


THE GAME IS OVER !!!.


Banks face "systemic margin call," $325 billion hit: JPM

Wall Street banks are facing a "systemic margin call" that may deplete banks of $325 billion of capital due to deteriorating subprime U.S. mortgages, JPMorgan Chase & Co, said in a report late on Friday.

JPMorgan, which sent a default notice to Thornburg Mortgage Inc. after the lender missed a $28 million margin call, said more default notices and margin calls were likely. The Carlyle Group's mortgage fund also failed to meet $37 million in margin calls this week.

"A systemic credit crunch is underway, driven primarily by bank writedowns for subprime mortgages," according to the report co-authored by analyst Christopher Flanagan. "We would characterize this situation as a systemic margin call."

The credit crisis that began about a year ago will likely intensify after Friday's weak February U.S. employment report "that most definitely signals recession," JPMorgan said.

Indeed, corporate bond spreads widened to a new record on Friday, surpassing levels seen in October 2002 during a boom in bankruptcies following the dot-com crash. U.S. employers cut payrolls in February for a second consecutive month, slashing 63,000 jobs, the biggest monthly job decline in nearly five years, the U.S. Labor Department reported on Friday.

"The weak February employment report points to an economy in recession," JPMorgan said.

The JPMorgan report included a revised bleaker forecast for subprime-related home prices. The bank now sees prices falling 30 percent, from its prior 25 percent forecast. Those prices have declined 14 percent since mid-2006, JPMorgan said.

The U.S. jobs results also came after the Federal Reserve expanded the amount of its short-term auctions to $100 billion in total in the central bank's latest effort to ease credit concerns. Ongoing concerns about bond insurers, known as monolines, and their effort to save their top ratings also are weighing on market sentiment.

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US Fed pins economic hopes on $200bn liquidity boost

The Federal Reserve has again been forced to step in to alleviate extreme stress in the US credit markets, pledging $200bn (£100bn) of emergency liquidity for the banking system.

The move culminates a dramatic week that saw yield spreads on Fannie Mae and Freddie Mac agency bonds surge to the highest levels in over 20 years. A panic flight to safety across the credit universe briefly drove the yield on 2-year US Treasury notes below 1.5pc, a sign that investors may be battening down the hatches for a violent storm. The Fed said the fresh money was needed to "address heightened liquidity pressures in the term funding markets".

A tentative rebound on Wall Street ran out of steam in late trading as shares slid perilously close to the January lows, deemed key support levels by technical traders. The Dow Jones index tumbled 202 points at 11,833 in late trading. Grim jobs data released by the Labour Department showed that employers had cut the workforce by 63,000 in February, the sharpest drop since the dotcom bust.

"A decline of that magnitude screams recession," said Paul Ashworth, US strategist for Capital Economics. "This will prompt the Fed to slash rates rapidly to 1pc. One thing that history teaches us is that when an economy stalls and drops into recession, things get very bad very quickly. There is no going back now: we are well past the tipping point," he said.

Ominously, the OECD club of rich states said its global "leading indicators" were pointing to a slowdown almost everywhere. "The latest data point to a potential downturn in China and India," it said.

BNP Paribas said the indexes measuring corporate default risk such as the iTraxx Crossover were flashing danger signals. "Credit market stress is intensifying with spreads reaching record wide levels on many measures. Risk appetite is being severely challenged," it said.

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Dr. Doom spreads the gloom

Watch for tumbles in bonds, real estate and commodities, famed Marc Faber proclaims

Dr. Doom saw it coming. Swiss economist and investment adviser Marc Faber became known as Dr. Doom after predicting, with varying timeliness, the crash of stock markets in 1987, the Japanese market meltdown starting in 1990, the Asian crisis in 1997 and later the collapse of U.S. technology stocks. About seven years ago, Faber was ahead of the pack again. From his base in Hong Kong, he foresaw an Asian boom that would raise living standards there and drive up the price of just about every raw material, including oil and gold.

Nations abundant with commodities, such as Canada, would go along for the ride. Meanwhile, mounting debt in the United States would send the U.S. dollar into a long tailspin, Faber predicted. A Canadian investor who acted on the advice would have profited handsomely. Today, though, it's harder to be a contrarian. The trends Faber predicted have played out for a few years now. Many market players are hot for commodities and cold on the U.S. greenback.

Faber says he sees far fewer investment opportunities, and he is urging caution. Stocks in China and India could fall 30 per cent to 40 per cent on top of recent drops, he warns. Bonds could tumble in value along with metals and real estate. "All commodities, in my opinion, are vulnerable to a correction," Faber warned in a telephone interview with the Toronto Star this week. "I would say that anyone who cannot tolerate a correction of 20 per cent should not be in anything."

Still, Faber remains a long-term gold bull. With prices nearing $1,000 (U.S.) an ounce this week, gold has risen so high in price he says some other bullion lovers he knows have already returned to cash. He has not. He thinks the metal could pass $3,000 an ounce, if only temporarily, like in the spike of the early 1980s. But the price could also fall sharply first. Prices of commodities were extremely low in the years before Faber wrote in 2001 his book Tomorrow's Gold: Asia's Age of Discovery predicting rising commodity prices. Some researchers calculate the prices for energy, minerals, food and other products were the lowest in the history of capitalism.

"If you told people to buy commodities they would say: `Ya, but they always go down,' because that was correct. They went down for 25 years," he said in the interview from Chicago during a whirlwind global tour this week. It's a contrarian bent and unconventional style that makes Faber stand out in the often staid, conformist world of finance. "As an investor, you have to look for things that are neglected, and once you identify these neglected sectors, then you can achieve high capital gains," Faber said.

Faber writes at his latest home and office, in Chiang Mai, Thailand. He retreated there for some privacy and enough space to store his collection of books and Mao Zedong memorabilia. The ponytailed prognosticator admits on his website that he's "smoked a lot of marijuana," but at breakfast he prefers Balinese magic mushrooms in an omelette.

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Countrywide under FBI investigation

The FBI has launched an investigation into the lending practices of battered home lender Countrywide Financial Corp., according to a report in The Wall Street Journal. The mortgage company is suspected of widespread fraud, the paper said, which may have contributed to the subprime mortgage crisis that has rocked the U.S. economy.

The probe will examine underwriting and mortgage origination practices, and whether the company misrepresented losses related to subprime loans. Bank of America, which agreed in January to acquire Countrywide for $4 billion in stock, denied any knowledge of a federal investigation. Calabasas, Calif.-based Countrywide is the nation's largest home lender, responsible for roughly one-fifth of the mortgages in the United States.

When the housing crash began, Countrywide was faced with an increasing number of subprime customers who were delinquent with their mortgage payments. The company was forced to essentially shut down its subprime lending operations last year to focus on originating loans that conform to Fannie Mae and Freddie Mac guidelines, considered to be safe investments.

On Friday Countrywide's founder and former CEO, Angelo Mozilo, testified before the House Committee on Government and Oversight Reform, along with two other CEOs who resigned in the wake of the mortgage crisis -- Charles Prince of Citigroup, and Stanley O'Neal of Merrill Lynch. All three defended their lofty compensation packages, despite the loss of billions to their companies and shareholders.

There is no evidence to suggest that Bank of America will back out on its acquisition of Countrywide, the paper said, and may even be trying to speed up the proce

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Q4 2007 Flow of Funds

I will continue to examine the stark contrasts between the current Post-Bubble "reflation" attempt and those that preceded it. When the seemingly irrepressible Bubble in Wall Street finance Bubble was expanding, aggressive Fed rate cuts fed quickly into speculative leveraging, heightened demand for securitizations, aggressive lending in the asset markets, asset inflation, the inflation (of volume and prices) of myriad Credit instruments with perceived limited liquidity and Credit risk (certainly including ABS, MBS and agency debt, along with more sophisticated Wall Street debt instruments and structures).


The Fed didn't really need to concern itself with the dollar. Not only were foreign financial institutions rushing in to play the boom in U.S. "structured finance", the U.S. Credit system was creating perceived "money"-like securities that were the envy of the world. As fast as our Trade Deficits and speculative outflows flooded the world with dollar liquidity, this finance would return to find a "safe and secure" home through various Monetary Processes right back into our asset-based securitization markets. It was a Bubble of historic proportions and it's all laid out on the L.107 page in the Fed's Z.1 report.

We haven't heard much of the "Bretton Woods II" nonsense lately. Somehow, everyone wanted to make believe that we would always enjoy the ability to trade our securities for imported energy, commodities, capital equipment, cheap electronics, and all the consumer goods we could ever dream of. The problem was that our Credit system was issuing ever larger quantities of increasingly suspect financial claims (well documented in the Fed's "Flow of Funds").


Well, the entire world has become aware of our situation and will be less than keen to accumulate more of our debt. The Fed's willingness to cut rates so drastically in the midst of faltering confidence and heightened inflationary pressures is certainly exacerbating the very dangerous dislocation that has erupted in the agency, MBS and investment-grade corporate markets.

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Ilargi: We reported yesterday on the 63.000 lost jobs number. The complete picture is that over 600.000 people don’t count any longer as unemployed because they gave up looking for a job. Hence the real picture is far worse than the official numbers indicate. But then, that’s no surprise when it comes to US government numbers. Now even the New York Times starts publishing on this crazy issue.

End to the Good Times (Such as They Were)

If history is a reliable guide, the recession of 2008 is now unavoidable. The dismal jobs report released Friday showed overall employment to be lower than it was three months ago. Every time such a slump has occurred since the early 1970s, a recession has followed — or already been under way.

And if the good times have really ended, they were never that good to begin with. Most American households are still not earning as much annually as they did in 1999, once inflation is taken into account. Since the Census Bureau began keeping records in the 1960s, a prolonged expansion has never ended without household income having set a new record.

For months, policy makers and Wall Street economists have been predicting, and hoping, that the aggressive series of interest rate cuts by the Federal Reserve would keep the economy growing, despite the housing bust. But the possibility seemed to diminish almost by the hour on Friday.

Even the one apparent piece of good news in the employment report was a mirage. The unemployment rate fell to 4.8 percent, from 4.9 percent in January, but only because more people stopped looking for work and thus were not counted as unemployed by the government. Over the last year, the number of officially unemployed has risen by 500,000, while the number of people outside the labor force — neither working nor looking for a job — has risen by 1.3 million.

Employment has risen by 100,000, but even that comes with a caveat: there are also 600,000 more people who are working part time because they could not find full-time work, according to the Labor Department. “The decline in the unemployment rate,” said Joshua Shapiro, an economist at MFR, a research firm in New York, “should not be viewed as good news.”

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Unemployed, and Skewing the Picture

This month's jobs report is a great example of how misleading the unemployment rate can be. In February, the economy shed 63,000 jobs, which is a strong indication a recession may be at hand. But the unemployment rate actually fell, to 4.8 percent from 4.9 percent. How could this be?

The government's definition of the unemployed includes only those people actively looking for work. And last month, the number of people in that category fell significantly. It seems that more of the jobless gave up looking for work. So the unofficial number of unemployed fell, even as the labor market worsened.

Over the last few decades, there has been an enormous increase in the number of people who fall into the no man’s land of the labor market that Carroll Wright created 130 years ago. These people are not employed, but they also don’t fit the government’s definition of the unemployed — those who “do not have a job, have actively looked for work in the prior four weeks, and are currently available for work.”

Consider this: the average unemployment rate in this decade, just above 5 percent, has been lower than in any decade since the 1960s. Yet the percentage of prime-age men (those 25 to 54 years old) who are not working has been higher than in any decade since World War II. In January, almost 13 percent of prime-age men did not hold a job, up from 11 percent in 1998, 11 percent in 1988, 9 percent in 1978 and just 6 percent in 1968.

Even prime-age women, who flooded into the work force in the 1970s and 1980s, aren’t working at quite the same rate they were when this decade began. About 27 percent of them don’t hold a job today, up from 25 percent in early 2000.

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Sharp Drop in Jobs Adds to Grim Economic Picture

The worst fears of consumers, investors and Washington officials were confirmed on Friday, as deepening paralysis on Wall Street collided with stark new evidence of falling employment and a likely recession. In a report that was far worse than most analysts had expected, the Labor Department estimated that the nation lost 63,000 jobs in February. It was the second consecutive monthly decline, and the third straight drop for private-sector jobs.

Even before the bad news on jobs emerged, the Federal Reserve was already racing to ease the latest crisis in the credit markets, where seemingly rock-solid companies have been caught short because the markets are devaluing the collateral they had posted to back billions of dollars in loans. Much of that collateral consists of mortgages.

In a surprise announcement early Friday, the Federal Reserve said it would inject about $200 billion into the nation’s banking system this month — with more to come after that — by offering banks one-month loans at low rates and in return letting them pledge mortgage-backed bonds and even riskier assets as collateral.

Though monthly payroll data are notoriously volatile and subject to revision, the jobs report was so bleak that many of the few remaining optimists on Wall Street threw in the towel and conceded that the United States was already in a recession. “Godot has arrived,” wrote Edward Yardeni, who had been one of Wall Street’s most relentlessly upbeat forecasters. “I’ve been rooting for the muddling through scenario. However, the credit crisis continues to worsen and has become a full-blown credit crunch, which is depressing the real economy.”

Fed officials said Friday that they were not pumping money into the system in response to the poor jobs data but rather to the growing unwillingness or inability of investors to finance even routine business deals. Fed officials have long feared that anxiety about credit losses would create a “negative feedback loop,” or self-perpetuating spiral of rising unemployment, more home foreclosures and yet more credit losses.

“You have big credit losses that make it harder to get new credit, which means the economy starts to slow down and foreclosures go up,” said Nigel Gault, a senior economist at Global Insight, a forecasting firm. “Then you get even bigger credit losses, which makes banks even less willing to lend and you keep spiraling down.”

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MBIA Asks Fitch to Withdraw Ratings

MBIA Inc. has asked a major ratings agency, Fitch Ratings, to stop rating the bond insurer's financial strength, the company said Friday.

The Armonk, N.Y.-based insurer did not explain why it asked Fitch to withdraw its ratings on the company's financial strength, or whether MBIA has also asked the other major ratings agencies to do the same. The bond insurance sector, which promises to reimburse missed payments on $2.3 trillion of debt, has been rocked by the prospect of downgrades by ratings agencies.

Most stocks in the sector have lost at least four-fifths of their value in the past six months, and some downgraded companies _ such as Security Capital Assurance Ltd. and ACA Capital Holdings Inc. _ are bankrupt or close to it. MBIA, though, has not been downgraded by any of the ratings agencies. The company has sold stock and bonds to raise $2.6 billion expressly to mollify ratings agencies like Fitch.

The ratings agencies are trying to determine whether bond insurers like MBIA have enough cash to pay the claims they are likely to face. MBIA insures $678.1 billion in debt. MBIA asked Fitch to withdraw only the financial strength ratings _ which judge an insurer's ability to pay claims. MBIA asked that Fitch continue to rate the company's credit, which judges how likely a company is to repay its debt.

"Fitch's ratings process differs in many significant respects from those of the other rating agencies, which affects how investors assess value," MBIA said in a statement. "Fitch's coverage of the underlying credit quality of the transactions that MBIA insures is limited, and in turbulent times, the impact of this difference becomes significant, raising the risk of misinterpretation."

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Fitch mulls slashing $160B in securities

.Fitch Ratings may cut the ratings on up to $160 billion in securities backed by alt-A mortgages as the likelihood that the homeowners will default increases amid the worsening housing crisis. Any downgrade could trigger more writedowns at financial institutions that hold the securities. Similar ratings cuts on securities backed by subprime loans helped fuel more than $160 billion in write-downs at banks and lenders.

The ratings agency said late Thursday it put 417 residential mortgage-backed securities transactions on a negative watch list. Alt-A mortgages are loans to people without proof of income or minor credit problems. They fall between subprime and prime loans in terms of default risk.

"Accelerating home price declines partly due to the dramatic contraction in... the mortgage markets has been the primary catalyst of the alt-A performance downturn," Fitch managing director Glenn Costello said in a statement. The Fitch move signals a further spread of troubles with mortgage-backed securities from the subprime realm to more-creditworthy areas. The agency said delinquency levels for bonds backed by alt-A loans have been rising rapidly in recent months.

On Thursday, the Mortgage Bankers Association reported that foreclosure rates in the fourth quarter rose to a record level as home prices continue to decline. When prices were rising, strapped borrowers were able to either refinance their loan for better terms or sell the house. Now, for the first time on record since 1945, homeowners have less than 50% equity in their homes, meaning they owe more than they own.

Fitch said its review will be based on a model that assumes home prices will fall 25% from peaks in 2006. Prices are down about 10% so far. "As in the subprime market, although to a lesser degree, the willingness of alt-A borrowers with high Loan-to-Value mortgages to 'walk away' from mortgage debt has contributed to high levels of early default," Fitch said. It will first review $10 billion of subordinate alt-A-backed securities and then look at ones with "AAA" ratings. It expects to complete the review by the end of April. 

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Fitch cuts WaMu rating, says may cut other banks

Fitch Ratings on Friday cut its ratings on Washington Mutual Inc, and said it may cut Bank of America Corp and Citigroup, due to their exposure to residential home loans. Fitch cut WaMu's ratings two notches to "BBB," the second lowest investment grade, from "A-minus." Bank of America and Citigroup's "AA" ratings, the third highest investment grade, were placed on review for downgrade.

The rating actions are based on an expectation that weakness in home equity portfolios will emerge in the first quarter of 2008. "Indications from rated banks in the past few weeks suggest that home equity delinquency rates are rising at a far more rapid pace than even most bankers' and analysts' grim outlook for 2008 had anticipated," Fitch said in a statement.

"Fitch anticipates that banks will significantly ratchet up loan loss provisions against home equity loans in the first quarter of 2008 and provisioning levels for 2008 will likely be much higher than 2008 overall, as deterioration in other consumer portfolios is also likely," the credit ratings agency added.

The ratings cut on WaMu reflects the banks higher concentration in home equity and residential mortgage loans, Fitch said. Fitch also cut its ratings on First Horizon National Corp one notch to "BBB-plus," the third lowest investment grade, from "A-minus" and cut National City Corp one notch to "A," the sixth highest investment grade, from "A-plus."

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WaMu rewrites execs' bonus plan to dodge subprime damage

WaMu has revised its bonus plan for nearly 3,000 top executives so continuing damage from the subprime-lending collapse won't crimp their annual awards. The struggling Seattle-based lender said in a regulatory filing Monday it will exclude the cost of soured real-estate loans and foreclosure expenses when it calculates net operating profit, the biggest component of executives' 2008 bonuses.

Other changes to the bonus plan also appear to reduce the impact of troubled parts of its business, while giving a bigger role to factors that are less problematic. "We are perplexed by the incentive created by the 2008 compensation scheme," wrote Keefe Bruyette & Woods analyst Frederick Cannon in a note Tuesday. "This management-incentive structure could result in executive focus away from issues that we feel are critical to the success of Washington Mutual in 2008."

He said the incentive plan "surprisingly excludes the costs of credit," meaning the cost of loans gone bad. WaMu stock has been hammered in the past year by large losses from real-estate loans, and more losses are expected this year. Sizable amounts of annual compensation are at stake: Chairman and CEO Kerry Killinger has a "target bonus" of 365 percent of his base salary, but the actual bonus "may be up to 150 percent" of that target, the plan says.

After WaMu's disastrous 2007, the company announced in January that Killinger would forgo last year's bonus of nearly $1.8 million — 33 percent of the target level of $3.65 million. But the bonus amount will still count in his retirement-pay calculations. Among the changes WaMu's board approved for 2008 is abolishing earnings per share as one of the four weighted factors used in calculating bonuses. In last year's bonus plan, earnings per share represented 40 percent of the potential bonus.

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Thornburg survival at risk

Thornburg Mortgage Inc., which provides loans to help people buy expensive homes, said yesterday its survival is at stake because it cannot meet its own lenders' demands for $610 million (U.S.) of cash or collateral.

Thornburg said falling mortgage prices, together with liquidity imperiled by a surge of margin calls from its own lenders, "have raised substantial doubt about the company's ability to continue as a going concern." It said the margin calls "significantly exceeded" its cash, though some lenders froze further calls through yesterday. "It appears the state of this company rests in its lenders' hands," said Steven Marks, at Fitch Ratings in New York.

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Takeover of BCE passes key hurdle

Quebec judge rejects lawsuit by bondholders, approving proposed buyout by Ontario Teachers' Pension Plan

A Quebec Superior Court judge has approved the proposed leveraged buyout of Canada's largest telecom company by the Ontario Teachers' Pension Plan and its partners and rejected a lawsuit by bondholders who had tried to stop the deal. Justice Joel Silcoff's ruling cleared the way for BCE's privatization in what would be the biggest takeover in Canadian history. A group led by Teachers' and including U.S. private-equity firms Providence Equity Partners, Madison Partners and Merrill Lynch has offered to buy BCE for $52 billion in cash.

Bondholders had tried to block the deal, saying it treats them unfairly. However, in his written decision, Silcoff said the deal doesn't change the bondholders' rights. "They have the same right to be paid principal and interest by Bell Canada after the plan of arrangement is implemented as they did before," Silcoff wrote.

"The fact that the BCE shareholders will receive a substantial premium on the previous value of their shares and that, at the present time, the economic interests of the contesting debentures may be adversely affected does not in and of itself give them the right to vote as a separate class on the plan of arrangement."

Before Silcoff's decision was handed down, BCE shares fell 37 cents to close at $35.70 on the Toronto Stock Exchange – 16 per cent below the $42.75 takeout price – as investors continued to worry whether the takeover would be completed in its present form. The takeover still needs approval of the Canadian Radio-television and Telecommunications Commission. Martine Turcotte, chief legal officer of BCE and Bell Canada, said the company was pleased with Silcoff's ruling.

"On every point of contention, the court ruled in favour of BCE," Turcotte said. "The court's decisions affirm our long-standing position that the claims of these debenture holders are without merit and that BCE acted in accordance with its rights and obligations with respect to the debenture holders." A ruling in favour of the bondholders could have added costs and possibly threatened the deal. The decision is expected to be appealed, with the bondholders facing a March 17 deadline for such a move.

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PM Harper Rejects 'Bail-outs' of Canadian Industries

Canadian Prime Minister Stephen Harper said his government rejects "bail-outs" for ailing industries, and said businesses need to be more nimble in order to weather the U.S. slowdown and strong Canadian dollar. "Canada can maintain a competitive manufacturing sector, but to do so in the modern global economy that sector will have to move to the higher, more capital-intensive end of the industry," Harper said today a speech to the Economic Club of Toronto, on the budget his government presented last week.

Harper, facing elections as early as this year, has tried to position his Conservative Party as the best steward of the economy, pledging to resist calls from opposition parties for more aid to the automotive and forestry industries. Promises by the Liberal Party to increase assistance for manufacturers would jeopardize a decade of budget surpluses, Harper said.

An employment report released today shows manufacturers continue to struggle. Factory payrolls fell by 23,700 in February, bringing the 12-month loss to 105,700 or 5.1 percent of the manufacturing workforce. Canadian Auto Workers President Buzz Hargrove called on Harper to take "immediate action," according to a statement from the union. Harper, 48, told the Toronto audience that Canadians "want prudent fiscal discipline during uncertain economic times, not reckless spending."

The budget released Feb. 26 forecasts Canada's surplus will shrink to the lowest since 2004 in the next fiscal year and to the smallest in a decade in the year after that, as the country feels the effects of the sluggish U.S. economy. A C$60 billion tax-cut package announced last October is also curbing revenue. It included a reduction in the federal sales tax and in corporate income-tax rates.

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Better TED than Dead! - The Tale of Inter-Bank Rates

The outlook for bank credit remains uncertain. Major global banks will record significantly lower profits and in some cases losses in 2007.

A large volume of assets - somewhere between US$ 1 and 2 trillion - held in off balance sheet vehicles such as collateralised debt obligations ("CDOs"), asset backed security commercial paper ("ABS CP") conduits and Structured Investment Vehicles ("SIVs") are likely to return onto bank balance sheets. A known unknown is the further amount of securities held as collateral for loans to hedge funds that may come back onto bank balance sheets. This re-intermediation is forcing banks to raise substantial volumes of term debt placing additional upward pressure on bank credit spreads. Banks have also been hoarding cash in anticipation of higher funding needs.

Bank capital positions have been sharply impaired. Recapitalisation of the banks is heavily dependent upon the investment appetite of sovereign wealth funds and banks in Asia and the Middle East. Given the size of the requirement and the frequent trips, this well is at risk of running dry. The quality of the banks credit portfolios remains questionable. In 2007, the banks losses were related to large mark-to-market changes in the value of structured securities (mortgage backed securities and CDOs) and leveraged loans. There were few actual defaults.

As the economy slows and borrowers need to refinance, actual losses may occur. Lenders to non-investment grade companies and private equity transaction look vulnerable. Consumer lenders have already reported slowdowns in consumer spending and increase in write-offs. Automobile loan delinquencies are also rising. Also if the mortgage rate freeze plan does not have the intended effect, mortgage losses in the US may also increase beyond anticipated levels.

Financial institutions also face a subdued profit outlook. Key areas of recent profitability (mortgages, securitisation and structured credit) are not likely to return to previous levels for some time. Corporate finance and mergers and acquisition revenues are slowing. Strong trading revenues will slow as risk appetite and capital available for risk taking reduces. It is unlikely that the credit quality of the banking system will rebound drastically. Certainly, the current share prices and credit default swap ("CDS") spread are not optimistic - in January 2008, a 'A' rated industrial company was able to issue bonds at a spread below that of a 'AA' rated major bank.

An additional complication will be the CDS market itself. Banks have used this market to lay off risk. There are significant documentary complexities - some untested. The efficacy of the CDS will depend on the quality of the counterparty to which risk has been transferred. If actual defaults occur and the CDS market does not function then uncertainty about who is holding which risk and concerns about bank credit quality may re-emerge.

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Can the World Afford A Middle Class?

The middle class in poor countries is the fastest-growing segment of the world’s population. While the total population of the planet will increase by about 1 billion people in the next 12 years, the ranks of the middle class will swell by as many as 1.8 billion. Of these new members of the middle class, 600 million will be in China. Homi Kharas, a researcher at the Brookings Institution, estimates that by 2020 the world’s middle class will grow to include a staggering 52 percent of the global population, up from 30 percent now.

The middle class will almost double in the poor countries where sustained economic growth is lifting people above the poverty line fast. For example, by 2025, China will have the world’s largest middle class, while India’s will be 10 times larger than it is today. While this is, of course, good news, it also means humanity will have to adjust to unprecedented pressures. The rise of a new global middle class is already having repercussions. Last January, 10,000 people took to the streets in Jakarta to protest skyrocketing soybean prices.

And Indonesians were not the only people angry about the rising cost of food. In 2007, higher pasta prices sparked street protests in Milan. Mexicans marched against the price of tortillas. Senegalese protested the price of rice, and Indians took up banners against the price of onions. Many governments, including those in Argentina, China, Egypt, and Russia, have imposed controls on food prices in an attempt to contain a public backlash.

These protesters are the most vociferous manifestations of a global trend: We are all paying more for bread, milk, and chocolate, to name just a few items. The new consumers of the emerging global middle class are driving up food prices everywhere. The food-price index compiled by The Economist since 1845 is now at an all-time high; it increased 30 percent in 2007 alone. Milk prices were up more than 29 percent last year, while wheat and soybeans increased by almost 80 and 90 percent, respectively.

Many other grains, like rice and maize, reached record highs. Prices are soaring not because there is less food (in 2007, the world produced more grains than ever before), but because some grains are now being used as fuel and because more people can afford to eat more. The average consumption of meat in China, for example, has more than doubled since the mid-1980s.

The impact of a fast-growing middle class will soon be felt in the price of other resources. After all, members of the middle class not only consume more meat and grains, but they also buy more clothes, refrigerators, toys, medicines, and, eventually, cars and homes. China and India, with 40 percent of the world’s population, most of it still very poor, already consume more than half of the global supply of coal, iron ore, and steel. Thanks to their growing prosperity and that of other countries such as Brazil, Indonesia, Turkey, and Vietnam, the demand for these products is booming.

Not surprisingly, in the past two years, the world price of tin, nickel, and zinc have roughly doubled, while aluminum is up 39 percent and plywood is now 27 percent more expensive. Moreover, a middle-class lifestyle in these developing countries, even if more frugal than what is common in rich nations, is more energy intensive. In 2005, China added as much electricity generation as Britain produces in a year. In 2006, it added as much as France’s total supply. Yet, millions in China still lack reliable access to electricity; in India, more than 400 million don’t have power. The demand in India will grow fivefold in the next 25 years.

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