Debt Rattle, May 22 2008: Risks and certainties

Carl Mydans: "Ford foundation", 1936
A one-room hut houses a family of nine in an open field between Camden and Bruceton, Tennessee, near the Tennessee River. The hut was built over the chassis of an abandoned Ford.

Ilargi: Recently, both Fannie Mae and Freddie Mac reported multi-billion dollar record losses. Nevertheless, their regulator, the OFHEO, likely urged on by Washington, allowed them to take on even more risk, and guarantee even more -and bigger- mortgages. That in turn today allows for lenders to finance and re-finance new loans, and shift the risk and losses to F&F, who now gobble up over 80% of all new mortgages.

Prices are plunging across the nation, and even if you don’t agree with me that they will drop 80%, we all know prices won’t stop falling anytime soon. Still, Congress manages to state with a straight face that Fannie Mae and Freddie Mac will "hand over $700 million a year", and on top of that, the FHA will charge borrowers and lenders billions of dollars in new fees.

Where will that all that money come from in a tanking market? The chances that it'll ever be paid are ZERO, while the odds that the reverse will happen, and money will have to be put in, are at precisely 100%. In other words, this no longer has anything to do with risk. That’s not the word we’re looking for here. Risk is when there's multiple possible outcomes. There are no risks here, only certainties. Embezzlement anyone?


The Risks of Rescuing Borrowers

When the Senate Banking Committee approved on Tuesday legislation to help suffering homeowners refinance costly loans, lawmakers said they had found a way to rescue the housing market without requiring taxpayers to foot the bill.

By forcing the nation’s two largest buyers of home loans — Fannie Mae and Freddie Mac — to hand over hundreds of millions of dollars each year, lawmakers said they were creating a fund that the government could tap to refinance as much as $85 billion in troubled home loans.

Senators said the plan, which empowers the Federal Housing Administration, or F.H.A., to insure risky loans, would most likely help hundreds of thousands of homeowners avoid foreclosure and stabilize the housing market. But some say that the government’s housing plan is riskier than disclosed and that if home prices continue to decline for years, taxpayers could be on the hook for billions.

Others complain that the plan creates worrisome pressures for Fannie Mae and Freddie Mac at a time when both companies are struggling with enormous losses and thin financial safety nets. The companies are essential lubricants in today’s housing finance market, and if either stumbled, it could set off a worldwide economic slowdown.

“There’s real concerns about the degree of risk that F.H.A. is taking on,” said Howard Glaser, a mortgage industry consultant who served at the Department of Housing and Urban Development in the Clinton administration. “And everyone is calling on Fannie and Freddie to do more to stabilize the mortgage marketplace, but at what point does imposing new costs on those companies undermine their financial safety?”

Lawmakers of both parties say such concerns are baseless. Congressional aides say that the housing plan’s estimated $1 billion cost will be more than offset by the $700 million a year that Fannie Mae and Freddie Mac will hand over and by the billions of dollars in new fees the F.H.A. will charge borrowers and lenders.

“We believe we’ve identified more than twice the funding that this program needs,” said Senator Richard C. Shelby of Alabama, the senior Republican on the Banking Committee. “We have to provide relief to people who are at risk of losing their homes, and this is a good start.”

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More Questions Are Raised About Moody’s Ratings

The Moody’s Corporation is investigating whether it assigned top-flight credit ratings to certain securities because of computer errors, the company said Wednesday, raising new questions about the credibility of its assessments.

News that Moody’s might have made such mistakes emboldened the company’s many critics and sent its stock price tumbling. Its shares closed down 15.9 percent, to $36.91, their biggest one-day decline in almost a decade.

The attorney general of Connecticut, Richard Blumenthal, who has criticized the practices of Moody’s and other ratings firms, said that he was investigating how Moody’s had dealt with the possible errors in its computer models.

“One of the areas that most concerns us is the potential favoritism and abusive and illegal practices that involve dealings with the companies that they rate,” Mr. Blumenthal said in an interview. News of the possible errors, first reported Wednesday by The Financial Times, comes as Moody’s and the two other big credit ratings firms, Standard & Poor’s and Fitch Ratings, are under scrutiny for how they rated securities backed by risky mortgages.

Many of the bonds that the firms rated highly in the last few years have fallen in value and been downgraded quickly. Citing internal company documents, The Financial Times reported that Moody’s discovered computer errors last year that had allowed some complex European securities to be rated triple-A, when they should have been rated four grades lower.

But instead of re-rating the securities, the newspaper said, Moody’s changed certain assumptions that allowed those bonds to retain those gilt-edged ratings. Moody’s said it recognized the seriousness of the questions raised by the report and has asked its law firm, Sullivan & Cromwell, to investigate the matter. “The integrity of our ratings and rating methodologies is extremely important,” the company said in a written statement.

If true, the allegations could pose a significant challenge and liability to Moody’s. Until now, the major criticism of ratings firms was that they were not skeptical enough in how they rated mortgage securities and that they used flawed assumptions in evaluating the investments.

“This is a whole different thing entirely,” said Janet Tavakoli, a financial consultant who raised concern about the types of securities Moody’s rated earlier this year. “Now it makes you wonder what else was going on.” The securities in question are known as constant proportion debt obligations, or C.P.D.O.’s, a relatively new investment vehicle that sold insurance protection on corporate debt issued in Europe and the United States.

Joshua Rosner, an analyst and critic of the ratings firms, said the questions about Moody’s C.P.D.O. ratings are particularly concerning because it appears the firm did not change the ratings after it learned of the errors. “I would suggest that the story is not in the C.P.D.O.s, it’s in the cover-up,” he said.

On Wednesday, Christopher Cox, the chairman of the S.E.C., told reporters in Washington that his agency does not have authority over the ratings in question because they had been assigned in Europe. At the same time, Warren E. Buffett, the investor who is the biggest shareholder in Moody’s with a nearly 20 percent stake, said the questions about the firm’s ratings would not permanently damage it.

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Fed sees economy getting worse

The Federal Reserve sees worse economic problems ahead, according to new forecasts from the central bank released Wednesday. But even so, the Fed may be reluctant to cut interest rates any further than it already has, the minutes from its last meeting show. (The minutes were also released Wednesday.)

The Fed lowered its economic growth forecast for the year. At the same time, it raised its projections for inflation and unemployment. The combination of slowing growth and rising prices created a difficult situation that made the Fed's latest decision to cut rates on April 30 a "close call."

Stocks, which were trading a bit lower before the release of the minutes, fell even further after the new forecast was revealed. The Dow finished the day with a more than 220 point loss. The central bank said it now believes full-year economic growth will be between 0.3% and 1.2% this year, significantly below its previous forecast of 1.3% to 2% growth in January.

The Fed said in its minutes that members now expect the economy to shrink in the first half of the year -- the clearest signal yet that Federal Reserve chairman Ben Bernanke and other bankers believe the economy is in a recession. But some policymakers argued the Fed has cut rates enough already and that the central banks should not lower rates further unless there is evidence of "significant weakening."

The Fed also raised its unemployment forecast for the year to between 5.5% and 5.7%, up from its earlier estimate of 5.2% to 5.5%. The unemployment rate was 5% in April. In addition, the Fed boosted its projection for inflation. It said it now expects personal consumption expenditures to rise between 3.1% and 3.4% in 2008, a full percentage point more than its earlier expectation.

Even when soaring food and energy prices are stripped out, the Fed expects steeper "core" inflation than its previous estimate. The Fed cut its federal funds rate, a key short-term rate, by a quarter- percentage point at the end of its last meeting on April 30. According to the minutes, that decision was viewed as a "close call" partly because of rising inflation pressures.

"I think they are stating more clearly that we are in a recession, but the main thing to take away from this is that they're not going to cut any further," said Gus Faucher, director of macroeconomics for Moody's Economy.com. The Fed' indicated it is expecting a pickup in economic growth in the second half of this year, as the effect of its previous rate cuts and tax rebates to consumers start to impact the economy.

But while it said it expects the economy to recover a bit next year -- forecasts call for growth of 2% to 2.8% in 2009 -- the Fed still sees some weakness lingering into next year.

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Has the Fed really flooded the world with dollars?

Professor Charles Goodhart - (Goodhart’s Law, ex Monetary Policy Committee, and now Olympian sage at the LSE) - is too polite to say that the Federal Reserve has made an utter hash of the US economy by slashing interest rates to 2pc. But that is clearly what he thinks.

US M1 money supply
“I would have done exactly the same as Bernanke given the financial crisis they were in,” he told me this week, sticking to the “mutual admiration” etiquette of central bankers. Then comes the sting. “The M3 money supply is rising very rapidly indeed. There has been a very expansionary increase in the size of balance sheets,” he said.

The professor warned that yields on 10-year Treasuries (now 3.79pc) have shot up so much on inflation fears since the Fed bail-out in March that the effect risks short-circuiting the whole monetary rescue. “They may find that they don’t benefit after all from cutting rates,” he said.

Well, yes, this is the great fear. The Fed may now be trapped. The argument is that the US 10-year rate - set by market forces, and increasingly by the actions of Chinese and Mid-East governments - is the key price setter for the US housing market and corporate debt. Mess with bond vigilantes at your peril.

Mr Goodhart warns that the Fed’s “ideological” attachment to core inflation - which strips out food and energy - could lead them up the creek this time. People do have to eat and drive. “The Fed thinks that headline inflation (3.9pc) will come back down to core inflation, but this time core may go up to headline,” he said. That would be nasty surprise.

“Of course, it is not for somebody sitting 3,000 miles away to judge whether rate cuts are well chosen,” he added, tactfully. Quite so, quite so. I flag these comments because they touch on the most neuralgic issue of the day. My own view - if I dare dissent from the professor - is that the M3 surge is a false alarm. Needless to say, the Fed has not helped matters by abolishing the data.

Paul Ashworth, US economist for Capital Economics, has reconstructed the M3 figures using the old Fed model. They show that the M3 growth rate has jumped from 8.1pc to 14.9pc since the credit crunch began in August - high, but nothing like the claims of 30pc that are bandied around. This rise is almost entirely due to a “bearish” flight from stocks and suchlike.

Nervous investors have parked their wealth in money funds for safety until the crisis blows over. These money funds are distorting the M3 data (as Prof Goodhart also recognizes). “Everybody keeps saying the Fed is dropping money from helicopters and flooding the economy with liquidity, but it is not true. All that is happened is that the precautionary demand for money has gone up. That is not inflationary in any way,” said Mr Ashworth.

Indeed, if you look at the narrower M1 money supply, which the Fed does control, it has actually fallen 0.7pc over the last year. The monetary base is contracting. It reinforces my fear that we are heading into a deflationary crunch. No doubt the Fed, ECB, the Bank of England, et al, will ultimately flood the system with money and set off another asset bubble. We are not there yet.

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The Slope of Hope

Connecticut's AG isn't asking "if", he's looking at this from a more "ordinary" perspective - that is, whether there was fraud involved either originally or in covering it up:

"'We have been aware of allegations that, in effect, there was a cover-up of these ratings inaccuracies and defects in the models applied to these complex structured securities,' Blumenthal said in an interview today. 'The question is whether the defects were purposeful' and whether Moody's subsequently sought to hide the errors, he said."

Funny how a State AG office is interested in the facts, while the US Congress plays footsie. Let's hope that Mr. Blumenthal hasn't visited any high-priced hookers, lest his reputation and investigation get short-circuited as Mr. Spitzer's recently did.

The "let's investigate this as a criminal matter" meme appears to be gaining ground:

"On April 30, the SEC sued Larry Langford, the former county commission president and now Birmingham's mayor, for fraud in allegedly accepting $156,000 from a local banker while refinancing the sewer debt. Langford denies any wrongdoing.

The Federal Bureau of Investigation has raided financial advisers in California, Minnesota and Pennsylvania to get files. In January 2007, Charlotte, North Carolina-based Bank of America Corp. agreed to cooperate with federal prosecutors in exchange for leniency. Bank of America spokeswoman Shirley Norton declined to comment."

Price fixing allegations... I guess that making money the old-fashioned way (that is, stealing it) may have made a comeback - and these are the very same bankers that Bernanke and Company are "trying to help." Sounds great, right?

Stocks went in the toilet yesterday due to The Fed releasing minutes that said what everyone already knew:

• Price inflation is way above desired levels, and threatens to become "expected" (that is, "inflation expectations" are becoming unhinged.)
• The Fed policy rate is a blunt instrument that can't fix insolvency problems, nor make bad loans into good ones.
• GDP growth is slowing if not outright negative.
• Unemployment will likely be significantly higher than it is now.

Is any of what The Fed said "news"? No.

So why did the market sell off by more than 200 points - for the second time in a week, based on "news" that wasn't news, and was in fact what people have been saying now for several months?

Simple - "the slope of hope."

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Ilargi: Funny how that goes, isn’t it? The Financial Times sees stabilizing capital markets, where I see banks desperate for cash. Maybe we can compromise, and call it stable desperation. The record debt issuance has one underlying motive, and one only: the banks need to build reserves, a lot of it and fast, to cover the writedowns and losses of Christmas yet-to-come.

High-grade debt issuance at record levels

The issuance of US investment-grade debt is running at record levels as the financial system reduces its reliance on the use of short-term funding. Jim Cusser, portfolio manager at financial services firm Waddell & Reed, said: “Slowly but surely the capital markets are becoming more stable and less reliant on short-term lending.”

So far this month, the sale of investment-grade rated debt beyond a maturity of 18 months by companies has reached $115.4bn, according to Thomson Reuters. Fixed-rate issuance accounts for $83.3bn of this amount. With just over a week left until the end of the month, issuance is just shy of last May’s total of $117bn and the all-time record $118bn sold in March 2006.

Last month, debt sales reached $117bn and the high-grade market has bounced back sharply from $48.6bn in issuance during March, the slowest month since last July. Long-term debt sales have flourished as traditional sources of short-term funding have continued to shrink. “Issuers have been chastened by the seizing-up of the market and the reliance on turning over short-term paper,” said Mr Cusser.

Outstanding US asset-backed commercial paper (ABCP) has declined for the past six weeks. This sector reached a peak of about $1,200bn last summer and has now fallen to about $722bn. The broader commercial paper market has also been shrinking since August and outstanding volume was at a two-year low of about $1,734bn last week. The latest weekly figures from the Federal Reserve are due out on Thursday.

Investors such as money market funds have shunned the ABCP market since the credit crisis struck last August. This has hurt bank-sponsored entities that relied on short-term funding as the value of mortgages and other assets used to back such paper in the market has deteriorated. One syndicate banker said companies were seeking to raise debt in order to navigate the business cycle.

The most recent senior loan officers survey by the Federal Reserve revealed that banks were tightening their credit standards as they faced writedowns and raised capital. Michael Kastner, portfolio manager at SterlingStamos, said: “No one knows what the future holds and companies are buying themselves time by rolling over their debt for longer periods.”

Leading that charge since April have been financials, as they seek to rebuild their capital. In March, financials comprised less than half of the total debt that was sold as the crisis in credit markets peaked. In April, financials represented 70 per cent of total debt issued, and so far this month that figure is running at 59 per cent, according to Richard Peterson, director of capital markets at Thomson Reuters.

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Ilargi: Point in case: UBS sells itself at a 30% discount. Yeah, that’s one way to stablize capital markets, I guess.

UBS surprises with size of rights issue

UBS, the biggest European casualty of the US subprime crisis, on Thursday morning surprised investors by announcing it would raise more than expected in the deeply discounted rights issue that was approved last month. The Swiss bank said it would offer shareholders seven new shares for every 20 held, with the new stock priced at SFr21.

That would raise almost SFr16bn ($15.6bn), SFr1bn more than initially indicated. The pricing represented a steep discount to Wednesday night’s SFr30.64 closing price in Zurich. UBS shares, which have recovered somewhat from their steepest falls at the peak of the credit crisis, have been under pressure again in recent days on renewed concerns over credit quality among banks and worries about the pricing of the Swiss group’s rights issue in particular.

Initial reactions from analysts were of relief that the bank had not felt obliged to price its new stock in the SFr17-20 range – the bottom range of expectations – that some had feared. The deal has been fully underwritten by a consortium of JPMorgan, Morgan Stanley, BNP Paribas and Goldman Sachs, ensuring UBS will receive its funds, irrespective of shareholders’ response.

Trading in the 760m new shares being offered will start on June 13. Plans for the rights issue were first announced at the beginning of April when the bank saw a fresh $19bn in writedown related to the US subprime property market and the stepping down of Marcel Ospel as chairman. The issue was approved by shareholders at the annual general meeting on April 23.

The capital raised, the bank has argued, will allow management to hold on to assets which have seen a sharp fall in market value rather than sell them at distressed prices. UBS has announced around $38bn in writedown related to the credit crisis since last year.

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Banks Continue to Stuff Loan Cushions

The hits that banks have taken from the subprime mortgage crisis may be relenting, but the tab from the credit crunch is far from tallied, banking executives say. Banks across the country from Wells Fargo to SunTrust Banks have already seen earnings sapped as they bulked up reserves to cover loan losses.

With many experiencing increasing delinquencies in consumer debt, including home-equity loans -- particularly ones made by third-party brokers -- credit cards and auto loans, executives say they're likely to step up the money they set aside to cover defaults.

The situation is becoming more dire as market observers and analysts acknowledge that the credit cycle and housing downturn are likely to last at least through next year. The state of the U.S. consumer "grows worse by the month," according to Oppenheimer analyst Meredith Whitney.

"Our view is that the credit crisis will extend well into 2009 and perhaps beyond, and although the complexion will change, the net effect will be the same: three years of multibillion dollar revenue reversals," Whitney writes in an industry note Tuesday. "We estimate that by the end of 2009, over $170 billion of reserve builds will flow through bank earnings on top of 'business as usual' loan loss provisions."

She remains cautious on financial stocks "as credit turns this early in the credit cycle signal to us that ultimate loss experience will be far worse than current expectations," Whitney wrote in a separate note last week.

Analysts also are pointing to commercial real estate loans -- particularly those made to residential real estate builders -- as another area of increasing concern. Banks, particularly in the Midwest and Southeast, have been hit by rising losses from loans to homebuilders as home prices slide.

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First Quarter U.S. Home Prices Fall 3.1%, Ofheo Says

U.S. house prices sank 3.1 percent in the first quarter from a year earlier, according to a government report, as buyers waited for values to stop falling. Prices for previously owned single-family homes fell in 43 states, with values in California and Nevada tumbling more than 8 percent, the Office of Federal Housing Enterprise Oversight, known as Ofheo, said today in Washington.

Potential buyers are waiting for prices to hit bottom, causing the inventory of unsold properties to swell. People who are ready to buy face difficulty obtaining financing as lenders tighten standards and cut back on the number of mortgages they are writing, according to Paul Kasriel, chief economist at Northern Trust Corp. in Chicago.

``It's a dismal picture, there's no way around it,'' Kasriel said. ``A complicating factor is the fact that so many homeowners owe more on their mortgages than their houses are worth. This is a financial crisis. You can't put lipstick on this pig.''

The number of mortgage originations is expected to drop 18 percent this year from 2007, according to the Mortgage Bankers Association.

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EU-wide 'super regulator' poses threat to City of London

A top cast of European statesmen has issued a blistering denunciation of financial markets and called for a creation of a pan-EU body to protect the citizens against the "social risk" posed by modern capitalism. "The financial world has accumulated a massive amount of fictitious capital, with very little improvement for humanity," said the group in an open letter to the European Commission and the EU presidency.

"The current financial crisis is no accident. It was not, as some top people in finance and politics now claim, impossible to predict. For lucid individuals the bell rang years ago. This crisis is a failure of poorly or unregulated markets, and shows us, once more, that the financial market is not capable of self-regulation," it said, calling for the a new "European Crisis Committee" to take the matter in hand.

"Free markets cannot ignore social morals. Decent capitalism needs effective public policy. But when everything is for sale, social cohesion melts and the system breaks down," it said. The letter is signed by former premiers and finance ministers from Europe's socialist bloc, including ex-German Chancellor Helmut Schmidt, France's Lionel Jospin and Michel Rocard, and former Commission chief Jacques Delors.

While the initiative comes from the Left, it is in tune with the views of French president Nicolas Sarkozy and German Chancellor Angela Merkel. Both have called for measures to clamp down on "speculation". The fulminating text is the clearest evidence yet of the mounting drive for an EU-wide "super regulator", which would reduce Britain's Financial Services Authority to a regional branch - and pose a grave threat to the City of London.

"Financial markets have become increasingly opaque. The size of the lightly or not-at-all regulated "shadow banking sector" has constantly increased in the last twenty years. Inadequate incentive schemes, short-termism and blatant conflicts of interest have enhanced speculative trading. One investment bank earned billions by speculating downwards on sub-prime securities while selling them to its clients, epitomising the loss of business ethics!" the letter said.

European critics of Anglo-Saxon "casino" capitalism have seized on the credit debacle as a chance to clip the wings of the City and to extend EU jurisdiction deeper into financial affairs - a jealously-guarded domain of EU member states. They know that Britain is unusually vulnerable to pressure after the Northern Rock affair, which exposed grievous shortcomings in the UK regulatory structure.

Brussels has so far played down suggestions for an EU "super regulator". Commission president Jose Manuel Barroso is an Iberian free-marketeer, but his term is coming to end. Charlie McCreevy, the "Thatcherite" single market commissioner, is almost certain to be replaced by somebody less sympathetic to London next year.

Britain may not have veto power to block unwelcome moves. Proposals under some single market clauses in EU treaty law can be pushed through by a majority vote. Britain can no longer count on Poland as a free market ally, tipping the balance. The letter leaves no doubt that hedge funds and private equity are on borrowed time in the new political landscape left by the credit crunch.

"Rising income inequality has gone in tandem with an ever growing financial sector. This financial crisis has thrown some light on the alarming income differentials which have increased in recent decades. Ironically, many CEOs' salaries and bonuses reached incredibly high levels while the performances of their companies stagnated, or even went down. There is a huge ethical issue here," it said.

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Sharp fall in UK new home sales puts thousands of jobs at risk

Sales of newly built houses have "fallen off a cliff" in the last few weeks, putting tens of thousands of jobs at risk across the economy, according to the chairman of the Home Builders Federation (HBF). The past month has seen a litany of profits warnings and redundancy announcements from building firms as the credit crunch, and banks' reluctance to lend, played havoc with the peak spring selling season.

The problems are escalating rapidly, despite measures from the Bank of England to improve banks' access to funds, and the knock-on effects on the wider economy will be even worse, says Stewart Baseley, from the HBF. "The slowdown last autumn was minuscule compared to what we are seeing now – since the start of April the market has fallen off a cliff and trade has almost stopped," he said.

"The implications for the economy are dire. Tens of thousands of jobs are at risk, possibly even more, as the potentially massive lay-offs amongst homebuilders start to filter through." Unless mortgage-lending picks up in the very near future, the situation will snowball, jeopardising the long-term capacity of the industry – and with it the Government's target for three million new homes by 2020.

"The Bank's £50bn special liquidity scheme is having precious little impact and the danger is that by the time anyone wakes up in six months, it will be too late and there won't be an industry there to respond," Mr Baseley said. "It takes a lot longer to put things back together again than it does to dismantle it so if the industry restructures itself to build far fewer homes then it won't have the infrastructure of people and skills to put its foot back on the accelerator again in the future."

But there is little sign of any respite for homebuilders, with the Council of Mortgage Lenders warning yesterday that it now expects house prices to fall by 7 per cent during 2008. The group had previously forecast a 1 per cent increase over the course of this year.

Howard Archer, the chief UK and European economist at Global Insight, said: "The bad news on the housing market is pretty relentless at the moment, with the low level of mortgage activity being a consequence of a damaging mix of stretched buyer affordability and very tight lending conditions."

Wolseley, the building supplies group, became the latest casualty yesterday. Pre-tax profits have fallen by 30 per cent in the last nine months, and 325 jobs have already been axed in North America, with more to go in both the US and Europe by the end of July. Taylor Wimpey, the UK's biggest homebuilder, said this week that it is closing 13 offices and cutting staff numbers by around 600, more than 10 per cent of the workforce.

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UK building society mortgage lending drops 40%

Nationwide today said new mortgage lending dropped by almost half last year as the UK's biggest building society looked to weather the credit storm. The society lent £6.7 billion on new mortgages in the year to April 4 - 40 per cent below the previous 12 months - although underlying pre-tax profits rose 17 per cent to £781.1 million.

Nationwide funded the lending entirely through retail deposits, which trebled to £9.1 billion as worried customers sought a safe haven for their cash. The group said its mortgage arrears were less than a third of the industry average as its focus on lower-risk borrowers paid dividends.

But Nationwide also predicted lower house prices this year and added it was "difficult to predict" how long the tough current market conditions would last. Chief executive Graham Beale described the crunch as "unprecedented", and added: "It will be the first quarter of next year before we are through the worst of this."

The mutual's share of the new mortgage market shrank to 7.1 per cent - compared to 11 per cent a year ago - as it looked to focus on quality rather than share. Mr Beale said he would be "comfortable" with a similar share in the current year. "We will continue to monitor our activity so we don't put undue pressure on our balance sheet," the chief executive added.

An average borrower with a 10 per cent deposit is now paying an interest rate between 1 per cent and 1.5 per cent higher than a year ago for a two-year fixed deal, Nationwide said. But as lending declined, the mutual gathered strength in the savings market as customers rushed to save, boosting its market share to 19 per cent.

Mr Beale said the building society had opened 1.5 million new savings accounts - equivalent to 4,000 a day - with almost £1 in every £5 saved in the UK going into a Nationwide account. Nationwide said it had no direct exposure to the crisis hit US sub-prime housing market - which sparked last year's crunch - although it took a £102.2 million write down on other financial vehicles hit by the market turbulence.

The mutual has also boosted its balance sheet with liquidity almost doubled to £27.3 billion. Nationwide completed its merger with Portman last August, giving it more than 900 branches and 14 million members. The society plans to make around £90 million in cost savings through the deal by 2011.

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US taxpayers' bill leaps by trillions

The federal government's long-term financial obligations grew by $2.5 trillion last year, a reflection of the mushrooming cost of Medicare and Social Security benefits as more baby boomers reach retirement. That's double the red ink of a year earlier.

Click to go to original interactive version

Taxpayers are on the hook for a record $57.3 trillion in federal liabilities to cover the lifetime benefits of everyone eligible for Medicare, Social Security and other government programs, a USA TODAY analysis found. That's nearly $500,000 per household. When obligations of state and local governments are added, the total rises to $61.7 trillion, or $531,472 per household.

That is more than four times what Americans owe in personal debt such as mortgages. The $2.5 trillion in federal liabilities dwarfs the $162 billion the government officially announced as last year's deficit, down from $248 billion a year earlier. "We're running deficits in the trillions of dollars, not the hundreds of billions of dollars we're being told," says Sheila Weinberg, chief executive of the Institute for Truth in Accounting of Chicago.

The reason for the discrepancy: Accounting standards require corporations and state governments to count new financial obligations, even if the payments will be made later. The federal government doesn't follow that rule. Instead of counting lifetime benefits for programs such as Social Security, the government counts the cost of benefits for the current year.

The deteriorating condition of these programs doesn't show up in the government's bottom line, but the information is released elsewhere — in Medicare's annual report, for example. Since 2004, USA TODAY has collected the information to provide taxpayers with a financial report similar to what a corporation would give shareholders. Big new liabilities taken on in 2007:

• Medicare: $1.2 trillion.
  
• Social Security: $900 billion.
  
• Civil servant retirement: $106 billion.
  
• Veteran benefits: $34 billion.

The multitrillion-dollar loss is a more meaningful financial number than the official deficit, says Tom Allen, chairman of the Federal Accounting Standards Advisory Board, which helps set federal accounting rules.

Medicare has an unfunded liability of $30.4 trillion. That means, in addition to paying all future Medicare taxes, the government needs $30.4 trillion set aside in an interest-earning account to pay benefits promised to existing taxpayers and beneficiaries. The amount is sure to rise when the oldest of 79 million baby boomers — 62 this year — reach 65 and become eligible.

Economist Dean Baker says the huge liabilities are potentially misleading because future generations will have greater income. "If we fix health care, then our deficits can be easily dealt with," he says.

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Ilargi: I know, I know, many of you are well versed in peak oil. I still thought I'd give you the UK Telegraph's economist Ambrose Evans-Pritchard's take on oil prices.

Oil's perfect storm set to blow over

The perfect storm that has swept oil prices to $132 a barrel may subside over the coming months as rising crude supply from unexpected corners of the world finally comes on stream, just as the global economic downturn begins to bite.

The forces behind the meteoric price rise this spring are slowly receding. Nigeria has boosted output by 200,000 barrels a day (BPD) this month, making up most of the shortfall caused by rebel attacks on pipelines in April. The Geneva consultancy PetroLogistics says Iraq has added 300,000 BPD to a total of 2.57m as security is beefed up in the northern Kirkuk region.



"There is a strong rebound in supply," said the group's president Conrad Gerber. Saudi Arabia is adding 300,000 BPD to the market in response to a personal plea from President George Bush, and to placate angry Democrats on Capitol Hill - even though Riyadh insists that there are abundant supplies for sale.

Like the rest of Opec, the Saudis blame "speculators" for running amok, pushing paper contracts into the stratosphere. The ever-diminishing reserves of oil in the earth's crust doubtless drive crude prices to much higher levels over time - provided no new technology such as nuclear fusion abruptly changes the picture - but that will not stop cyclical ups and downs along the way.

The world's finely balanced market for crude has been creeping into surplus for several weeks. Opec's monthly report says that demand this quarter will average 85.75m BPD. Supply was 86.8m BPD in April. The fresh output from Nigeria, Iraq and Saudi Arabia may push it significantly further into surplus.

The signs are already surfacing in global inventories. Opec says that stocks held by the OECD club of rich countries are above their five-year average, with "comfortable" cover for 53 days' use. US stocks have edged up for the last four months, though they fell last week. While it is widely reported that output from the non-Opec trio of Norway, Britain, and Mexico has relentlessly fallen, it is less well known that a clutch of other countries are gradually filling the breach.

The US Energy Information Agency says non-Opec supply will edge up by 600,000 BPD over coming months as Brazil, Azerbaijan and the Sudan raise production. By next year, the US itself will be producing enough extra oil to shave its import needs. None of this has been enough to curb the buying frenzy this spring.

Goldman Sachs has warned that prices could reach $200 in a final spike, and even the bears at Lehman Brothers say there may be enough momentum to keep the boom going until Christmas. It is unclear whether hedge funds and investors piling into futures contracts have now become the driving force in a speculative bubble. The Bank of England said yesterday that they were not a factor.

Lehman's latest report - Is it a Bubble? - says commodity index funds have exploded from $70bn (£36bn) to $235bn since early 2006. This includes $90bn of fresh money. Energy takes the lion's share. Every $100m flow of investment money into oil lifts crude prices by 1.6pc, it said. "We see many of the ingredients for a classic asset bubble," said Edward Morse, Lehman's oil expert.

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Ilargi: Here come the warning tales on pension plans. For today’s children, the term “retirement age” will be an alien unknown.

Actuaries Scrutinized on Pensions

By firing its actuarial consultant last week, the New York State Legislature shone a light on one of the public sector’s deepest secrets: All across the country, states and local governments are promising benefits to public workers on the basis of numbers that make little economic sense.

The numbers are off-base for a variety of reasons. Sometimes there is a glaring conflict of interest, as there was in Albany, where the consultant was being paid by the workers seeking richer benefits. More often, there is subtle pressure on the actuary to come up with projections that make the pension fund look good. Most of all, public pension actuaries use old methods that have fallen far out of sync with the economic mainstream.

That does not necessarily mean their figures are wrong, but it does make them vulnerable to distortion, misunderstanding and abuse. “Financial burdens have been hidden” as a result, said Jeremy Gold, a New York actuary and economist who was one of the first to call attention to the gap between actuarial figures and economic reality.

Many economists now agree with Mr. Gold, saying they believe actuaries are routinely underestimating the cost of providing governmental pensions by as much as a third. The difference “is going to come out of services, and the services are for the working poor,” Mr. Gold said.

In the private sector, pension funds are highly regulated, and actuarial numbers are less of an issue. But in government, actuaries and the consulting firms that employ them are starting to draw lawsuits in places like Alaska, San Diego, Milwaukee County, Wis., and Evanston, Ill. In Texas, the attorney general is calling for actuaries to be registered, so the state can keep them on a shorter leash.

Federal regulators are also flexing their muscles, and the actuarial rules-making board is being pushed to change. Two big problems are being laid on actuarial doorsteps: overly aggressive investing and overly rich benefits. Benefits can go off the scale because widely used actuarial methods tend to make them look inexpensive.

And this tends to encourage aggressive investing, because the greater the risk in the portfolio, the less costly it can seem to provide the benefits. “Actuarial assumptions based on misinformation are a recipe for disaster,” said the Texas attorney general, Greg Abbott. After the Fort Worth pension fund was found to have a crushing $410 million deficit, Mr. Abbott sent his staff to dig through more than a decade’s worth of documents, to find out why.

They found that in 1990, an actuary had calculated that the city could put less money into the pension fund and increase workers’ benefits simultaneously — without making a dent in the fund — if he assumed that the fund would earn 10.23 percent a year on its investments. This worked on paper but not in the real world.

In reality, Fort Worth actually lost money on its pension investments that year. And the new benefits did, in fact, have a cost. But the city forged ahead, armed with an actuarial opinion letter stating that “the numbers are correct.” It generously sweetened public workers’ benefits five times in subsequent years.

From time to time, the actuary issued muted warnings, but he was ignored. He also began tweaking other numbers in his calculations, which kept the plan looking viable on paper. Meanwhile, the imbalances in the pension fund compounded. “It went bust,” said David C. Mattax, the attorney general’s chief of financial litigation.

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Take this 401(k) and shove it

Last week's West Virginia election should frighten you. No, I'm not talking about Hillary Rodham Clinton's steamrolling of Barack Obama in that state's Democratic presidential primary contest. I'm referring to a far more obscure contest, one that virtually no one outside that state noticed - but one that illustrates perfectly why so many Americans are headed for a retirement crisis.

Here's the lowdown: The election in question involves nearly 20,000 West Virginia school teachers who are currently attempting to gain coverage under the state-run traditional pension plan. These so-called "defined-benefit" pension plans give workers a guaranteed annual payment upon retirement - $2,500 a month, say, for an employee with 30 years of service and an average salary of $50,000.

The employer puts up all or most of the money and workers gain real retirement security. But for employers, these plans are an expensive proposition. That's because by law, retirees must receive their predetermined pension benefit each and every month, even if the pension plan's investments perform poorly.

For that reason, corporate America has taken an ax to these pensions in recent years: The proportion of private sector workers who participate in a traditional pension plan has dwindled almost 40% at the beginning of 1980 to only about 17% now. Scores of big companies, including IBM, Sears, and Verizon, have closed off the plans to workers.

The story is very different in the public sector, though, where traditional pension plans have continued to flourish. About 90% of all state and local government workers are currently covered by a defined-benefit plan. The main reason is that a much larger proportion of teachers and other public sector workers are unionized, and elected officials are often loath to take on those powerful unions, whose members can both vote and strike.

Moreover, funding for public-sector pensions is backed by the full faith and credit of the taxpayer. And that brings us back to West Virginia. For many years, West Virginia did, in fact, have a defined-benefit plan for its teachers. But by the early 1990's, the plan had run into massive financial difficulties. A combination of underfunding by the state legislature and poor investment returns made the West Virginia teachers' pension plan the worst-funded of its kind in the nation.

So in 1991, West Virginia took a page out of corporate America's playbook. In order to stem the financial bleeding, the state closed the defined-benefit plan to new teachers and created a 401(k)-style plan for them. These types of plans are cheaper - an employer's financial commitment to a 401(k) plan is pretty much limited to offering a matching contribution to the employee's account (and even that's optional.) And in this case, it limited the future outlays required by West Virginia taxpayers.

Fast forward to today. It turns out that for a very large segment of West Virginia teachers, the 401(k)-type plan hasn't panned out too well. According to a study done by West Virginia's Consolidated Public Retirement Board, the average account balance is just $33,944 and only a handful of teachers age 60 or older have amassed more than $100,000 in their accounts - a fraction of what the pension plan would've paid.

So the West Virginia teachers now want a do-over. Essentially, they want to treat the past 17 years under the 401(k)-style system as though it never happened. They are asking to be put back - retroactively - into the traditional defined-benefit pension plan. Like a bad dream, their paltry 401(k) balances will disappear, to be replaced by the more generous pensions they would have racked up had they been in the traditional plan all along.

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BCE Plunges Most in 25 Years as Buyout in Jeopardy

BCE Inc. plunged the most in at least 25 years in Toronto trading as investors bet the Canadian phone company's record C$52 billion ($52.9 billion) leveraged buyout may collapse or be renegotiated at a lower price.
BCE fell as much as 16 percent after bondholders won an unexpected court ruling yesterday, letting them challenge the buyout because BCE didn't take their interests into account.

BCE agreed to a C$42.75-a-share offer from a group led by the Ontario Teachers' Pension Plan in June. A collapse would make it the largest leveraged buyout ever to fail. BCE would top the list of 62 LBOs worth a combined $174 billion announced last year that have been abandoned as borrowing costs more than tripled, according to data compiled by Bloomberg. BCE had expected to complete the buyout by next month.

``The probability of the deal closing at C$42.75 a share on June 30 is almost zero,'' said Craig MacAdam, who helps manage about $3 billion as a portfolio manager at Aurion Capital in Toronto. ``But there's still room to maneuver. The deal is not completely dead yet. All the stakeholders will have to get back to the table and renegotiate.''

The bondholders, among them CIBC Global Asset Management Inc., say the acquisition would load Canada's biggest phone company with debt, increasing the risk of a default. Teachers' had planned to raise about C$34 billion in debt for the deal, according to regulatory filings.

Shareholders voted in September to accept the bid, whose equity value is more than C$34 billion and which includes C$16.9 billion in debt, preferred shares and minority interests. Montreal-based BCE and the buyers plan to appeal the decision by Quebec's Court of Appeal to Canada's Supreme Court.

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Quebec court impedes takeover of BCE

BCE Inc.'s $35-billion sale to Ontario Teachers' Pension Plan is in jeopardy after some angry bondholders convinced a Quebec appeal court that the buyout plan is unfair. The Quebec Court of Appeal said that BCE hadn't proved that it tried to ensure that all bondholders were treated fairly in the transaction.

As a result, the five-judge panel sent the case back to a lower court, where the bondholders had previously lost their challenge. The ruling throws up yet another roadblock in an increasingly difficult path to closing the buyout for Teachers and its acquisition group, which also includes Providence Equity Partners LLC, Madison Dearborn Partners and a private-equity arm of Merrill Lynch & Co.

The group agreed to buy BCE for $42.75 a share last summer, a move that shareholders loved but bondholders hated because the plan included loading down the company with gobs of new debt. As a result, while BCE's shares soared, the bonds sank. “If it was possible to structure an arrangement so that a satisfactory price could be obtained for the shares, while attenuating the adverse effect to the debenture holders, then the Board had a duty to examine it.,” the Quebec Court of Appeal said in its ruling.

“The failure of BCE to present evidence on this issue precludes the Court from determining whether or not it is possible,” the court said. “BCE must bear the consequence of its failure to attempt to discharge this burden.” The court decision is the latest in a series of recent obstacles to the deal. The upheaval in the credit markets has caused the banks that are supposed to put up the bulk of the money for the buyout to balk, with talks starting to bog down last weekend.

In response, the three biggest lenders -- Citigroup Inc., Deutsche Bank AG and Royal Bank of Scotland -- are demanding higher interest rates and even potentially a cut in the acquisition price to reduce the size of the loan package. The issue now is whether BCE and Ontario Teachers can come up with a way, and the money, to satisfy the bondholders before a June 30 deadline to close the deal. Alternatively, BCE and Ontario Teachers can seek to extend the closing and hope to fight the ruling in the last remaining court -- the Supreme Court of Canada.

Bondholders, including a mutual fund arm of Canadian Imperial Bank of Commerce and Manulife Financial Corp., appealed after losing a March decision when a lower-court judge overruled their attempt to stop the buyout, or at least win compensation. The angry bond investors started the court challenge in 2007 because they were upset that the plan to buy BCE with loads of new debt caused existing bonds to slump in price.

The bonds slid on concern that the new debt will make BCE a riskier investment. The lower court judge ruled that the bondholders should have known a buyout was a possibility and as such, BCE and its buyout syndicate owed nothing to debt investors. “They should have foreseen the risk,” Quebec Superior Court Justice Joel Silcoff wrote in March, adding, “If they were not prepared to manage that risk, they should have taken appropriate steps to protect themselves. They chose not to and must accept the consequences of their decisions.”

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Stakes high in BCE negotiations

As details emerge from the Clear Channel Communications buyout that now looms so large at BCE, what's astounding is the pettiness of the financiers involved. In one of the fly-on-the-wall stories they do so well, Wall Street Journal reporters captured the animosity that took hold between bankers and their supposed clients: Clear Channel and private equity executives.

The two sides grew to hate each other. The same bank CEOs who are now facing off with BCE stopped returning phone calls from their Clear Channel clients, who had promised the banks $300-million in fees. Meetings had to be held in neutral sites, such as aircraft hangars. Now the $34-billion BCE loan package is moving into the same nasty territory.

The WSJ reports there's a meeting in Manhattan today that will see lenders Citigroup, Deutsche Bank and Royal Bank of Scotland try to win better terms on their loans to a buying group led by the Ontario Teachers Pension Plan Board. Tough talk is expected in these situations. Concessions may need to be made. But let's hope both sides recognize the stakes, and keep negotiations professional.

The world's largest buyout shouldn't end up on the rocks because a couple of bankers are worried about this year's bonus – its doubtful they get one no matter what happens at BCE -or some perceived personal slight. (There's bad blood between newly-named Citigroup CEO Virkam Pandit and Teachers.) Citigroup and the rest of the lenders need to understand that their domestic franchises hang in the balance.

Blowing up BCE kills their reputations north of the border for a generation. From home buyers to the biggest companies, who wants to use a bank that doesn't follow through on a promised financing? Reneging on BCE would also give Canadian capital markets a black eye around the globe, as this deal is being followed in every market. And that's not exactly what this country needs, given a track record that includes the income trust debacle, Nortel scandals, that botched Hydro One IPO and a gold play named Bre-X.

Toronto-Dominion Bank CEO Ed Clark seemed to understand all this early on. He's the one banker who's been publicly supportive of his clients in the BCE buyout, recognizing that lending money and managing risks is what banks do. It's hard to imagine Mr. Clark ducking phone calls from other CEOs, or engaging in the other petty tactics that marked Clear Channel negotiations. The same customer-first spirit is needed at BCE.

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CIBC faces more monoline write-offs

For all the brave talk that the worst is over in credit markets, CIBC still faces the potential for further writedowns on its exposure to monoline insurers.

Rating agency Moody's took an axe to CIBC counterparty CIFG on Tuesday, downgrading the monoline by a dramatic seven notches, from A1 to Ba2. Bermuda-based CIFG CEO John Pizzarelli said the company was “very disappointed by this action,” which comes as the insurer looks at “strategic alternatives” that would improve its balance sheet.

CIBC previously disclosed $628-million of notional subprime mortgage-related exposure to CIFG, and $1.5-billion of non-subprime insurance with the company. Part of this exposure may have already been written down, but Blackmont Capital analyst Brad Smith wrote Wednesday that the latest Moody's cut has not been reflected in the bank's results, “leaving scope for the additional write-off of the $617-million pre-tax in fair value exposure.”

“The downgrade of CIFG highlights the continued stress on the financial condition of major monoline insurers to which CIBC has economic exposure,” said Mr. Smith. CIBC has total notional subprime monoline insurance exposure of $7.9-billion. To date, the banks has taken a $2.8-billion writedown on these positions. The bank is scheduled to report second quarter financial results on May 29.

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Ilargi: If you want to understand why the world food situation is doomed, as are tens of millions people, look no further. If people really believe that "solutions to the global food crisis" will come from Coca-Cola, McDonald's and DuPont, as this maroon claims, then there is no solution.

Fixing farming

Backyard vegetable gardens are fine. So are organics, slow food and locavores - people who eat produce grown nearby. But solutions to the global food crisis will come from big business, genetically engineered crops and large-scale farms. So, at least, says Jason Clay, one of the world's leading experts on agriculture and the environment.

Clay leads a global effort to reform agriculture at the World Wildlife Fund, working with buyers and producers of farm products including Coca-Cola, McDonald's and DuPont. The problem they face has made headlines lately. Demand for farm products - food, fiber and fuel - will keep growing, as the population grows and as hundreds of millions of people move into the middle class and consume more meat and dairy.

Global per capita meat consumption has increased by 60 percent in the last 40 years - that's 60% per person. Meanwhile, the supply of farmland is limited. Agriculture already uses 55% of the habitable land on the planet. According to Clay, farming is the single largest threat to biodiversity; what's more, if farmers destroy tropical forests in Brazil or Indonesia to raise cattle or produce palm oil, the impacts on climate change will be severe, because forests store lots of carbon.

"We are reaching the limits of natural resources on the planet," Clay says. The answer is for farmers to become more productive - generating more output from fewer inputs. That requires economies of scale. "Any thinking environmentalist," says Clay, "would want to see more intensification of agriculture."

Clay, 57, is nothing if not a thinking environmentalist. He literally wrote the book on sustainable farming - a 570-page volume called "World Agriculture and the Environment" (Island Press, 2004), which analyzes the production practices and impacts of 21 commodities, from coffee, tea and orange juice to shrimp, cashews and bananas.

He grew up on a Missouri farm where his family raised beef cattle and grew soybeans and corn; he was educated as a scholarship student at Harvard, the London School of Economics and Cornell, getting his PhD in anthropology; and he worked as an anthropologist and human rights activist in Latin America and Africa.

In the 1980s, he got into the commodities business as a way to help poor people in the tropics; after meeting Ben Cohen at a Grateful Dead benefit, they created Ben & Jerry's Rainforest Crunch ice cream, to create a market for sustainably harvested ingredients from the Amazon. Today, Clay spends more time with global companies like Unilever (which now owns Ben & Jerry's) than with hippie-inspired startups.

He is pursuing a big idea - that the world's leading buyers of commodities can be persuaded to dig deeper into their supply chains, influence farmers to adopt better practices, and then create global standards so that agriculture can become both more productive and sustainable. He has convened industry roundtables of retailers, buyers, producers and environmentalists with the goal of reducing the key impacts of producing sugarcane, soy, palm oil and other crops.

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