Near Muskogee, Oklahoma. Elmer Thomas at the wheel.
Ready to depart for the journey to California.
Ilargi: Starting today, we’re stepping it up a few notches in seriousness. It’s time to call a spade a spade, and look beyond curtains and smokescreens. I don’t know whether markets will reflect what’s going on, and that’s not so important to me.
We have a format here that differs from others in that we don’t do headlines of articles. There’s enough of that. We aim to be a one-stop shop, and that requires longer quotes from relevant media reports. While I do comment on some things, the underlying idea is for the reader to make up his/her own mind. To me, that’s the only way we’ll get somewhere in trying to make you see.
The extra notches in today’s Debt Rattle leave you with a lot of reading material. I have faith in everyone’s ability and discretion to pick out what catches the eye, if it’s too much to go through all at once, or perhaps to come back later in the day. I know it’s often hard to understand the world of finance, but I don’t want to make up your mind for you. That’s up to you, and that’s what The Automatic Earth wants.
Yesterday, commenters were looking for defining moments, black swans if you will. I don't think there'll be such a thing, not shaped as a singularity. That is because there is too much hiding and lying and manipulating going on. There are instead a series of points of no return. I've identified one for instance back in March. These days there's another one: the breakdown of the UK mortgage and banking sectors. But while it's obvious there's no saving them, that doesn't mean everybody takes out their cash all at once. The smoke will imperil many people's views for a while to come.
Recognizing that points of no return imply that there's no way back, no saving our present economic system, is more important than being able to pin an exact date on any specific event among the many unfolding.
As for this morning’s news, I find it stunning to see how accounting rules allow Wall Street banks to book their losses as gains. It's turning the world upside down, 180 degrees, and it's all legal. Lobbying pays off big-time. When looking at that, how could you have any faith in what media, government and the Dow try to portray? It’s all just a stay of execution.
England gets hammered. One of its biggest banks is on the verge of the abyss. It’ll be bought soon by a foreign institution, for pennies on the pound. The UK government will actively stimulate such a sale, it can’t afford more Northern Rocks. But I think there’ll be more of this among UK banks, and they can’t all be bought. More delay of inevitabilities.
Wall Street Says -2 + -2 = 4 as Liabilities Get New Bond Math
Leave it to Wall Street to profit from its own distress. Merrill Lynch & Co., Citigroup Inc. and four other U.S. financial companies have used an accounting rule adopted last year to book almost $12 billion of revenue after a decline in prices of their own bonds.
The rule, intended to expand the "mark-to- market" accounting that banks use to record profits or losses on trading assets, allows them to report gains when market prices for their liabilities fall. The new math, while legal, defies common sense.
Merrill, the third-biggest U.S. securities firm, added $4 billion of revenue during the past three quarters as the market value of its debt fell. That was the result of higher yields demanded by investors spooked by the New York-based company's $37 billion of writedowns from assets hurt by the collapse of the subprime mortgage market.
"They can post substantial gains as a result of a decline in their own creditworthiness," said James Cataldo, a former director of treasury risk management for the Federal Home Loan Bank of Boston and now an assistant professor of accounting at Suffolk University in Boston. "It's completely legitimate, but it doesn't make sense by any way we currently have of thinking of net income."
The paper profits have helped offset more than $160 billion of writedowns taken by U.S. financial-services companies during the past year. Now some investors and analysts say the winnings are illusory and may have to be reversed. "The piper will have to paid eventually," said Robert Willens, a former Lehman Brothers Holdings Inc. accounting analyst who left the New York-based firm earlier this year to become an independent consultant.
The debate over what is known as Statement 159 adds to the number of accounting techniques called into question as the U.S. debt market unravels. Investors have criticized banks for booking some writedowns in an accounting category called "other comprehensive income" that bypasses their income statements. Accounting rulemakers are now proposing changes to standards that let banks use off-balance-sheet vehicles to juice earnings without tying up precious capital.
Statement 159, formally known as the "Fair Value Option for Financial Assets and Financial Liabilities," was issued in February 2007 by the Financial Accounting Standards Board, or FASB, which sets U.S. accounting rules. It was adopted by most large Wall Street firms in the first quarter of last year and becomes mandatory for all U.S. companies this year, although they have wide latitude in how to apply it, if at all.
The rule was enacted after lobbying by New York-based companies, led by Merrill, Morgan Stanley, Goldman Sachs Group Inc. and Citigroup, which wrote letters to FASB arguing that it wasn't fair to make them mark their assets to market value if they couldn't also mark their liabilities.
"We do not believe it would be appropriate" to let investors consider creditworthiness when valuing bonds if the issuing company couldn't do the same, wrote Matthew Schroeder, managing director of accounting policy at Goldman, the largest U.S. securities firm by market value, in an April 2006 letter.
Companies are allowed to decide for themselves which of their outstanding bonds, loans and other liabilities will get mark-to- market treatment. That's an unprecedented degree of leeway, said Willens, who is also an adjunct professor at Columbia University in New York. "It's kind of a dumb rule," Willens said. "In the entire panoply of accounting, this is the most flexible and elective and optional rule that we have."
It's Only Going to Get Worse
Everything you always wanted to know about the housing crash, but were afraid to ask.
America has not had a nationwide housing crash since the 1930s. At one point during that calamity, an estimated 60 percent of all mortgages were in technical default. The rather primitive housing credit system of the time, which relied on five-year balloon mortgages, certainly exacerbated the problem, but the bulk of the problem was related to the general economic downturn.
There have been some regional housing crashes that were short and relatively mild, most notably in California, Texas, and New England in the late 1980s and early 1990s. Most of those were caused by declines in key local industries: oil in Texas, aerospace and defense in Southern California and Massachusetts. The current downturn, by contrast, is due almost exclusively to a change in the housing credit cycle from excessively easy to modestly restrictive.
Housing turned down before the economy, and even now, nearly 18 months into the housing recession, the national unemployment rate is still at what economists consider full employment. That is unlikely to last as credit problems spread into the consumer sector, layoffs spread, and the resulting rise in unemployment makes the consumer credit situation still worse.
It is the uniqueness of the current housing crash that adds to its intractability. Policymakers haven't been here before, so they're not certain of the way out. Many of the institutions that underpin the industry are relatively new--actually created since the last downturn in the early 1990s--and untested. We also know that many of those institutions were far from transparent, and some were fraudulent.
As a result, everyone needs to be suitably modest about predicting how the housing crash will end and remain flexible about the policy actions that may be needed to augment the normal functioning of the market. Some basic facts about supply and demand offer a good, if sobering, place to start.
There are 129 million housing units in the United States, comprising owner-occupied, rented, and vacant units. Of these, 18.5 million are empty. This vacancy rate is 2.5 percentage points higher than it has been at any point in the half century the data have been tracked, translating into at least 3 million too many empty housing units in the country. This number, moreover, is rising.
This is the most intractable part of the real estate bubble, for we cannot find a true bottom to home prices until this inventory of empty units starts to clear, and we cannot find a bottom to the mortgage finance market until home prices bottom out. The worst type of inventory is an empty house, which people in the industry like to say has about the same half-life as a head of cabbage. As the former chairman of the Neighborhood Investment Corporation, I've seen the damage done to neighborhoods by vacant homes.
They are never maintained adequately, depress surrounding property values, and can quickly become temporary retail space for drug lords and a playground for juvenile delinquents. They are also the homes whose owner has the least incentive, and usually the least ability, to service the mortgage or pay the property taxes. So whittling down the inventory of empty houses should be the first economic, social, financial, and political objective.
The math of the housing market is fairly clear. Each year roughly half a million homes are destroyed to make better use of the land on which they sit. Population growth also helps whittle down inventory. The household formation years--ages 25 to 34--have 39.5 million people in them forming 19 million households, a group that creates demand for 1.8 to 1.9 million units each year. On the other hand, households pass from the scene later in life, and the homes they used to live in go onto the market.
There are 11.6 million households of 65- to 74-year-olds and 9 million households of 75- to 84-year-olds. Their departure increases supply by around 1.1 million units per year. On net, therefore, demographic realities add about 850,000 units to demand on top of the half-million homes that are destroyed and removed from supply. The home building industry is in a deep recession, with additional yearly new home supply cut in half since 2006. But homebuilders are still adding nearly a million units per year.
The math is simple: Build a million, tear down half a million, form 850,000 households, and the country only whittles down its excess inventory by 350,000 units per year. This is one reason to expect a further drop in new home construction, but it will still take years to get our housing inventory back to normal. The economic, social, and financial damage over that time could be staggering.
Permabear Peter Schiff's Worst-Case Scenario
Economic punditry tends to fall broadly into glass-half-full or half-empty categories. Then there are those who see a cracked glass, teetering on the edge of a table just moments from a shattering fall.
Enter Peter Schiff, the permabear president of brokerage Euro Pacific Capital and coauthor of last year's Crash Proof: How to Profit From the Coming Economic Collapse. Schiff spent the past decade urging brokerage clients to jump ship from the American economy ahead of what he views as inevitable pain caused by a toxic cocktail of lax monetary policy, wayward spending, and tougher competition from all corners of the globe.
Even with some pain already felt as America's economy stumbles, Schiff saw nothing but downside in a recent chat with U.S. News. You'll want to buckle up for some characteristically apocalyptic talk from one of the gloomiest market watchers around. Excerpts:
Say something positive about the U.S. economy.
There's nothing good to say about our situation. The policies both the Fed and government are pursuing are making the situation worse. We've been getting a free ride on the global gravy train. Other countries are starting to reclaim their resources and goods, so as Americans are priced out of various markets, the rest of the world is going to enjoy the consumption of goods Americans had previously purchased. This is a natural consequence of this phony economy. If America had maintained a viable economy and continued to produce goods instead of merely consuming them, and if we had saved money instead of borrowing, our standard of living could rise with everybody else's. Instead, we gutted our manufacturing, let our infrastructure decay, and encouraged our citizens to borrow with reckless abandon.
So what are you doing about it?
I'm getting my clients' money outside of the United States as fast as they can send it to me. I've been recommending that to my clients for close to 10 years. You've got to own resources and energy. I was saying oil was going to $200 a barrel in 2002. I've been buying gold, silver, industrial metals, and all kinds of stocks. My main theme is the global economy will survive and the U.S. economy is a disaster. Everything is about how you benefit from the increased purchasing power and rising standard of living in the rest of the world.
OK, where are the best non-U.S. markets this year?
I still like Singapore, Hong Kong. Asian markets are the place to be. I like resource markets like Scandinavia. I'm spreading my chips around the world. I'm just avoiding the United States.
What are your best or worst calls through this downturn?
I've been bearish on bonds. U.S. bonds have lost a lot of real value but not nominal value. I still think that's going to be proven to be correct. While the housing bubble was inflating, I was telling people to rent. I was telling people to get out of tech stocks in 1998 and 1999. They kept rising, but then they collapsed, and I turned out to be right. The reality is I don't think I've been wrong on anything.
Most people disagree with that sort of pessimism. If you're staying in the United States, how do you invest?
If you want to be in U.S markets, you avoid anything connected with the American economy. You avoid retailers, the home builders, the financials—anything having to do with consumers buying something or paying back the money they borrowed. If you want to invest in U.S. markets, stick with exporters and resource companies. I've been saying that for five or six years; I haven't gotten anything wrong. We shorted subprime mortgages. I have clients that made 10 times their money. We've never sold an oil stock. We've never sold a gold stock.
Why don't you think soaring oil, grains, or commodities prices are the next bubble?
These prices do not constitute bubbles. They simply constitute the repricing of goods to reflect the diminished value of our money. The way you can tell there's not a bubble is that these markets are clearing. People are buying food and eating it. They're buying gasoline and using it. Speculators aren't buying gasoline and warehousing it in big facilities because they think the price is going to go up. At the same time, we've increased the supply of money dramatically, and the Fed is increasing it even faster now to deal with the bursting of the housing bubble. The only thing that can happen is for prices of commodities to rise to reflect the equilibrium of a greater supply of money. It's not even that oil prices are going up. Oil prices are staying the same. What's happening is the value of money is diminishing, so we need more units of currency to buy the same amount of oil or wheat or corn or whatever.
How about some predictions?
• I think the stock market is headed lower. Gold is going to be $1,200 to $1,500 by the end of the year. That puts the Dow at a less-than-10-to-1 price ratio to gold. Right now, it's about 13 to 1. That's another 30 percent drop in the real value of stocks by the end of the year if you price them in gold. The Dow was worth 43 ounces of gold in 2000. It'll get to 10 by the end of the year and continue to fall from there.
• Oil prices had a pretty big run and might not make more headway by the end of the year. But we could see $150 to $200 next year. I don't think oil will hit $250 because there will be enough destruction of demand in the United States to keep it from doubling. The big problem for us is if the Chinese substantially allow their currency to rise. It could increase at least fivefold against the dollar over the span of a year or two. That reduces the price of oil by 80 percent for 1.3 billion Chinese. Consumption would go through the roof, and that will drive prices through the roof for us.
• At a minimum, the dollar will lose another 40 to 50 percent of its value. I'm confident that by next year we'll see more aggressive movements to abandon the dollar by the [Persian] Gulf region and by the Asian bloc. That's where the stuff really hits the fan.
US staring at double-dip recession as calls for higher interest rates grow
By slashing interest rates in the face of rising price pressures, has the world's most important central bank sowed the seeds of a new inflationary era? It's an alarming idea, but one gaining currency all the time.
Since the sub-prime crisis broke last summer, America's Federal Reserve has dropped rates by 325 basis points - all the way down to 2 per cent. But looser money, along with sky-high oil and food prices, has cranked up US inflation, which now stands at 3.9 per cent.
In real terms, American borrowing costs are firmly in negative territory. No wonder the markets are wondering if Ben Bernanke, Fed chairman, has made a grave error. A growing band of analysts has been arguing the Fed should have handled the credit crisis in the same way as the European Central Bank - injecting liquidity into gummed up money markets, rather than lowering rates.
Last week, such criticism got much louder. The US is now suffering from the aftershock of the irresponsible policies of Alan Greenspan. By keeping rates too low for too long following the terrorist attacks of 2001 and the dotcom crash, Bernanke's iconic predecessor may have pleased his political masters, but he also pumped up America's gigantic real estate bubble.
Amid an excess supply of unsold newly built homes, that bubble is now bursting. Fresh figures show that during the first quarter, the highly respected Case-Shiller national house price index fell, on an annual basis, by 14.1 per cent. Believe it or not, that's a steeper decline than during the Great Depression of the early 1930s.
Last week, brought more bad news. As housing woes compounded the consumer gloom, a trusted index of retail confidence fell to its lowest level since 1992. And with unemployment now above 5 per cent, new survey evidence reports jobs are suddenly much harder to find.
The Fed has just slashed its forecast of this year's US growth to 0.3-1.2 per cent. That's a shocking downgrade from its prediction of 1.3-2.0 per cent just three months ago. But the Fed could soon be downgrading again. For just as Greenspan caused a housing bubble, so Bernanke's rate cuts - combined with rising fuel and food costs - have unleashed an inflationary bubble.
Back in mid-March, this column argued that the Fed's rate cuts were "worse than useless" - given that they would "stoke inflation and destroy Bernanke's inflation-fighting credibility". Billions of dollars of real cash is now asking a similar question.
Last week, traders in Fed funds futures priced in a 60 per cent probability of a rate rise by the autumn. In other words, the markets think US inflation will get so bad that rather than helping America climb out of recession by cutting rates, Bernanke will be forced to raise borrowing costs, however painful that may be.
It's a scary thought. But it's not just a thought - for the multi-billion dollar futures market now predicts the next move in rates will be up. Only three weeks ago, the smart money put such a probability at close to zero. But the markets can ignore America's inflation problem no longer. As the world's biggest oil importer, the country is hugely exposed to a crude price which has doubled in not much more than a year.
Companies heavily dependent on oil inputs are now suffering badly - and not just the airlines and other transport firms. Last week, Dow Chemicals, the largest US chemicals producer, said it was raising the price of all its products by up to 20 per cent to offset soaring energy and raw materials. US consumers - still America's economic engine room - are adjusting to the realities of "$4 a gallon gasoline".
Inflation is on everyone's mind. The hope had been that Bush's $150bn emergency tax rebates - which began arriving in bank accounts last month - would provide households with a shot in the arm. But the truth is, even before the rebate has been fully delivered, its impact has been largely offset by inflation.
While the US government's positive fiscal boost is a one-off, high oil prices will continue to hobble the world's largest economy for the foreseeable future. Crude prices aren't expected to fall sharply any time soon. So, it won't be long before any positive effect from the tax rebate is completely swamped.
The Fed has long been able to lower interest rates despite inflationary pressures. The dollar's reserve currency status has traditionally given the US central bank room for manoeuvre. The world has now changed. So weak is the US currency, so large are the country's debts, and so powerful is this "structural" oil price shock that even an overtly political central bank like the Fed can no longer do what it wants.
So this inflation spike will harm the US not only via escalating costs and lower spending power but, as the markets have now reluctantly concluded, by forcing the Fed to raise rates just when the broader economy so badly needs them to fall.
In a recent private seminar, I heard Greenspan say: "If we allow inflation to re-emerge, growth rates will slow, living standards will suffer and we could well see US stagflation. And the only way you can truly contain inflation is by raising rates." It doesn't help Bernanke that his predecessor has the brass neck to offer advice he refused to follow himself.
But with producer price inflation above 6 per cent and one-year inflationary expectations hitting a record 7.7 per cent last month, US rates must rise. And that's why America's economic turmoil is going to get a lot worse before it gets better. We're looking at a double-dip recession.
Pinched US Consumers Scramble for Cash
As consumers max out their credit lines and banks clamp down on lending, many older and middle-class Americans are resorting to pricey, often-risky alternatives to stay afloat. Some are depleting their retirement accounts, tapping 401(k)s for both loans and hardship withdrawals.
Some new fast-cash options allow homeowners to squeeze equity from their houses -- without the burden of monthly payments. One new product offers a one-time payment. In exchange, the company shares in as much as 50% of any future gain or loss in the property's value, typically collecting proceeds when the house is sold.
Americans are resorting to these more extreme measures due to the combination of dwindling jobs, falling home prices, shaky credit markets and a sharp run-up in food and energy prices. Consumer confidence hit a 28-year low in May, according to the latest Reuters/University of Michigan survey of consumer sentiment. Consumer spending and income inched up 0.2% in April from March, but after adjusting for inflation were flat, government data show.
Many people are resorting to more conventional means of borrowing: In March, consumers had a record $957 billion of credit-card and other types of revolving debt outstanding -- up about 8% from a year earlier, according to preliminary data from the Federal Reserve.
But businesses are reporting greater demand for newer cash-raising techniques. Reverse mortgages are gaining new favor. Secured by a home's equity, this vehicle can provide consumers with a lump-sum payout, a line of credit, periodic payments or a combination thereof. Also flourishing: niche products that quickly unlock the value of a particular asset.
Life settlements, once marketed mainly to the wealthy, have grown in popularity as companies target smaller policies, like Ms. Brunner's. A number of companies cater to people who've won personal-injury settlements -- which are often paid over a period of years -- by buying them out up front, typically for a sum much lower than the amount of the payments sold. Reserve Solutions Inc. of New York offers debit cards to help workers access funds from preapproved 401(k) loans.
Though seemingly convenient, each of these fast-money options "is an expensive way to tap cash," says Tom Orecchio, chair of the National Association of Personal Financial Advisors. "You don't want to do these things unless you absolutely have to." In life-settlement transactions, sellers like Ms. Brunner often receive only about 20% of their policy's face value. People who sell the rights to their legal-settlement payments often forfeit much of those payments' value.
Ken Murray, chief marketing officer at J.G. Wentworth, the company that had the life-settlement agreement with Ms. Brunner, says that in many cases, it may be wiser for consumers to do a transaction like a life settlement rather than "incur additional debt in order to finance what you need to do." While 401(k) loans generally carry reasonable interest rates, individuals who take them lose some of the valuable power of compounded returns -- jeopardizing their retirement security in the process.
Reverse mortgages often involve high fees and costs, which often add up to as much as 5% or 6% of the home value. A homeowner or his heirs must typically sell the house to repay the loan, which becomes due when the borrower leaves the home for more than one year or dies.
So an owner who becomes incapacitated and needs an assisted-living facility for more than 12 months could face a huge balance due immediately. Despite the risks, business in the fast-cash lane has been accelerating. In 2007, 18% of workers had taken a retirement-plan loan within the past year, up from 11% in 2006, says a recent survey.
Should Britain dump the pound for the euro?
The news on the UK economy just keeps getting worse. Last week’s news was unremittingly glum - from falling house prices to income squeezes, most of us are quite a bit worse off than we were a year ago. And with inflation soaring, we can’t expect the Bank of England to cut interest rates this week to try to alleviate any of the pain.
To add insult to injury, the pound, our national virility symbol, has plunged against the euro, so we can’t even afford to go away from it all on holiday on the Continent. And we came last in Eurovision… again. We seem to be becoming the sick men of Europe. If you can’t beat them, they say, join them. So has the time finally come to dump the poor old pound and plump for the euro?
With the euro now among the world’s strongest currencies, you might assume that the eurozone was in a much better state than Britain. But take a closer look and you soon see that plenty of problems have been cropping up on the other side of the Channel, as well as across the Irish sea. Take housing. Last week’s Nationwide house prices survey showed that prices were down 4.4% year-on-year in May, the biggest fall since the early 1990s. That’s pretty grim.
But in Spain house prices have already fallen 15% across the board since September, according to the developers' association (APCE). And in Ireland, house prices were down nearly 10% year-on-year up to the end of March. Of course, the UK property market is set to get a lot worse. But the same could be said for Spain and Ireland.
Then there’s consumer confidence. In Britain this has crumpled, according to the latest GfK indicator, to its lowest point since Margaret Thatcher was ousted from office. Again, pretty grim. But the eurozone isn’t immune either - French consumer confidence has now fallen to its lowest level in 20 years.
And as for inflation, despite the European Central Bank’s (ECB) reputation as a hard-nosed inflation fighter, Europe’s having trouble with rising prices too. Last Friday’s figure turned out worse than expected, coming in with an annual rate of 3.6%, adding to what ECB president Jean-Claude Trichet has called policy makers’ “biggest challenge”. Despite the strong currency, that’s 0.6% higher than in the UK. Indeed, the pressure’s now building on the ECB for the next move in interest rates to be up.
And the broader picture for the euro isn’t looking a lot brighter than for the pound, either. Because long-term private investors are pulling their cash out of the eurozone at the fastest rate since the creation of the single currency, says a report by BNP Paribas. Foreign direct investment in plant and factories has swung down over the past year to a negative €149bn (£117bn), including a drop to minus €19bn in March alone as the surging euro drove up relative labour costs in southern Europe. Add in a $280bn withdrawal of private funds from eurozone equities and bonds, and total outflows have exceeded €400bn over the last twelve months.
Argentine alert as inflation spectre stalks half the world
Argentina is defaulting on its sovereign debt yet again, this time by stealth. Wealthier Portensos with a nose for trouble are pulling their savings out of Buenos Aires banks. Most are buying dollars, or slipping across the Rio de la Plata to deposit their stash in Uruguay.
European and US pension funds that snapped up Argentina's peso bonds at the height of the credit bubble are discovering that it pays to probe the politics of Latin America - and indeed, Eastern Europe, and emerging Asia - before taking the plunge. It seems like only yesterday that Argentina halted payments on $95bn of external debt. The "Great Haircut" of 2001 was the biggest default in history. Investors are so forgiving.
Argentina's trick this time, under the presidential double act of Nestor and Cristina Kirchner, has been to purge the National Statistics Office and appoint a friend to manage inflation data. The official Consumer Price Index (CPI) is 8.9pc. This is the benchmark used to set payments on inflation-linked bonds, now 40pc of the country's debt.
The true inflation rate is more than 25pc, according to union staff of the statistics office. They allege manipulation. St Luis province is issuing its own data, three times higher. "Argentina is engineering a partial default on its domestic debt," said Professor Carmen Reinhart, from Maryland University.
Some $300bn of inflation-linked bonds from Turkey, Hungary, Poland, Mexico, Brazil, South Africa, and other emerging markets (EM) have been sold, mostly to pension funds. Bankers in London and New York have hawked the debt with the same insouciance that they hawked US sub-prime mortgages. These "Linkers" were also deemed to be as safe as houses. Well, not quite.
Vladimir Werning, from JP Morgan Chase, said the yield spread on inflation-linked peso debt has ballooned to 1230 basis points. They are priced for the dustbin. On paper, Argentina looks safe. The world's biggest exporter of soybeans - and number two in corn - is riding the food boom, even if at war with its own farmers. The trade surplus is $12bn. Foreign reserves are more than $50bn. Yet the default premium is soaring anyway.
Argentina is a warning of what can go wrong once inflation gets out of hand, as it has in roughly half the world.
Among the CPI rates - if you believe them - are: Ukraine (30pc), Venezuela (29pc), Vietnam (25pc), Kazakhstan (19pc), Latvia (18pc), Qatar (17pc), Pakistan (17pc), Egypt (16pc), Bulgaria (15pc), Russia (14pc), the Emirates (11pc), Estonia (11pc), Turkey (9.7), Indonesia (9pc), Saudi Arabia (9.6pc), Romania (8.6pc), China (8.5pc) and India (7.6pc).
The International Monetary Fund says 70pc of the EM inflation shock came from soaring food costs last year (typically 40pc of the basket, versus 12pc for richer states). But the home-grown part is fast gaining a life of its own. "Easy money is the culprit," says Joachim Fels, chief economist at Morgan Stanley.
"Weighted global interest rates are 4.3pc, while global inflation is above 5pc. The real policy rate in the world is negative. Central banks are both fuelling and accommodating the rise in food and energy prices," he said. Fixed exchange rates are playing havoc. Most Gulf states are pegged to the dollar, while China runs a crawling peg. These countries are importing the emergency stimulus of the US Federal Reserve when they least need it.
Across the EM universe, states are now hitting the inflationary buffers. Either they hit the brakes, or risk repeating the errors of the 1970s - if they have not already done so. The top ten states liable to have an accident are: Jamaica (1), Ukraine (2), Kazakhstan (3), Bulgaria (4), Suriname (5), Latvia (6), Lithuania (7), Ghana (8), Vietnam (9) and Sri Lanka (10).
This decade has been a great coming of age for the catch-up countries. Bond yields have dropped to western levels. Exotic bourses have been the darling of the City. The MSCI index of EM stocks has risen fourfold since 2003. It suffered a mini-crash before the Fed rescue in March, but has bounced back.
China, Russia, and others have amassed a war chest of reserves to see them through bad times. Most no longer borrow much in foreign currencies - although the property booms across Eastern Europe are funded in Swiss francs and euros. Some have independent central banks. Credibility is higher.
Dividends in jeopardy at 34 of biggest U.S. companies
Dividends may be in jeopardy at almost three dozen of the biggest U.S. companies where annual payouts exceed cash flow from selling everything from cars to mobile telephones to newspapers.
General Motors Corp., the biggest U.S. automaker, produced 33 cents a share in so-called free cash flow last year while maintaining a $1 dividend. Motorola Corp. took in 8 cents a share from operations after capital expenses, and paid a 20-cent dividend. New York Times Co. pays investors 92 cents per share a year and spent $1.87 a share more on operations than it made in cash.
Investors are depending on dividends to limit losses as the Standard & Poor's 500 Index falls for the first time since 2002, the U.S. economy slows and corporate earnings drop for a fourth quarter. While the S&P 500 fell 8.8 percent in the past year, reinvested dividends reduced the loss to 7 percent, according to data compiled by Bloomberg.
"If earnings and cash flow don't match your dividend, it's not a sustainable thing," said Phillip Davidson, who oversees $18 billion as chief investment officer for value equities at American Century Investments in Kansas City, Missouri. "Some companies will cut their dividends and others will choose to rough it out."
GM, Motorola and New York Times declined to comment on their dividends. A total of 34 companies in the S&P 500 outside of real estate, banking and power generation paid more in dividends than they made in free cash flow in the past year, according to data compiled by Bloomberg. Motorola, GM and New York Times are among those whose dividends will be costliest to keep, analysts say.
Wachovia Ousts Thompson on Writedowns, Share Plunge
Wachovia Corp. ousted Kennedy Thompson as chief executive officer of the fourth-largest U.S. bank after the board blamed him for losses that cost the lender more than half its market value in the past year.
Chairman Lanty Smith was appointed interim CEO, the Charlotte, North Carolina-based company said today in a statement that cited "a series of previously disclosed disappointments and setbacks" for the change. Thompson quit at the board's request, the statement said.
Wachovia had already stripped Thompson, 57, of the chairman's title after shareholders -- incensed by the company's first quarterly loss since 2001 -- demanded his removal at April's annual meeting.
The bank named a four-member search committee headed by Smith to find a replacement to deal with fallout from rising mortgage defaults and writedowns tied to subprime home loans. "This company was run under Ken Thompson without very good controls," Gerard Cassidy, an RBC Capital Markets analyst, said in a Bloomberg TV interview. It's more than "50-50" that Wachovia will seek a new CEO from outside the bank because there isn't a clearly designated successor, Cassidy said.
The search committee will include three retired CEOs: Robert Ingram of drugmaker Glaxo Wellcome Inc., Joseph Neubauer of food-service company Aramark Corp. and Mackey McDonald of apparel maker VF Corp. Thompson's credibility was dented after he said this year that Wachovia's $24 billion purchase of Golden West Financial Corp. in 2006 at the peak of the housing boom was "ill-timed." About half of the unit's lending is in California and Florida, two states with some of the highest foreclosure rates.
His reputation took another hit May 6 when the bank said its first-quarter loss was $708 million, 80 percent more than what Wachovia previously reported, because of writedowns for bank-owned insurance policies. Wachovia cut its dividend by 41 percent in April and raised about $8 billion in new capital.
Oil bubble could prove threat to pension funds
Pension funds and other investors who rushed into oil through commodity indexes this year chasing big returns as other asset classes tanked could face steep losses if prices fall from record highs.
An avalanche of cash has rolled into commodities through simple long-only indexes this year, feeding the record-setting oil rally some experts say could be a bubble that is becoming more vulnerable to shifts in supply and demand fundamentals.
A sell-off in oil could spell big losses for the pension funds, municipal funds, college funds, unions and other groups that jumped out of equities-market plays and into the indexes, but have little experience or flexibility to deal with fundamental changes in commodities.
"A lot of the accounts that that have moved into commodities over the last 8-12 months clearly don't belong in this forum," said Peter Beutel, president of Cameron Hanover. "It means that when this market turns, these people are going to get hurt, and they are going to get hurt badly, and there will be tons of lawsuits because they have no understanding how quickly commodities markets can turn and leave them in the dust," he explained.
While many in the energy sector, such as U.S. Energy Secretary Sam Bodman, argue that fundamentals are driving oil's rally, others say investment in commodity indexes has pushed prices beyond what supply and demand may justify, contributing to the 30 percent price rise over $130 per barrel this year.
"We are seeing the classic ingredients of an asset class bubble," said Edward Morse, chief energy economist for Lehman Brothers. "Financial investors tend to 'herd' and chase past performance, comforted by the growing analytical conclusion that markets are tightening, and new flows, in turn, drive prices higher."
Indexes such as the giant S&P GSCI and DJ-AIG offer investors a passive way to own a basket of commodities futures including oil, gasoline, metals and grains. They sell front-month futures and buy second-month contracts, allowing them to make money when oil prices rise across the curve, particularly when front-month prices are higher than second-month prices.
Investors, exiting asset classes hit by the global credit crunch, have sought to cash-in on a six-year rally that has sent oil prices up sixfold to $135 a barrel this month as supplies struggled to meet rising demand from such emerging economies as China and India.
Some experts say much of the 30 percent rise in oil prices since the start of this year may owe a lot to the inflow of new money, and that fundamentals may not justify current prices. Demand from big consumer nations like the United States has already faltered, and moves by some Asian countries to cut fuel subsidies could clip usage further.
Prices could also fall with a significant rebound in the U.S. dollar, after weakness in the greenback sent speculators into oil. "These are institutional investors who have said we have looked at all the things we can invest in and we decided it's commodities," said Sarah Emerson, director of Energy Security Analysis Inc. "They are buying and holding and then buying more and holding more, and the physical market doesn't discipline them," she added.
Investment under commodities indexes has ballooned from around $70 billion at the start of 2006 to $235 billion in mid-April, about $90 billion of which has come from fresh financial flows with the rest coming from gains in the underlying commodities, according to Lehman Brothers.
The bubble of all US bubbles
Two great issues define this moment in America: war in Iraq and economic turbulence dominate debates, fears and campaigns. Optimistic pitches can be heard about the effectiveness of the "surge" in Iraq and policy responses to subprime-driven economic pain.
Many and influential voices loudly tout economic and military success. Public perception on both fronts lags pundit wisdom. Polling data suggests that more and more Americans oppose staying in Iraq and believe the US is already in recession. There is an unusual disconnect between general opinion, policy and reality. All we can know for sure is that either the general public or leading voices are very, very wrong.
The "surge" in Iraq and the surge in interest rate cuts by the US Federal Reserve are very similar. Both involve heavily spun attempts by authorities to postpone pain and avoid responsibility for past miscalculation. Each policy offers as a cure more of what created the trouble in the first place. This can last a while, not forever.
Loose money and narcotic debt dreams fueled the housing crisis run-up. Fear of loss was contained by assurances of endless credit, increasing housing prices and omnipotent Federal Reserve management. The bottom dropped out of these dreams in late 2006 and we began to admit the long obvious truths in the spring of 2007. Before spring 2008 dawned, the Federal Reserve, Treasury Department and experts were massively intervening to slash rates, offer larger and longer loans to more institutions and assure that the genie was already being put back into the bottle.
A broke government was going to hand out magic checks - with borrowed money of course - to a broke public. This entailed trying something new. Deficit spending and expensive, impotent cash hand-outs are so alien to business-as-usual in America. The solution to a debt-fueled explosion was to offer more credit for less cost to a greater array of large and largely indebted financial firms.
The folks at home, some of them anyway, would be getting US$300-$1,200 a few months after lenders and investors received several hundred billion in new loans, lower costs and credit access. A bigger brassier credit and assurance surge would do what past credit provision and assurance failed to do. It has, so far. It has also left in many out in the cold. They are poorer, angrier and worse off then they were last year.
The troop "surge" in Iraq was much the same. In January 2007, President George W Bush announced a troop "surge" to stem violence in Iraq and violently falling US support for his policy there. In response to much mayhem and death, the administration announced plans to send more troops, extend the tours of many and increase the US military presence in Iraq. In March 2007, eerily almost exactly a year before the Fed economic surge, Bush and company decided to send a further "surge" of troops into Afghanistan and Iraq.
Why? US and coalition military "progress" in both nations was inadequate, public support was waning and more of past failed policy was just what was needed. Like the Fed and Treasury responding to economic crises, the Bush administration decided that more manpower and money - more of the same - was the best redress. Faced with falling house prices, slowing economic conditions and serious debt problems economic officials decided on a surge in Federal Reserve credit creation.
The similarities do not end here. Rapid shifts in press attention away from negative stories and toward details of surge action help to deflect attention and awareness. The surges of money and manpower become the story. Lost in the rush of new exciting details and minor strategy debates are the actual issues.
U.K. Mortgage Approvals Drop, Factory Growth Stalls
U.K. mortgage approvals dropped in April to the lowest in at least nine years and manufacturing growth ground to a halt, bringing the economy closer to a recession.
Banks granted 58,000 loans for house purchase, the least since the series began in 1999, the Bank of England said in London today. An index based on a survey of more than 600 manufacturers fell to 50 in May, signaling no expansion, the Chartered Institute of Purchasing and Supply of manufacturing said today.
Bradford & Bingley Plc, the U.K.'s largest lender to landlords, fell as much as 32 percent after its earnings slumped because of "difficult economic conditions." Bank of England policy makers will probably refrain from reducing the benchmark interest rate this week from the current 5 percent as they guard against accelerating inflation caused by record oil prices.
"Risks of a recession seem to be increasing," said George Buckley, chief U.K. economist at Deutsche Bank AG in London. "Inflation is another risk to recession as it limits the bank's ability to cut interest rates. The bank won't do much for the next few months but I think they will eventually have to cut."
The December U.K. interest-rate futures contract fell 10 basis points after the reports to 5.77 percent as of 12:01 p.m. in London, as investors raised bets on rate reductions. Stocks declined for a third day in London, led by Bradford & Bingley. HBOS Plc, Britain's biggest mortgage bank, also slumped.
The CIPS factory index fell to the lowest since July 2005, and was less than the 50.5 median estimate of 36 economists in a Bloomberg News survey. Readings below 50 indicate contraction. Net lending on homes was 6.4 billion pounds ($12 billion) in April, the least since November 2004, compared with 6.7 billion pounds in the previous month. Net credit card lending fell to 74 million pounds in April from 396 million pounds in the previous month, the Bank of England said.
Lenders are making it harder to get mortgages as they try to shore up balance sheets hurt by the credit squeeze and have refused to pass on the Bank of England's three interest-rate cuts since December. The cost of home loans with a 5 percent down payment rose to the highest in more than eight years in April, according to central bank data.
House prices fell 2.5 percent in April, Nationwide, Britain's fourth-biggest mortgage lender, said May 29. The value of mortgages granted fell to 23.8 billion pounds, the least since June 2005, from 24.2 billion pounds in March, the Bank of England said today.
Ilargi: From yesterday’s Debt Rattle“At its peak, in March 2006, [Bradford & Bingley]’s stock-market value hit £3.2 billion. It is now a shadow of its former self and at Friday’s close was worth only £545m.”
Looks like another £150-200 million vanished this morning. even as a similar amount was injected. That’s called rowing upstream, I think.
B&B secures private equity rescue funding; shares fall 30%
Shares in Bradford & Bingley (B&B), the UK's biggest buy-to-let mortgage lender, fell more than 30 per cent this morning as it announced a shock profits warning that was first disclosed in The Sunday Times. It also confirmed that TPG, one of the world’s biggest private equity firms, is to take a 23 per cent stake in the group.
News of the investment came as B&B announced that Steven Crawshaw is stepping down as chief executive of B&B with immediate effect due to “a serious cardiovascular condition". The bank also said pre-tax figures for the first four months of this year fell from a £107 million profit to a loss of £8 million, blaming “difficult market conditions”.
It predicted that more customers will default on mortgages as the economic slowdown takes hold, revealing the number of people who are more than three months behind with their mortgage payments has jumped from 1.63 per cent to 2.16 per cent over the past four months. The bank also said that it had lost £15 million through organised frauds.
TPG, the American buyout house, has agreed to make a £179 million cash injection into the company alongside a £258 million fundraising from existing City shareholders in the form of a rights issue. All shares will be issued at an offer price of 55p per share and raise £400 million for the troubled lender, well below the original rights issue price of 82p.
Shares are currently at 68.5p, down 22 per cent, having fallen by 30 per cent in early trading. Last month B&B announced plans for a £300 million rights issue at 82p, which was a 48 per cent discount at the time. However, the lender’s stock has since fallen by more than 40 per cent and on Friday it closed at 88.5p.
The lender will publish a prospectus this week and hold an extraordinary meeting in early July to approve the capital raising. An extraordinary meeting originally planned for June 16 has been adjourned indefinitely. The rights issue has been underwritten by Citigroup and UBS. Rod Kent, the former Close Brothers managing director who has been B&B’s chairman for almost six years, has become executive chairman and will run the company until a new chief executive is found.
Mr Kent said today: "When we started the year with our expectations we weren't anything like as gloomy as we are now. Our view of arrears' figures has changed." He added: "The last few weeks have been challenging for Bradford & Bingley, and this is a disappointing trading update reflecting a more difficult market environment. I understand shareholders' disappointment."
Bradford & Bingley: Sign of things to come?
Bradford & Bingley’s announcement may be the start of even more misery for UK banks and savers should spread their deposits around as much possible, experts warned today.
As the UK’s largest buy-to-let bank announced it was selling a 23 per cent holding to a US private equity firm, experts say that similar buyouts or even full takeovers may be on the cards for other UK banks. But savers should not panic and remember that up to £35,000 with any one institution is guaranteed by The Financial Services Compensation scheme.
Kevin Mountford from comparison service Moneysupermarket.com said: “This is a very concerning time and, of course, people with savings in B&B will be worried. Whilst I think it’s very unlikely that a UK bank will disappear, I would still advise people not to have more than £35,000 with any one institution.
“UK banks are prime material for potential takeovers at the moment. Banks have not become bad businesses overnight and there is still a lot of fear about what other skeletons will emerge from the closet. With share prices so depressed, this could be a great buying opportunity for an overseas bank wanting a foothold in the UK market,” said Mr Mountford.
B&B’s announcement may also cause consternation among UK landlords, whose borrowing options have reduced dramatically in recent months. David Hollingworth at broker London and Country said: “Potential landlords have suffered recently because the buy-to-let mortgage market has shrunk so rapidly. But borrowers who have already secured a loan with B&B, or any lender, should not worry. A mortgage is a legally binding contract and borrowers will remain unaffected.”
Landlords have taken a big hit since the credit crunch hit last summer, with the number of available buy-to-let mortgages plummeting from around 3,000 to 543 today. Darren Cook at Moneyfacts.co.uk said: “B&B currently offers just 14 mortgages, compared to 41 in January, which is a good indicator of how the market has shrunk overall. In January we had 303 two-year fixed rate deals, with an average rate of 6.32 per cent. Now there are just 87 such deals, with a higher average rate at 6.96 per cent.”
As well as raising interest rates, buy-to-let lenders now demand a deposit of at least 25 per cent, while the amount of rental cover needed to obtain a loan – the amount of rent that covers the mortgage – has risen from 100 per cent to 120, or even 130 per cent. Most lenders are also reluctant to provide mortgages to new-build properties, particularly flats, as these properties are the most likely to depreciate in value in a falling market.
B&B, like other buy-to-let mortgage lenders, has been badly hit by the credit crunch. It previously raised more than a quarter of its capital through the wholesale money markets but, since these sources have dried up, it has struggled to raise funds elsewhere. As well as raising £400 million from shareholders, it has sold £4 billion in loans, switched focus to lower-risk lending and increased savers’ deposits, taking in £1.9 billion during the first quarter of this year.
Specialist buy-to-let lender Paragon, the first UK bank to raise a rights issue with shareholders after the credit crunch, closed to new business in February, saying it needed a new source of funding. The bank, which also relied heavily on the wholesale money markets to raise capital, has seen its lending levels halve since last summer. Despite the £287 million raised from its shareholders, the lender announced a 39 per cent fall in first-half profits last month.
Steven Crawshaw's departure from Bradford & Bingley taints banks' rights issues
For Britain's beleaguered banking sector, the timing could hardly have been worse. For Bradford & Bingley to turn to TPG is a stunning move considering that just a few weeks ago the UK bank was telling investors it had no need to raise cash.
Not only that, B&B is completing redrawing a rights issue that it said was not necessary. And on top of this, the chief executive Steven Crawshaw is leaving ahead of – but apparently not because of – a profit warning being announced today.
All this comes just days before the deadline for investors to buy into another rights issue - the biggest in British history at £12bn, courtesy of the Royal Bank of Scotland, where chairman Sir Tom McKillop is now staring down a plot by some institutional investors to overthrow him.
It comes as the City grows impatient waiting for details of the £4bn rights issue planned by HBOS, owner of the Halifax and Bank of Scotland. And it comes as Barclays, wary of the negative publicity some of its peers have attracted for going cap in hand to investors, ponders the best way to add some fat to its own balance sheet.
Before yesterday, analysts, investors and Bradford & Bingley executives were watching with - respectively - intrigue, caution and outright anxiety as the bank's share price buckled. B&B shares plunged more than 25pc today having closed at 88.25p on Friday.
The ramifications are both several and severe, potentially giving Bradford & Bingley the dubious honour of being one of the first British companies in two decades to have a major rights issue fail. For one, retail investors who have seen the incentive for taking up their allocations progressively chipped away as Bradford & Bingley's share price has fallen, will be left with no incentive at all.
For them - the bread and butter of Bradford & Bingley's investor base, accounting for about 40pc of the company's ownership - buying into the issue would be throwing good money after bad. At 82p, Bradford & Bingley shares are less than one fifth their value this time a year ago.
Institutional investors, meanwhile, will see no value in buying into a rights issue when they could potentially buy the same shares later for less just by sitting on their hands. That leaves those propping up the issue with a headache. The underwriters, UBS and Citigroup, have doubtlessly sub-underwritten some of the stock to other investors. The question, one that the banks wouldn't answer yesterday, is how much.
The underwriters will, no doubt, have their best legal minds scouring their agreement with Bradford & Bingley to assess whether the profits warning, share price collapse or Crawshaw's resignation constitute the material change in circumstances needed for them to back out.
If so, the "for sale" sign is as good as hoisted above Bradford & Bingley, if it is not already. This is not another Northern Rock. Bradford & Bingley relies on the wholesale markets for roughly half its funding, leaving it far less exposed than the Newcastle lender that drew three quarters of its funding from the money markets.
And the Financial Services Authority, thanks to the Rock debacle, now guarantees at least the first £35,000 of depositors' savings, meaning that we are unlikely to see a repeat of the infamous run on the Rock. Nonetheless, the profit warning from Bradford & Bingley today is likely to reflect a serious problem with the business: its dominance in the buy-to-let mortgage marketplace, where it is Britain's biggest lender.
Banking group won't change way Libor measure is set
The group that oversees the London interbank offered rate will implement no changes in the way it is set, confounding critics who said the rate, known as Libor, had become unreliable as a gauge of the cost of borrowing. The British Bankers Association said Friday that oversight of Libor would be strengthened.
But the composition of the bank panels that contribute to compilation of the rate were left unchanged. The association, an unregulated trade group, has been under pressure to overhaul the 24-year-old system after the Bank for International Settlements said in a March report that some members had understated their rates to avoid being perceived as having difficulty raising financing.
In the first four months of 2007, the difference between the highest and lowest rates for three-month Libor rates on dollar loans did not exceed 2 basis points, according to JPMorgan Chase. In the same period this year, it was as wide as 17 basis points. A basis point is one-hundredth of a percentage point.
"The next time Libor spikes you don't want market participants looking at Libor and wondering whether it's a completely artificial number or shows a dislocation in borrowing costs," Brian Yelvington, a strategist at the bond research firm CreditSights in New York, said Thursday.
Every morning the association, based in London, asks member banks how much it would cost them to borrow from each other for 15 different periods, from overnight to one year, in currencies from dollars to euros and yen. It then calculates averages, throwing out the four highest and lowest quotes, and publishes them at about 11:30 a.m. in London.
Libor gained attention last August as banks suddenly became wary of lending to each other because of mounting losses linked to U.S. subprime mortgages. Three-month Libor soared to 2.40 percentage points above yields on U.S. Treasury bills on Aug. 20, the widest margin since December 1987 and up from 0.39 percentage point a month earlier. The figure was 0.79 percentage point as of 4:30 p.m. in London on Friday.
The statement Friday followed a meeting of the association's independent Foreign Exchange and Money Markets Committee after a review conducted by John Ewan, who directs setting Libor. Libor is used to calculate rates on at least $350 trillion of derivatives and corporate bonds as well as six million U.S. mortgages. Financial products worth about $150 trillion are indexed to Libor, according to the association's Web site.
The Lowdown on Libor
Financial institutions the world over use Libor—short for the London interbank offered rate—to set the interest paid on everything from mortgage loans to complex financial instruments. But now questions are being raised about whether the rate has been manipulated. Here's what you need to know about how Libor affects you.
What exactly is Libor?
Libor is a global interest rate benchmark that's used to set rates on $150 trillion worth of financial products. Each day, the London-based British Bankers' Assn. (BBA) surveys 16 banks, asking each for the rate they'd charge their peers to borrow cash—ranging from an overnight loan to one that matures in 12 months. From the reported rates on 15 different maturities, BBA drops the top and bottom four and averages the middle eight to calculate the rate. On May 27, the six-month Libor was 2.84938%.
What does Libor have to do with me?
Libor is a popular tool for setting rates on consumer loans. It has the biggest reach in the mortgage arena, where, for example, it was used in 2005 and 2006 to set rates on approximately 75% of subprime, adjustable-rate mortgages (ARMs)—about $700 billion worth of the loans, according to Guy Cecala, publisher of Inside Mortgage Finance. Of prime, adjustable-rate mortgages, up to 40% were pegged to Libor, too. Currently, about half of private student loans are pegged to Libor. (The rate has no effect on federal student loans, such as the Stafford Loan, which are set using fixed-rate instruments.)
What's the recent controversy about?
With the aftereffects of the credit crunch lingering, a high Libor, especially relative to U.S. Treasuries, would set off alarm bells that capital-starved financial institutions are still at risk for further meltdowns, says market research firm Global Insight's Brian Bethune. Some industry insiders have accused the banks of quoting falsely low rates for the surveys in order to force down Libor and paint a rosier picture of the lending environment.
It's more likely that the banks are simply reporting their best rates, not the rate at which they're most commonly lending, Bethune says. The BBA is conducting what it calls "a regular review," with results due May 30. In the meantime, proposals have been offered to ensure Libor's accuracy, from surveying more banks to ditching Libor in favor of an alternative rate.
Liquidity levels hit funds of hedge funds
Investing in funds of hedge funds should, in theory, smooth out the volatility of financial markets and generate a steady stream of returns. But, in reality, a rather different picture has emerged in recent months. Some hedge fund managers have classed the first quarter of this year the worst on record. Very few have met their performance targets and many have fallen into negative returns.
Volatile markets have made it hard for fund managers to judge how assets will perform, while the drying up of credit has forced many to sell investments. “Most funds of funds have done poorly in the past six months,” says Mick Gilligan, director of fund research at Killik & Co. “The first quarter of the year has been pretty extreme, with many managers describing it as the worst they have ever experienced.”
He says that only 40-50 per cent of funds of hedge funds have generated a positive return in the past six months. The uncertainty in the market has created a difficult backdrop. “It has been quite volatile in every sector,” says Martin Baxter, who manages a fund of hedge funds at Collins Stewart. “A lot of people are making money one day and losing it the next.” The main obstacle for hedge funds, however, has been the sudden withdrawal of liquidity from the market.
Banks had been happy to lend up to 75 per cent of an investment, enabling hedge fund managers to gear up their portfolios. But, in recent months, many banks have reined in the level of risk they are willing to take. As a result, hedge fund managers have seen their ability to borrow diminish. “Managers have got to find more capital to put up against their positions, and so have been forced to sell other positions,” says Gilligan. These forced sales have distorted asset pricing in the markets, which has created further problems for managers.
Gilligan says that in some cases managers are now having to put up 75 per cent of the capital for new investments. Many listed funds of hedge funds, which have been a popular way for private investors to access this sector, have seen their share prices drop and asset values fall as a result.
There are more than 30 London-listed funds of hedge funds, which can be bought and sold via a stockbroker. These funds manage diversified portfolios of underlying hedge funds, with varying target returns and much lower entry requirements than single funds.
New massive malls to open within 18 months
Shopping centres equivalent to eight Bluewaters are due to open over the course of 2008 and 2009, just as the economy heads into its worst period for more than a decade. A total of 1.25 million sq m will be opened in the next 18 months, the first of which was the Liverpool ONE city centre development, which centres on a new John Lewis and the largest Debenhams in Britain.
According to Mark Hudson, retail and consumer leader at PricewaterhouseCoopers: “The amount of space coming on is potentially massive and, with the trading conditions we have and the ongoing shift towards online, it's going to mean more empty shops in market towns. More marginal sites will become unprofitable and more companies will go bust.” Nearly a dozen retailers have collapsed into administration since the turn of the year, including Dolcis, Ethel Austin, Base, The Sleep Depot and Toyzone.
New developments such as Liverpool One, and two more mammoth centres due to open later this year - Bristol Cabot Circus and Westfield London - take years of planning and are almost impossible to stop. However, a number of smaller developments, including a regeneration scheme in Dumfries and another in Chester, have been postponed as the credit crunch affects funding and the number of retailers signing up to the project.
This month St Modwen put the development of a £100 million retail-led development in Hatfield, Hertfordshire, on hold because of the retail and economic climate. Alistair Parker, head of Cushman & Wakefield, the property development consultancy, said: “The monster malls take ten years to deliver. They are like oil tankers - once set down, they take a while to slow.”
Mr Parker said that new centres such as Liverpool One were essential to reviving areas where most of the retail estate pre-dated the Second World War: “Liverpool believed it was losing large amounts of trade over the years to everywhere else, so the effect will be to pull that trade back to Liverpool. Clearly, other areas will lose out, but that's what drives improvement.
JPMorgan defeats $700m claim for compensation
JPMorgan Chase won a $700 million court case yesterday that has dealt a blow to investors claiming compensation for allegedly being mis-sold exotic investments.
Although the dispute relates to financial instruments sold a decade ago, lawyers have been awaiting the result because the issues involved are similar to those expected to arise in litigation stemming from the credit crisis. These include what responsibility, if any, a bank has for the losses of its sophisticated clients on complex investments and whether the investments were mis-sold.
The High Court in London dismissed a claim by one of Greece's oldest and wealthiest shipping dynasties - the Polemis family - which sued JPMorgan in an effort to recoup losses suffered in the Russian debt crisis of 1998. The family said that it had lost almost half of its $700 million portfolio in emerging markets securities after it hired JPMorgan on an advisory basis and only bought investments on the direct recommendations of JPMorgan bankers.
Adam and Spiros Polemis, the brothers who control the family interests, claim this advice was negligent because JPMorgan recommended high-risk securities despite knowing the family had requested a low-risk approach. Their lawyers had told the High Court that more than half of the Polemis portfolio was comprised of Russian or related securities. “The portfolio that we ended up with is one that no reasonable adviser would have advised us to hold,” their barrister said.
JPMorgan claimed it did not have an advisory relationship with the Polemis family, which the bank says are experienced investors that chose their own trades in full knowledge of the risks involved. Yesterday, Mrs Justice Gloster found for JPMorgan saying that the bank was not liable to compensate the family for its losses. Lawyers said the judgment was a significant win for investment banks that are steeling themselves for a wave of similar litigation in the wake of the current credit crisis.
A litigation partner at one City law firm said: “Private bankers all over the City have been sweating over the prospect of mis-selling claims, where investors say they did not understand what was going into their portfolios and so the bank should pay when things go sour. “This ruling sets the bar fairly high; it says you can't trade complicated investments when the sun shines then play dumb when it starts to rain.”
The Polemis family's claim was so large because, in addition to investment losses, it also claimed that the collapse of its portfolio stopped it from expanding its core shipping business. It therefore added a further $450 million to its lawsuit as compensation for lost shipping profits.
Going Bankrupt in Vallejo
Bankruptcy is a damn nuisance. But it is a boon to the fiscally irresponsible, notably town councilors and municipal officials.
The city of Vallejo in the Bay Area has filed for bankruptcy protection (May 23) under Chapter 9 of the Banking Code through its city manager, fearing a queue of hungry creditors. A report on the council's special meeting in February predicted insolvency in late April.
The seven-member City Council authorized the move unanimously on May 6, thereby joining a list of 500 or so municipalities throughout the US which have invoked the measure since the Great Depression. Such an move reorders debt arrangements while still financing operations.
Vallejo remains to date the largest town in California to have taken the plunge, after Orange County (1994) and Desert Hot Springs (2001). Reasons for this insolvency crisis in this town of 120,000 vary. Officials and councilors have found a key culprit: the city's supposedly generous pay benefits to police officers and firefighters.
These, it is claimed, have pushed the deficit to $16 million at the start of the new fiscal year in July. Councilwoman Stephanie Gomes might 'value' the police forces and firefighters, but she can't help turning her nose up at them. They are the ones who 'can afford to live in Marin and Napa'.
The 'very hardworking, blue-collar residents of Vallejo' have paid the penalty. Some balance is in order here. Salaries may be high, but the working hours are commensurately long and wearing. According to the San Francisco Chronicle (February 21), rehiring in the firefighting forces has not kept apace with retirements since 2001.
Overtime sessions are unavoidable, with 96-hour shifts, punctuated by a two-day break, common. Cities, like common mortgage holders, have been struck down by the credit squeeze, entering into labor contracts now deemed unsustainable. Tax revenue has also shrunk by $2 million, with drops in revenue recorded in development fees, property tax and sales tax.
Vallejo is, to use the words of Capt. Jon Riley, vice president of the Fire Fighters Union Local 1186, the 'poster child for mismanagement'. According to Gomes, who was interviewed in February this year, 'We've been spending more than we've been making for 20 years and it's time to pay the piper.
'The vast portion of the city's general fund (some $74 million) goes towards publicsafety contracts (fire and police services), though this is not unusual for cities in California. Unions and various associations are skeptical about the council's moves. The municipality had filed for bankruptcy protection and called it necessary to avert the catastrophe of insolvency.
Union management is making the argument, with some grounds, that the case for insolvency has not been made out. Individuals like Mat Mustard, vice president of the Vallejo Police Officers Association, are irate. The meeting proceedings of February discuss the consequences of such a suit.
'Bankruptcy will not create additional revenue. A bankruptcy filing may allow the City to take actions contrary to existing contractual obligations that would allow continued General Fund operations. 'An argument might well be made that bureaucratic incompetence has been insulated.
Legal teams who specialize in bankruptcy are beside themselves with joy. Other municipalities may well follow Vallejo. Mark Levinson, a bankruptcy lawyer retained by Vallejo is smacking his lips. 'Vallejo is not the only city in California or the U. S. that is saddled with employee contract that are burdensome. '
Oil price profiteering to be curbed at ICE Futures Europe and Nymex
Two of the world's largest energy exchanges have forced traders to deposit significantly more money when investing to curb volatility in energy markets and drive out speculators. The exchanges and related clearing houses have found themselves at the centre of the growing storm over claims that speculators have been behind the recent rise in oil prices to record levels.
The New York Mercantile Exchange (Nymex) and ICE Futures Europe in London, the former International Petroleum Exchange, have now tripled "margin calls" for some contracts. They hope the increased margin calls will reduce volatility and force out some of the more speculative players.
Nymex has announced a threefold increase in margin calls for long-dated Brent crude futures in New York. As a result margin calls on some contracts will jump from $100 to $300 for clearing members. On more popular contracts, such as Brent for one-month delivery, the margin call will rise by 12.5pc to $450 for clearing members.
For investors with sizeable positions, the increase could mean the difference between a profit and a loss and appears to have already forced some speculative traders to close their positions. The move, introduced by ICE earlier in the week and followed by Nymex yesterday, has coincided with a fall in the price of oil by around $7 a barrel from last week's record high of more than $135.
Rob Laughlin, senior energy broker for MF Global in London, said that, as a result of the increases, many "smaller speculators have finally taken their money and run". However, Walter Lukken, acting chairman of the US Commodities Futures Trading Commission, yesterday dismissed the idea that raising margin calls would help long- term, saying it would just force speculators to go elsewhere.
Ilargi: I guess it’s kind of good to get noted by the Financial Times. However, I did not say what she has me say, I merely quoted..
Blackrock, UBS and the SWFs: A deal made in heaven
The FT’s weekend report on how sovereign wealth funds have provided more than half the equity for the BlackRock fund that bought $15bn of troubled mortgage debt from UBS this month is about one of those rare deals that makes everybody happy.
First, as the FT noted, the BlackRock deal marks one of the first big forays into mortgage debt by SWFs, and is bound to provide ammunition for those who are now arguing that the mortgage market is recovering. BlackRock’s founder, Larry Fink, is preparing to take his board on a swing through the Middle East this week with a stop in Kuwait. Undoubtedly, US mortgage debt and real estate will be high on the agenda.
Most striking, however, is the way this deal effectively continues the SWF bailout of troubled western investment banks. BlackRock raised $3.75bn in equity for the fund, the greater part of which is with the SWFs. The rest of the money - the senior financing - was borrowed from UBS itself.
For the likes of Kuwait’s KIA and Singapore’s Government of Singapore Investment Corporation, though, why invest in such a circuitous, back-door way? As the FT notes, the BlackRock deal highlights the “rapidly evolving strategies of such SWFs”, which initially sought to take advantage of the turmoil in global markets by investing directly in beleaguered financial institutions.
But these rescue financing deals led to fears of losses by the funds — and a rather ugly political backlash against SWFs in the West. Perfect, then, to invest in western investment banks in a nice, discreet way through private equity funds.
For BlackRock, meanwhile, having written down the UBS assets to $15bn, it can enjoy a 32 per cent discount, as blog Automatic Earth noted.
If the debt or assets perform, there is a large potential upside. The assets have a nominal value of $22bn and are mostly subprime and Alt-A mortgages, as Bloomberg reported on May 21, and you can bet BlackRock fully intends to make a killing in reselling the debt.
For UBS, while it may be providing $11.25bn of the $15bn BlackRock is paying, it nevertheless means the Swiss bank is insured against the first $3.75bn of deterioration in the portfolio. With that transfer of risk, UBS can too free up a lot of capital it would otherwise have had tied down under Basel-II requirements.
US war spending 'out of control'
The Pentagon's internal watchdog office has warned in a report to Congress made public that its auditors are unable to keep pace with a ballooning US defense budget. The rapid growth of the defense budget to more than $US600 billion ($626 billion) "leaves the department increasingly more vulnerable to fraud, waste, and abuse," the Pentagon's Office of the Inspector General said.
The March 2008 report said the office's ability to adequately cover high risk areas and defense priorities "has become strained due to the fact that our staffing levels have remained nearly constant". "Furthermore, the demand for IG services to support the GWOT (global war on terrorism) and the ongoing operations in Southwest Asia has forced us to readjust priorities," it said.
The result has been "gaps in coverage in important areas, such as major weapons systems acquisition, health care fraud, product substitution, and defense intelligence agencies". The agency said that to expand its work force it needed $25 million more in funding in 2009 than the $247 million requested by the administration.
The report was made public by the Project on Government Oversight, a private non-profit group dedicated to exposing waste and corruption in government. Nick Schwellenbach, the group's national security investigator, said, "it's stunning that we've been spending so much for so long with so little oversight".
Whereas in 1997 there was one auditor for each $642 million in Pentagon contracts, in 2007 the ratio was one auditor for each $2.03 billion in contracts, according to the report. It said $152 billion in money spent on weapons acquisitions in 2007 received insufficient audit coverage.
Briton Gets Refund For Having too Many Germans in Hotel
First, a British court awarded a man compensation because there were too many Germans in his holiday hotel. Now, the German press is firing back -- with tips on how best to avoid the English this summer. Hint: It involves football.
A court in Britain appears to have wounded German pride by awarding British tourist David Barnish £750 pounds (€948/$1,484) in compensation because there were too many German tourists at the Greek island hotel where he spent a family holiday last August.
Barnish had sued holiday company Thomson because it hadn't told him the Grecotel resort on the island of Kos was occupied almost exclusively by Germans -- more than 600 of them. Only 25 of the 700 guests at the hotel were English. Barnish had paid £4,000 for the holiday. Barnich claims his family was unable to take part in entertainment or children's activities at the hotel because they were only organized in German.
Germany's tabloid newspapers were quick to respond. "They're crazy, the British" wrote Bild and Express. Bild published a list of six resorts frequented by British tourists including Magaluf in Mallorca. "If you don't want to meet English people, avoid these places!" the newspaper warned.
To provide added incentive, it published a photo of two grinning Englishmen on holiday -- one of them tattooed, bare-chested and sporting an impressive beer gut -- with pints of beer in their fists. Bild quoted tour operators as warning that German tourists couldn't expect similar compensation if they came across British hordes at their hotel.
Canada hears pain of Indian abuse
A truth and reconciliation commission examining what Indian leaders call one of the most tragic and racist chapters in Canada's history has begun. The commission will study Canada's decades-long policies that removed Indian children from their families to force Christianity upon them.
The state-funded religious schools were often the scenes of horrific physical and sexual abuse. The commission has a five-year mandate to detail the abuses. From the 19th Century until the 1970s, more than 150,000 aboriginal children were required to attend Christian schools in an attempt to rid them of their native cultures and languages and integrate them into society.
The federal government admitted 10 years ago that physical and sexual abuse in the once-mandatory schools was rampant. Many students recall being beaten for speaking their native languages, and losing touch with their parents and customs. That legacy of abuse and isolation has been cited by Indian leaders as the root cause of continuing epidemic rates of alcoholism and drug addiction on reservations.
The commission, which is in the early phase of its research, will spend five years travelling across the country to hear stories from former students, teachers and others involved in the so-called residential schools run by the Roman Catholic Church and various Protestant denominations.
The goal is to give survivors a forum to tell their stories and to educate Canadians about what happened.
"It's the darkest, most tragic chapter in Canadian history and virtually no one knows about this," said Phil Fontaine, chief of the national Assembly of First Nations, the umbrella group that speaks for Canadian Indians.
Mr Fontaine was himself among the victims of sexual abuse at a church school. "I'm just one of many," he said.
Aboriginal Judge Harry LaForme, who heads the commission, is hopeful Canadians will be more sympathetic of the plight of aboriginals once they know more. Mr LaForme told the BBC that the aim of the commission was not to name offenders and point fingers, but to foster healing. "We know what occurred, what we now want to hear is the stories from the people themselves."
The commission was created as part of an agreement in 2006 between the government, churches and the 90,000 surviving Indian students to help redress some of the issues plaguing the Indian population. About C$60m (£30m) will be used to fund the commission's work. No date has been set yet for testimony to begin.
The start of the commission's work precedes a public apology that Prime Minister Stephen Harper is scheduled to deliver in parliament on 11 June - an acknowledgment that native leaders have sought for years.
Canada's aboriginals - who number nearly one million - remain the country's poorest and most disadvantaged group, with a life expectancy five to seven years lower than non-natives. Suicide rates are three times higher than the national average, and teenage pregnancies are nine times higher.
Ilargi: Just in case you still had any illusions about who these people really are. We will not, can not, stop this. Man is a tragic creature, perfectly fit for destroying everything around him, and then himself, and unable to stop it. Man can fake it though......
Gordon Brown blows a loophole in ban on cluster bombs
Gordon Brown has negotiated a loophole for Britain to continue using cluster bombs, despite his declaration of a full ban. The prime minister appeared to reinforce his humanitarian credentials when he dramatically overruled the Ministry of Defence (MoD) in talks at a 109-nation conference in Dublin on Wednesday.
While Brown announced support for “a ban on all cluster bombs, including those currently in service by the UK”, the government quietly excluded new anti-tank cluster shells that are not yet in service. Britain will now press ahead with an £83m contract to buy a new generation of the munitions, signed last November with GIWS, a German manufacturer.
Brown’s intervention in Dublin does mean an end to Britain’s two existing “smart” cluster munitions. The M85 artillery shell, which splits up into 49 bomblets and was last used in Iraq, will be taken out of service immediately. The M73 rocket, fired from the army’s Apache helicopters, contains nine bomblets and is deployed in Afghanistan.
It will be phased out over eight years. By then the new ballistic sensor fused munition shell will be in service. The shell splits into two bomblets that descend on small parachutes, which make them particularly attractive to children if they do not detonate.
'We're Only at the Beginning' of the Food Crisis
The UN's Food and Agriculture Organization is holding a summit in Rome this week to discuss the global food crisis. Assistant Director-General Alexander Müller speaks to SPIEGEL ONLINE about the rising oil prices, the risk of biofuels and how agriculture could be transformed to help tackle climate change.
SPIEGEL ONLINE: This week governments from across the world are gathering for a special summit in Rome to discuss the global food crisis. Why is the summit only being held now?
Alexander Müller: The 850 million people who have been going hungry for many years, mostly in remote rural areas, never had the power to draw attention to their plight. Now rising food prices are hitting entirely new sections of societies. People in towns are protesting and governments notice this immediately. The pressure is enormous.
SPIEGEL ONLINE: What is the main reason for food production no longer keeping up with demand?
Müller: Various factors, including very significantly the rising oil price. Traditional agriculture is itself very energy intensive: It needs oil for fertilizer, pesticides, tractors and transport. To get away from that, many governments are promoting fuels made from agricultural products. This is turn links the price of bread to the price of oil.
SPIEGEL ONLINE: Has the food crisis reached its peak?
Müller: Quite the opposite, we're only at the beginning. Unchecked climate change would lead to farmland drying out or becoming flooded. New animal and plant diseases are emerging; yields could fall. We have to produce 40 percent to 60 percent more food, while there is a marked reduction in the land available for cultivation in the south.
SPIEGEL ONLINE: But agriculture is actually responsible for one third of CO2 emissions.
Müller: That is exactly what has to change very quickly, otherwise the system will devour itself. We want to highlight this point during the summit: climate protection is the same as food protection.
SPIEGEL ONLINE: How will that work?
Müller: We have to practice agriculture so that it captures carbon rather than releases it. That means putting a stop to deforestation. And we have to cultivate the soil with greater care, so that more CO2-capturing grassland is preserved. On top of that we have to, for example, create so-called agricultural savannahs, where livestock can graze in specially planted tree plantations.
SPIEGEL ONLINE: Where will the money come from for such a radical transformation?
Müller: From CO2-emissions trading in industrialized countries. The industrialized countries will anyway only get a grip on their CO2 problems with the help of developing countries. Billions are already being invested to neutralize our own emissions. But so far all the money has been chanelled into industrial projects. Why shouldn't small farmers in Asia and Africa profit from this, if they can capture carbon on their land just as efficiently, maybe even more cheaply.
SPIEGEL ONLINE: That sounds like a green revolution?
Müller: But unlike the ones in the past. We will soon publish maps that show in what regions of the world agriculture can capture carbon, how to manage the land and where new forests must be planted.
SPIEGEL ONLINE: Should the production of biofuels be stopped to achieve this?
Müller: That would be good in countries where forests are cut down to make way for palm oil and soya plantations. But you have to differentiate. The situation is different in Brazil. There biofuels are being produced, without state subsidies, unlike in Europe and the US. But we need international agreements on how sustainable biofuels can be produced, without worsening the international food crisis.
SPIEGEL ONLINE: Germany's Agriculture Minister Horst Seehofer claims biofuels have no impact on food prices, because their production takes up only 2 percent of the arable land.
Müller: Our specialists, as well as other experts, have come to a different conclusion: 20 to 50 percent of the hike in food prices is the result of the demand for biofuel plants.
SPIEGEL ONLINE: Germany's Development Minister Heidemarie Wieczorek-Zeul is therefore calling for a general biofuel ban. What do you think of that?
Müller: Not much. I also think it's wrong to say an ever-rising proportion of fuel must consist of biofuels, as the EU and Germany have done, without having a sustainable model. The subsidies create market distortions, which make CO2 reduction unnecessarily expensive. In any event, feeding the world has to take precedence over energy production.
SPIEGEL ONLINE: German Chancellor Angela Merkel has promised €500 million ($777 million) a year from 2013 for the protection of forests. Is that enough?
Müller: It's a good start. UN experts in nutrition, development and the environment are already working closely with Norway, which has announced a similar initiative. Such funds offer the chance to no longer have to address the problems in isolation with small budgets, but tackle them at their roots. Until now climate change negotiators, conservationists and agricultural professionals have undertaken their tasks separately. This has led to a dead end.