Ilargi: It has remained conveniently hidden amid the rubble of the collapsing North American and global economies, but these days a trend becomes visible that is as sinister as it is predictable and repetitive, and The Dark Knight serves as a fitting metaphor.
In the US in the 19th century, there were several attempts at establishing a central bank; all failed. After the economic crash of 1907, voices once more were raised to try again. One of the pivotal arguments behind the scheme was that the devastation caused by the crash was a direct result of the fact that politicians had too much influence on the topic of banking and financial policy, while they had far too little knowledge in the field.
Therefore, a central bank, it was argued, had to be independent from Washington, and its directors should be private bankers instead of elected political representatives of the people. Bankers knew the field much better, which would lower the risks of another crash, and they would not abuse their financial powers for political ends.
To fully assure its independence, the prospective central bank was made responsible for "printing" all of the nation’s money as well, and would be paid a 6% interest rate over all money it issued. These provisions exist to this day.
Despite a lingering and deeply seated suspicion of the bankers, the Federal Reserve Act was pushed through Congress in 1913 when most members had already left for Christmas recess. The Federal Reserve system is not federal, since it’s not part of the government; that would have prevented the very independence that was the stated goal. It’s owned and controlled by a group of banking families, who each hold a set number of -untradable- shares.
Forward to today: one of the main objectives of the Federal Reserve was to ensure the nation’s currency would be stable. Since the US dollar has lost about 95% of its value since 1913, it’s obvious that the central bank has failed that objective to an astonishing extent.
More relevant, though, for the present day, is that the US economy is a complete wreck (or maybe "roadkill" is a better term). Existing debts for businesses, governments and individuals alike are at levels that can only be done justice by labeling them "insane". This situation has built up over decades. And no matter where you stand, there’s no way you can defend this as being the product of a sound financial policy.
When it comes to both housing and financial markets, it is very obvious, and has been for a long time, that levels of borrowing, available credit and leverage are very unhealthy for the economy. The Federal Reserve, which is after all the very institution that has access to more data and numbers than any other entity in the country, was the one party that could have halted this development, at any point through the years. Every single day, thousands of them, it could have intervened. It never did.
On the contrary, interest rates were lowered below inflation rates for years, and Alan Greenspan repeatedly encouraged people to go out, get a cheap "creative" mortgage at low interest, and buy a home (an initiative that had nothing to do with his job description). He equally endorsed the proliferation of new financial instruments, such as mortgage backed securities, swaps and various derivatives, claiming (no, really) that they were taking the negative risk out of the markets.
We don’t have to answer the question whether Greenspan was too dumb to understand what his public enthusiasm for these new-found instruments would cause, or whether he intentionally misled his audiences. We just need to acknowledge that he left behind a gigantic mess.
And that brings us to what started off this diatribe. The same calls for "independence" and "strength" that led to establishing the Federal Reserve are once again in fashion. Congress is about to hand over even more powers to the central bank that is beyond the control of the American people. The mess we’re in, say the pundits, as they did in 1912, is a result of the Federal Reserve not having enough power over the American economy, not the opposite.
Is there really such an ironclad guarantee that handing over the last little bits of control over your economy to a group of private bankers will solve the problems? Does anyone ever consider the idea that they are the cause of the problems? Could it be that perhaps their interests are different from those of the American people?
Why is the idea so strong and persistent that the Fed works tirelessly and incessantly for the happiness and wealth of US citizens? What proof is there of that? Have you taken a look at the numbers lately? And if you did, what makes you think they will improve by giving more power to the institution that was established explicitly to prevent those numbers from ever occurring?
I’m curious to see the logic.
Update 5.00pm EDT.Ilargi: Here's my list of financials for the day, the same list as yesterday. It's almost all red ink again. Fannie and Freddie are being read the last rites as we speak, I expect full-blown nationalization as early as tonight. They cannot go on like this. Wachovia is teetering. Note the losses for BoA, Citi and Merrill. 6% every day, it starts to add up (or down, if you will).
The only positive numbers are WaMu and Lehman, which take a breather after yesterday's (and earlier) losses, only to undoubtedly go underwater once again soon, as well as the monolines Ambac and MBIA. In their case I wouldn't be surprised if that uptick has to do with an upcoming public announcement.
And now I'll go do actual work, with my hands that is, and outside.
The Fed As Super-Regulator
Who's the real winner in the Fannie Mae/Freddie Mac crisis? The Federal Reserve, which is emerging with unprecedented power as the government moves to provide Fannie and Freddie with a financial lifeline.
The plan must still be approved by Congress, but after the dust clears the Fed will not only serve as the lender of last resort to the ailing mortgage buyers but will also have a consultative role in their regulation. By coincidence, the central bank on Monday approved a new rule designed to protect consumers from deceptive lending practices, including advertising practices that say interest rates are fixed when in fact they're not.
It applies to all mortgage lenders, not just those under the Fed's control. The news this week comes four months after the Fed facilitated JPMorgan Chase's $30 billion buyout of Bear Stearns and the Bush administration's blueprint to overhaul the U.S. financial regulatory system, granting the Fed even more power.
"I think the Fed has established a menu of things that will give them much more power than they've ever had before," says Peter Wallison, a fellow at the American Enterprise Institute and a former general counsel to the U.S. Treasury Department. "Why waste a good crisis?"
It's all a bit ironic. It can be soundly argued that regulatory inaction and too-lax monetary policy earlier in the decade are what caused the current economic malaise in the first place. Now the Fed is scrambling to catch up. Makes sense. The Fed is considered a world-class regulator, and its intervention sends a sign to markets that the government has a crisis under control.
But is there a point where the central bank might obtain too much power? Bert Ely, a Virginia-based financial services expert, thinks so. "The big danger is [that] they'll lose their independence," he says, adding that if the Fed takes a loss on any of its obligations, it puts taxpayer money at risk.
Fortunately, this hasn't happened yet. In fact, the government's proposal to restore confidence in Fannie and Freddie--which includes extending their lines of credit from the Treasury and allowing Uncle Sam to buy their shares if necessary--is designed to help the mortgage buyers keep operating under their current, shareholder-owned business models. "Those actions have not been taken and hopefully will not ever need to be taken," says Freddie Mac spokeswoman Sharon McHale of the government's rescue plan.
But if they do, the Fed could be the first to come to Freddie's and Fannie's rescue. Aside from the central bank's offer to let the mortgage buyers borrow funds if necessary, the rescue proposals outlined by Treasury Secretary Paulson on Sunday require congressional approval. Legislators plan to bundle the administration's proposal with a housing bill now moving through Congress--but the fine details of this proposal still remain largely unknown. That puts the Fed in the role of first responder for now.
On Tuesday, Fed Chairman Ben Bernanke begins two days of testimony on Capitol Hill as he delivers his semiannual economic report to lawmakers. He'll talk about the growing threat of inflation, the government's response to the Fannie and Freddie meltdown, the Fed's recent actions to curb irresponsible lending and the overall economic outlook. But don't expect him to say the Fed is accumulating too much authority.
US concerns prompt global market falls
Global shares have fallen sharply with London's FTSE 100 index seeing about £35bn wiped off its value as it faces its lowest close since October 2005. After a heavy sell-off in Asia, markets in Europe have spiralled downwards - with key indexes in London, Paris and Frankfurt all losing more than 2%.
Analysts blamed mounting concerns about the health of US financial institutions and possible global fall-out. Oil moving back above $146 a barrel has also added to investor worries. Meanwhile surging inflation - which hit 3.8% last month in the UK - has also unnerved investors.
Markets had steadied as traders absorbed details of the US government-backed rescue of Freddie Mac and Fannie Mae - in the aftermath of the collapse of another lender IndyMac. But while this was initially well received, analysts say optimism appears to have faded.
"The problems Fannie Mae and Freddie Mac face still highlight issues which are fundamental to the market," said Henk Potts, equity strategist at Barclays Stockbrokers. "The reality is everyday investors are looking at runaway inflation, falling house prices, weak business and consumer confidence surveys and that continue to sap away investors' confidence."
In the UK, the FTSE 100 hit its lowest level since 2005 - with banks including Royal Bank of Scotland and Lloyds TSB among the biggest fallers. The financial sector in Germany was also hit where the Dax index lost 2.7%. Germany's leading index is heading for its lowest close since October 2006, as a survey suggesting that investor confidence was at a record low was released.
Meanwhile France's Cac 40 index, down 2.3% on the day, faces its worst finish in more than three years. A sell-off in Asia hit Hong Kong's Hang Seng index, down 4%, while Japan's Nikkei 225 index lost 2% and Chinese shares fell 3%. Of the Asian losses, banks were the hardest hit as investors worried that US financial market woes would spill over to Asia.
Crunch week for the economy
It has been billed as a crunch week for the economy and financial markets, and in only its first few hours it didn't disappoint.
On the financial side, there was good news late in the weekend and early yesterday morning as, respectively, Fannie Mae and Freddie Mac were supported by the United States government and Alliance & Leicester was approached by Spanish banking giant Santander.
The economic news was no less dramatic, though rather more alarming, encapsulating the dilemma the Bank of England finds itself in, trapped between rising inflation and a slumping consumer sector.
Producer prices soared to a new record high, underlining the rising cost of raw materials, while, in a report to be published today, the Royal Institution of Chartered Surveyors reveals that activity in the housing market has fallen to a 30-year low.
But anyone who assumes that markets will now be given some time to chew over these events will be disappointed - for the next four days will only see the roller coaster accelerate through some even more dramatic twists and turns, which could leave consumers and investors even more shaken than they are today.
For in a series of data releases, consumers may finally get an answer to three of the big questions dominating financial and economic debate both domestically and throughout the world. First up is whether we are heading for a serious inflationary spike, a question today's inflation figures may go some way towards answering.
Most economists are expecting the Office for National Statistics to report another big jump in the Consumer Price Index - from 3.3pc to around 3.6pc or 3.7pc. However, if the eventual result is higher than expected, the shock it delivers to the City could be disturbing. Indeed, it was after the past two CPI figures (both higher than expected) that money markets started pricing in rises, rather than cuts, in interest rates in the coming months.
Should the inflation figures be lower than expected, investors may finally start betting on the Bank of England cutting borrowing costs - if they are higher, it could pave the way for more jitters about inflation. The second big question concerns the labour market. So far, the economy has seemingly ground to a halt without suffering a significant rise in unemployment.
While it is probably wishful thinking to expect this slowdown to be unaccompanied by redundancies, the scale of that jobs slump is still unclear. The British Chambers of Commerce expects around 300,000 staff to be axed, while others think the number could reach 500,000.
Either way, a significant leap in the official unemployment figures tomorrow could confirm economists' growing fears that the UK is already in the teeth of a recession. The figures may also shed light on whether the record number of Eastern European immigrants to the UK in recent years could leave these shores, helping to keep unemployment relatively low.
However, even if the jobless total remains high, it will still leave tantalisingly unanswered the question of how great the eventual job losses will be. The problem is that, like most statistics, unemployment data tends to lag the actual economic story, so even more attention is focused on the market, which is itself facing one of its most eventful weeks yet.
It so happens that this afternoon brings the start of Federal Reserve chairman Ben Bernanke's six-monthly testimony to Congress. The session, which straddles today and tomorrow, will doubtless see Mr Bernanke quizzed about his state of mind as regards Fannie and Freddie.
But just as important will be the hints he gives - or withholds - about the Fed's next interest rate move, not to mention the Fed's updated economic forecasts, which are likely to be sharply downgraded, given the flood of bad news since the beginning of the year. If markets manage to surmount these challenges unbroken, they then have to contend with the potential horrors lurking beneath the banking system.
For on Thursday and Friday, Merrill Lynch and Citigroup release their second-quarter earnings figures, providing an indication of the scale of writedowns they have had to absorb since the start of the year. The sub-prime crisis has come in waves since last autumn as banks have slowly but surely uncovered the full scale of their losses. Investors are hoping that this reporting season does not bring another tsunami.
Meanwhile, in the background, lurk the persistent threats of record oil prices, slumping economic performance throughout the Western world and rising interest rates in Europe and the US. The US mortgage market crisis over the weekend, among the biggest threats facing the market, passed without major panic, largely thanks to the Fed and the US Treasury's decisive action.
However, this is only the first of five nail-bitingly tense days for the market.
Meredith Whitney Cuts Wachovia on 'Bleak' Prospects
Oppenheimer & Co.'s Meredith Whitney, the analyst who correctly predicted Citigroup Inc. would reduce its dividend this year, said the earnings outlook for Wachovia Corp. has "dramatically diminished" and bank stocks will keep falling until asset prices "get real."
Wachovia fell as much as 15 percent in early trading after Whitney said prospects for shareholders of the Charlotte, North Carolina-based bank are "bleak." Mortgage-related assets are still priced too high on U.S. banks' balance sheets, she said. "Historically, financials have not shrunk well," the New York-based analyst said in an interview with Bloomberg Television.
She said Wachovia last week released charge-off figures that didn't correspond with portfolio values, meaning the bank might be shrinking its balance sheet. "Your revenues go down dramatically. Effectively, you'd be eroding capital."
The world's biggest financial services companies have posted more than $416 billion of losses and writedowns tied to the mortgage-market collapse, according to Bloomberg data. Wachovia's losses totaled $13.7 billion. The Federal Reserve has authorized Fannie Mae and Freddie Mac to borrow directly from the central bank to stem a collapse of confidence in the companies, which own or guarantee about half the $12 trillion in U.S. mortgages.
Whitney reduced her rating on Wachovia to "underperform" from "perform." The company will report a loss of $1.35 a share this year and lose 35 cents a share in 2009, compared with prior profit estimates of $1.55 and $2.65, respectively, Whitney wrote. Wachovia has plunged 74 percent this year in New York Stock Exchange composite trading and ousted Kennedy Thompson as chief executive officer on June 2 after it cut its dividend 41 percent and raised $8 billion in capital.
The lender hired Treasury Undersecretary Robert Steel as CEO July 9, announced a second- quarter loss of at least $2.6 billion and said it plans to disclose information about cost cutting and "reducing its mortgage exposure" later this month. "We are hard pressed to find examples of financial companies that have successfully shrunk their businesses," Whitney said. Wachovia probably reduced its mortgage assets by $50 billion in the second quarter, Whitney wrote in her note.
More write-downs loom at banks
It’s a foregone conclusion that Merrill Lynch & Co. and Citigroup Inc. will post enormous losses yet again when they report second-quarter results later this week.
Even JPMorgan Chase & Co., which has avoided the worst of the mortgage crisis, is expected to post a 60% drop in profits, according to Crain's New York Business. As bruised and bloodied as these three banks are, more difficulties lie ahead. “There is still tons of junk on banks' balance sheets, and no one knows just how bad it is,” said Graham Summers, chief executive of GPS Capital Research.
Mr. Summers has gained enormously this year from shorting the entire financial sector, and he remains bearish. “After a roughly 20-year rally in financial stocks, we're in the midst of a major correction, and it isn't going to be over after just a few months,” he said.
Financial institutions, which have suffered ghastly hits from their exposure to subprime mortgages, bond insurers and leveraged loans, now face more pain because of the slowing economy. Analysts warn that the slowdown will lead to losses connected to home equity loans, credit cards and auto loans.
Meanwhile, such lucrative Wall Street businesses as taking companies public and advising on mergers remain all but dead.
The outlook is arguably bleakest at Citigroup, which has been battered by more than $40 billion in mortgage-related losses — with more to come.
When the bank reports its results Friday, Oppenheimer & Co. analyst Meredith Whitney forecasts that Citi will write down another $12.2 billion in mortgages and other assets, and post a loss of $1.25 a share, its third straight quarterly loss. Though Ms. Whitney expects Citi to return to the black next year, she cut her 2009 earnings estimate earlier this month to 45 cents a share from 80 cents.
The company said last week that it would sell its German retail banking business for $7.7 billion. Investors can expect more such sales and an additional dividend cut—Citi reduced its payout by 40% in January. Asset sales also loom at Merrill, which is expected to report its fourth consecutive quarterly loss Thursday. Analysts expect the firm to raise cash by parting with at least some of its stakes in money manager BlackRock Inc. and financial news and news and data provider Bloomberg LP.
Sanford C. Bernstein & Co. analyst Brad Hintz wrote in a client report last week that he doesn't expect the credit crisis to ease until at least early 2009 — meaning brokerage houses like Merrill will face more epic losses. J.P. Morgan, which will also report Thursday, is in much better shape: its stock has fallen only about half as much as Merrill's or Citi's.
But storm clouds loom for the bank, even if they are mainly due to broad economic weakness rather than ill-advised gambles on subprime instruments. Last week, Citi analyst Keith Horowitz cut his 2009 earnings forecast for J.P. Morgan by 22%, to $3 a share, on the likelihood of growing losses in its portfolios of consumer loans.
IndyMac Reopens, Halts Foreclosures on Its Loans
IndyMac Bancorp Inc., the failed thrift, reopened its doors under federal control Monday and promptly moved to toss ailing homeowners a lifeline by halting all foreclosures on the mortgages it owns.
Federal Deposit Insurance Corp. Chairman Sheila Bair, who has been one of the most outspoken officials calling for banks to ease up on struggling homeowners, said that the agency is "really focused" on keeping borrowers in their homes for both their sakes and to maximize IndyMac's value for taxpayers. "We will very aggressively pursue loan-modification strategies for unaffordable loans to make them affordable on a long-term, sustainable basis," Ms. Bair said in an interview Monday.
The FDIC's move came as hundreds of depositors lined up to withdraw funds at the branches of the thrift, now renamed IndyMac Federal Bank. At the thrift's Santa Monica, Calif., branch, a line extended down the street and around the corner. Some people waited for hours to get their money at IndyMac's Pasadena, Calif., headquarters, but the crowd remained orderly.
The FDIC typically insures as much as $100,000 per depositor, but nearly $1 billion of IndyMac's roughly $19 billion in deposits was uninsured, affecting about 10,000 people, according to the FDIC. Officials have said they would be able to make 50% of customers' uninsured funds available. "People are not happy about having to wait outside," said Evan Wagner, a IndyMac spokesman. "But they're not leaving here unable to get their money."
In its effort to halt foreclosures, the FDIC has much more flexibility to intervene with the roughly $15 billion of loans that were owned by IndyMac. But IndyMac also was handling another roughly $185 billion in mortgages in its servicing business. Ms. Bair said that FDIC officials also were looking at the troubled loans in the broader portfolio to see if there was a way to help borrowers avoid losing their homes.
"We can't make any promises," Ms. Bair said. "We're going to look at each one before we are going to let them continue on to foreclosure, and when we find people who want to stay in their homes, we are going to try to work with them to see if we can modify their loan."
The FDIC's foreclosure freeze was one of the most dramatic steps it has taken since Friday, when the agency took over IndyMac in the third-largest bank failure in U.S. history. Since then, agency officials have been poring over the thrift's books as part of its strategy to sell the bank or its assets.
Ms. Bair's move could offer only brief respite for troubled borrowers, as the agency is trying to sell the bank and its assets within 90 days. Still, that could be enough time for many borrowers to rework their loan terms. IndyMac was the 10th-largest mortgage lender by loan volume in the country, according to industry newsletter Inside Mortgage Finance.
It specialized in so-called Alt-A loans, a category between prime and subprime that frequently included loans in which borrowers didn't fully document their incomes or assets. Such loans, which have become known as "liars' loans" because of the frequency in which borrowers' incomes were overstated, contributed to IndyMac's financial troubles.
Not all the bank's customers, however, are going to be as favorably treated as struggling homeowners. What's less certain, for example, is how the FDIC is going to treat IndyMac's construction-lending business. The bank stopped making new loans to home builders in the fourth quarter, but at the end of the first quarter it was still encumbered by $1.4 billion in commitments it had made to developers but still hadn't fulfilled.
While IndyMac had no choice but to keep funding those commitments, experts say the FDIC can decide to pull the plug. "They don't have to go through with it," says Walt Moeling, senior partner at law firm Powell Goldstein LLP. "The FDIC has the statuary rights, just like a trustee in bankruptcy, to renounce those still-to-be-performed contracts."
Ilargi: It’s hard to believe sometimes these days, but the Wall Street Journal really was once a quality publication. That time is now a distant past. This is another op-ed, and it tries to paint off Hank Paulson as a terribly naive person who’s been terribly misled by the lies of terribly deceitful people around him. Yes, that is the same Paulson who ran Goldman Sachs for years, a firm known for a lot of things; however, naiveté is not among them.
Now, the op-ed argues, the man who for so long believed the lies of all those people around him, has unexpectedly woken up, should be given greater powers, and everything will be alright. But it won’t be easy: the Journal has changed tack, and done a 180 turn on a dime.
The good news is vanishing from its pages, and instead we now get this: ”IndyMac Bank's failure is only the first of many more failures to come, and Treasury is going to have its hands full. The airline and car companies may follow...”. The sudden change in the paper’s editorial policies serves one purpose: to gather support for the transfer of more powers to fewer people. No matter how easy they are to fool, apparently.
Paulson's Fannie Test
We're about to find out why Hank Paulson left that lucrative job at Goldman Sachs to be President Bush's last Treasury Secretary.
Was it merely to add a fancy title to his obituary, or does he want to leave the U.S. financial system better than he found it? That's his test in the wake of his Sunday commitment to use taxpayer money to rescue Fannie Mae and Freddie Mac.
The past week's market turmoil over the mortgage giants has certainly been instructive for most Americans, not least Mr. Paulson. For 18 months, the Treasury Secretary had been told by Fannie, Freddie and their friends on Capitol Hill that the companies were in good shape.
He was told that Fannie's critics at the Federal Reserve, in the Senate (Richard Shelby) and in the media (us) were "ideologues" who should be ignored. Ease up on reform, they told him, cut a deal with House Financial Services Chairman Barney Frank to let the companies grow, and they'll help end the mortgage crisis. Mr. Paulson went with the Beltway flow.
We hope he now realizes he was lied to. More pointedly, on Sunday he was left naked on Pennsylvania Avenue, with no recourse but to disavow his own prior statements about Fan and Fred's good health and to bail them out. Now we'll see if he has the fortitude to stand up to these "government-sponsored enterprises" and protect taxpayers going forward.
The issue isn't whether the government should rescue the companies. Congress made that decision when it created the duo with an implicit taxpayer guarantee. Everybody has long known that, as the owner or guarantor of half of America's mortgages, the companies are too big to fail.
The question has been how to manage and regulate these monsters in a way that minimizes risks to the larger financial system and taxpayer. Had Treasury and Congress acted two years ago, or even three or six months, the current panic could have been avoided. The good news is that the crisis gives Mr. Paulson new political leverage, if he's willing to use it.
The companies are straining to raise capital, with their share prices falling yesterday even after the Treasury's commitment to keep them solvent. Thus they are more politically vulnerable than ever. Their main patrons in Congress – Mr. Frank, Chuck Schumer, Christopher Dodd – should also be on the defensive after shilling for the companies for so many years.
Mr. Paulson's Sunday statement at least began to show more leadership. The Treasury Secretary wants Congress to give the government more power to rein in the companies, including with a preferred stock capital injection if required. This is progress, but it's not aggressive enough given the risks. He could make more progress more rapidly toward a safer financial system by putting the companies into federal receivership.
If current law doesn't give Treasury that power – and we hear conflicting legal claims – Mr. Paulson should seek it from Congress. The Secretary could then appoint a prominent financial figure with bipartisan credibility as a receivership czar, with a mission to protect taxpayer interests. A czar would have the power to replace Fan and Fred's management and directors, as well as give priority to taxpayers above the current private shareholders if the government does inject capital.
It's true that this might well require a larger up-front taxpayer contribution. But after Sunday, the taxpayers know they are on the hook for big losses in any case. Putting the companies in federal receivership would insulate them from a political class that has shown itself unable or unwilling to control their risks. Without such a move, the companies could easily use the taxpayer cash as protection in the short run, emerging both larger and more dangerous. Mr. Paulson will have been stripped naked twice.
Receivership doesn't mean the companies will fold up overnight. They continue to hold trillions of dollars in mortgage assets, and they would continue to buy and package mortgages. But as a first priority, a receiver would be able to rein in their portfolios of mortgage-backed securities (about $1.5 trillion now) that are a major source of their risk.
Down the road, as the mortgage crisis eases, the receiver could decide whether to wind the companies down, sell them in parts to the private sector, or let them continue in far more restricted form. Keep in mind that these semisocialist giants (private profit, public risk) were founded in an era when mortgages were sold and held by the same lender.
The idea was that Fannie and Freddie, by buying and packaging those loans, could supply more liquidity to the mortgage market. Whether or not that taxpayer risk was worth it at the time, it clearly isn't now that the bill is coming due and private companies can do the same thing.
The receivership option would also help Mr. Paulson get out ahead of the many other looming financial problems. IndyMac Bank's failure is only the first of many more failures to come, and Treasury is going to have its hands full. The airline and car companies may follow. Putting Fan and Fred in firmer hands now will reassure investors that at least one risk is being well managed, reducing public fear that the government is overwhelmed.
US government not expected to help more companies
The U.S. government is signaling it won't throw a lifeline to struggling financial companies — except for mortgage linchpins Fannie Mae and Freddie Mac — marking a shift to a new and potentially more volatile phase of the credit crisis.
Such an approach could mean beaten-down investment banks like Lehman Brothers Holdings Inc. and regional banks must now fend for themselves as they try to recover from billions of dollars in mortgage-related losses — unlike Bear Stearns Cos., whose buyout the government helped orchestrate in March.
That is bound to unnerve an already turbulent Wall Street and make investors even more anxious as they await financial companies' earnings expected to be down a stunning 69 percent from a year ago when all the numbers are in. And, for consumers already squeezed by tightening credit standards, it could mean getting a mortgage will become even harder.
The short-term uncertainty about Freddie Mac and Fannie Mae — which together hold or guarantee half the nation's mortgage debt — was to an extent relieved on Sunday. Federal officials again threw their support behind the government-sponsored enterprises; the Treasury pledged to expand its current line of credit to the two companies and Treasury Secretary Henry
Paulson also said the government could, if needed, buy equity capital in the companies, whose stocks lost half their value last week. The Treasury's moves would require congressional approval. Meanwhile, the Federal Reserve said it will provide additional loans if needed.
But some of Wall Street's biggest investors believe there was another message in the government's announcement — the rest of the financial sector seems unlikely to get a helping hand. Global banks and brokerages have already written down nearly $300 billion in soured mortgage investments — a number projected to ultimately reach $1 trillion.
"The credit crisis has obviously entered into a new phase — the government has one bailout left in them, and this is it," said Jeffrey Gundlach, chief investment officer of TCW Group in Los Angeles, which invests $160 billion. "One consequence of Freddie and Fannie is that other firms are allowed to go under," he said. "If you couldn't get your act together after four months of unprecedented financing terms, maybe you don't deserve to be thrown yet another lifeline."
Worries about financial companies failing intensified after a run on IndyMac Bancorp Inc. led to the bank's takeover by the government on Friday. It wasn't the Treasury or Fed helping to keep IndyMac in business, but a transfer of control to the Federal Deposit Insurance Corp. — which backs deposits on all the nation's banks.
Analysts said these kind of failures will curtail competition among financial institutions, which might in turn make it even harder for some borrowers to get mortgages, personal or auto loans or credit cards.
Regional Banks Take It on the Chin As Fallout Spreads
Bank stocks were hammered Monday as the seizure of IndyMac Bancorp Inc. sank in with investors, who already were bracing for the worst as U.S. banks report second-quarter results this week and next.
In a sign of how panicky investors are about the industry's ballooning loan losses, National City Corp., a regional bank based in Cleveland, took the rare step of issuing a statement that it was "experiencing no unusual depositor or creditor activity." National City shares fell 15%, or 65 cents, to $3.77 in 4 p.m. New York Stock Exchange composite trading. The stock is down 77% so far this year.
After Washington Mutual Inc. plunged 35%, the Seattle thrift said it "significantly exceeds all regulatory 'well-capitalized' minimums for depository institutions." The company promised a "more-detailed report on its capital position and liquidity" when it announces quarterly results next week. WaMu shares fell $1.72 to $3.23 -- a year-to-date tumble of 76%.
Also behind the selloff was a report issued over the weekend by longtime banking analyst Richard X. Bove of Ladenburg Thalmann & Co. titled "Who Is Next?" While Mr. Bove wrote that none of the financial institutions he follows is "in the danger zone," some of the lenders listed in two tables in the report were among the hardest hit Monday.
On Monday afternoon, Mr. Bove issued a "clarification," noting that the "main thrust" of his earlier report was "that the banks are in better condition than is generally perceived." "We are definitely not suggesting" National City or First Horizon National Corp., of Memphis, Tenn., which sank 25%, or $1.66, to $5.04, "is in dangerous condition at the present time," he added. First Horizon said it would report quarterly results Tuesday, instead of Thursday as planned, "due to increased market speculation."
In the case of banks, Friday's seizure of IndyMac, based in Pasadena, Calif., adds to "concerns about the economy that are hurting regional banks," said Tim O'Brien, a research analyst at Sandler O'Neill & Partners. M&T Bank Corp., of Buffalo, N.Y., long known as one of the steadiest performers in the banking industry, reported a 25% profit decline and tripled its loan-loss provision.
M&T shares fell 16%, or $10.88, to $58.82. Another traditional stalwart, SunTrust Banks Inc., which hasn't been forced to slash its dividend or raise additional capital, sank 8.6% Monday, or $2.66, to $28.28. The Atlanta bank's stock price is down 55% this year.
Confidence Ebbs for Bank Sector and Stocks Fall
Even as the Bush administration moved to rescue the nation’s two largest mortgage finance companies, confidence in the banking sector spiraled downward Monday.
In Southern California, lines snaked around branches of IndyMac Bancorp, the large lender that was seized by federal regulators on Friday, as customers hurried to withdraw their money. As the anxiety spread through the financial markets, two other big banks, one in Ohio and another in Washington State, were compelled to assert that they were sound.
Even as federal regulators issued assurances that depositors’ savings were safe, Wall Street analysts circulated lists of lenders that might be vulnerable. Shares of regional banks plunged in one of the sharpest declines since the 1980s.
Many investors fear that the government’s resolve to help Fannie Mae and Freddie Mac, the giant companies at the center of the nation’s mortgage market, will not hold back the rising tide of bad loans unleashed by the weakening housing market and faltering economy.
Sheila C. Bair, the chairwoman of the Federal Deposit Insurance Corporation, said the F.D.I.C. expected a small number of the nation’s banks to run into trouble over the next year. But she asserted that the worries driving down banking shares, fed by rumors in the marketplace, did not presage widespread failures.
“People should not assume that just because the stock price has been going down, that we’re going to close their bank,” Ms. Bair said. “In addition to our credit problems, I don’t want to have to start worrying about bank runs.”
Wall Street staged its own sort of bank run. Investors fled banking stocks en masse. The Standard & Poor’s 500 Bank Index fell nearly 10 percent. Washington Mutual, the nation’s largest savings and loan, lost more than a third of its value, prompting the lender to issue a statement that it was “well capitalized.”
National City Corporation of Cleveland, which is the largest bank in Ohio, fell almost 15 percent. That bank also took the unusual step of issuing a statement saying that it was sound. The stock prices of large lenders in Tennessee, Alabama and Florida also swooned.
The worries about the financial industry that gripped Wall Street when Bear Stearns imploded in March spilled over to Fannie Mae and Freddie Mac last week. They are now buffeting small and midsize banks, many of which are heavily exposed to weakening local property markets and loans to home builders. Some investors fret small institutions will not receive the kind of federal support that rescued Bear Stearns and the two mortgage giants.
“The market wonders: which institution is too small to bail out?” said William H. Gross, the chief investment officer of Pimco, the large money management company. Traders “seem to have picked on the regional banks as potential candidates to be the ones too small to bail out.”
Several bank analysts issued dire warnings about the banking industry, particularly smaller, regional lenders. Goldman Sachs said regional banks may be forced to cut their dividends to safeguard their finances, driving down shares of banks like Zions Bancorporation of Utah and the First Horizon National Corporation of Tennessee.
Rumors swirled that customers at National City were pulling money from the bank. There were no indications of mass withdrawals at the Ohio bank or any others aside from IndyMac, the lender based in Pasadena, Calif., which was seized by regulators last week. “Look, we are not experiencing any unusual depositor or creditor activity today,” said Kristen Baird Adams, a spokeswoman for National City. “There is widespread speculation and rumors in the markets today.”
The rumors continued to rip through the markets despite a warning from the Securities and Exchange Commission on Sunday that it would crack down on traders who spread false rumors. More bad news is likely this week from large banks like Citigroup, which are expected to report bleak quarterly earnings.
On Monday, M&T Bank kicked off the string of earnings releases, saying its profits dropped 25 percent from a year ago. The bank’s stock price fell 15.6 percent on Monday. Regulators and investors are bracing for a small number of banks to fail over the next 12 to 18 months.
Analysts predict that 50 to 150 banks might stumble. In the first quarter this year, the F.D.I.C. listed 90 banks as troubled, which is far lower than the levels during the savings and loan crisis of the 1980s. Still, Ms. Bair said that number would increase. IndyMac, for example, was not on that first quarter list at the F.D.I.C. but was still seized by regulators.
“We’ve been saying for a long time that the number of troubled banks will go up, the number of failed banks will go up,” Ms. Bair said. “It’s going to be well into the next year at least.” Ms. Bair said her agency was prepared to handle the problem banks, after an extensive staffing increase.
The F.D.I.C. has about $53 billion to pay back consumers for deposits that are lost at failed banks and is already working on plans to raise more money to cover the depositor balances at IndyMac. The agency will raise the money from banks, she said, with riskier banks paying more. She emphasized that the number of failed banks still appears to be significantly less than those closed in the 1980s. Some banks may avoid failing because they are purchased just in time.
Nevertheless, the financial markets are reacting to even small rumors, so every bank failure presents the potential for panic, analysts said. “It’s about to start getting real bad,” said Richard Christopher Whalen, managing director at Institutional Risk Analytics, a research firm based in Torrance, Calif. The government, he said, should just move on with the process and “close not just one but a half-dozen institutions at the same time.”
The government’s plan for Fannie Mae and Freddie Mac initially seemed to calm nervous markets on Monday morning. The Dow Jones industrial average opened more than 100 points higher. The announcement should help regional banks that hold Fannie or Freddie bonds as well as Wall Street firms that do a significant amount of business for the government-sponsored entities.
Some investors said the government’s plan simply reaffirmed negative fears about the mortgage market. “One could argue that government measures validated concerns about how bad things really are,” said David Bullock, managing director of Advent Capital Management, an investment fund in New York. “We are closer to the Depression scenario than not.”
Freddie, Fannie Debt Demand Rises, Shares Decline
Freddie Mac received higher-than- average demand for its $3 billion of short-term notes as the U.S. Treasury's rescue plan buoyed confidence the government will back the company's debt. Freddie Mac and Fannie Mae stocks fell on concern shareholders will be left out of any bailout.
U.S. Treasury Secretary Henry Paulson's decision to seek authority to buy equity stakes and increase the government's credit line to Fannie Mae and Freddie Mac spurred demand from bond investors who interpreted the move as a step closer to an explicit backing of the companies' debt.
That support may not extend to shareholders, who would have their holdings diluted in any new equity raising, said Dan Castro, chief risk officer at hedge fund Huxley Capital Management. "If you're a bondholder, this helps," said Castro, who is based in New York. "But if you're an equity shareholder, that is a different thing.
You can make the argument that they are too big to fail, but that still doesn't mean the equity holders deserve to get bailed out. Shareholders will only get as much help as is absolutely needed to keep them afloat."
Freddie Mac, based in McLean, Virginia, dropped 64 cents, or 8.3 percent, to $7.11 today in New York Stock Exchange composite trading. Washington-based Fannie Mae fell 52 cents to $9.73. Almost 263 million Freddie Mac shares changed hands, 41 percent of the stock outstanding. Almost 216 million Fannie Mae shares were traded, 22 percent of the total.
Freddie Mac and Fannie Mae dropped almost 50 percent last week on concern shareholders would be wiped out. Freddie Mac is down 79 percent this year and Fannie Mae has declined 76 percent. The declines by Fannie Mae and Freddie Mac combined with a slump in regional banks to push down U.S. stocks.
Financial shares fell to their lowest level since October 1998 and the Standard & Poor's 500 Index dropped 0.9 percent. Fannie Mae and Freddie Mac debt yields narrowed compared with U.S. government notes.
The difference between yields on Fannie Mae's 5-year debt and 5-year Treasuries fell to as low as 76.4 basis points, the lowest since June 5, before settling back at 80.8 basis points, according to data complied by Bloomberg. The spread on Freddie Mac's 5-year debt was also at 80.8 basis points after being as low as 76.1 basis points earlier today.
"It's something that gives equity holders probably a little less of an upside and that solidifies the debt," said Andrew Harding, chief investment officer for fixed income at Allegiant Asset Management in Cleveland, which manages $20 billion in fixed-income assets.
U.S. Stocks Fall, Led by Biggest Drop in Financials Since 2000
U.S. stocks fell, sending financial shares to their biggest drop in eight years, on heightened concern that bank failures will spread.
Washington Mutual Inc. posted the steepest retreat ever and National City Corp. tumbled to a 24-year low after last week's collapse of IndyMac Bancorp Inc. spurred speculation that regional banks are short of capital. The companies said they've seen no unusual depositor activity.
Fannie Mae and Freddie Mac erased an earlier rally fueled by Treasury Secretary Henry Paulson's plan to help rescue the largest U.S. mortgage lenders.
The declines pushed the Standard & Poor's 500 Financials Index of 89 companies down 6.1 percent, its steepest plunge since April 2000. The S&P 500 slid 0.9 percent, to 1,228.3. The Dow Jones Industrial Average lost 0.4 percent, to 11,055.19. The Nasdaq Composite Index slipped 1.2 percent, to 2,212.87. More than two stocks dropped for each that rose on the New York Stock Exchange.
"The factors that affected IndyMac are not isolated; while they're probably more severe, the pressures are evident in other financials," said Alan Gayle, the Richmond, Virginia-based senior investment strategist at Ridgeworth Capital Management, which oversees about $74 billion.
The Treasury's plan for Fannie Mae and Freddie Mac is "encouraging, but it does suggest that credit availability is going to remain somewhat impaired and borrowing costs will likely be higher."
Benchmark indexes rallied more than 1 percent each at the open as confidence in the banking system was boosted by Paulson's plan to ask Congress for authority to buy unlimited stakes in Fannie Mae and Freddie Mac and provide loans to them.
Fannie and Freddie erased their advance after investor Jim Rogers said in a Bloomberg Television interview that the government's proposal was an "unmitigated disaster" and Goldman Sachs Group Inc. predicted the shares would resume falling.
The S&P 500 fell to the lowest level since June 2006, extending its drop from an October record to almost 22 percent. Record fuel prices and more than $400 billion of writedowns and credit losses globally stemming from the U.S. housing market collapse have dimmed the outlook for corporate profits.
The Perils of Paulson
Investors have recently become concerned about what would happen if the implicit guarantee were tested. If markets turned against Fannie and Freddie, would all securities be backstopped by the government? Would the interests of existing shareholders be diluted?
As worries have spread, Fannie and Freddie's reception in funding markets has chilled and their share prices have plummeted. These concerns set policymakers in motion. The government has essentially built two bridges for these institutions. In the very near term, the Federal Reserve has granted them access to its discount window.
The Fed bridge is set to shut down when the Treasury link opens. This requires Congress to expand the Treasury's authority to lend and to allow the purchase of preferred stock. The Treasury would be providing longer-term funding, presumably giving the entities time to shore up their balance sheets by raising more capital.
The argument is that if the government opens its checkbook to these firms, private investors will be less likely to flee. Indeed, if investors become sufficiently confident, the crisis could fade without the government's lines being tapped at all. Yet there are two reasons to doubt that this movie ends so happily and two reasons to wish it were never made.
First, in the near term, continued double-digit declines in housing prices will raise doubts about the repayment prospects of more and more mortgages. Add to that the difficulties associated with an economy teetering on the brink of recession. Anyone holding mortgages or mortgage-related securities is in for a bumpy ride. Fannie and Freddie, which are exposed to more than half the market, are sure to face large losses and squalls of investor uncertainty.
Thus the second problem: The endgame is uncertain. The government's funding responsibility will end only when the two firms have raised sufficient capital. It will be impossible for the Fed or the Treasury to turn away a request for more credit. The overall provision of credit could, therefore, be sizable and extended. While policymakers have at least temporarily resolved this crisis, we will live with the consequences for a long time. Consider the downsides:
First, the Federal Reserve is likely to be given additional responsibilities related to overseeing housing finance. What happens when that goal interferes with the ones Congress has already given it -- fostering maximum employment and stable prices? An overextended Fed might be tempted to keep the liquidity tap open too long to support housing finance, even at the cost of a pickup in inflation.
Second, the government had to act because, in today's interconnected markets, Fannie and Freddie are too big to be allowed to fail. Policymakers missed an opportunity for significant reform. The public-private mix embodied in the GSEs has been shown once again not to work. The public aspect lulls investors into complacency, while the firms' private management will always try to keep their capital reserves as low as possible, potentially endangering the companies' solvency.
Policymakers could have used the crisis to focus attention on the entities' appropriate long-term status. The government could have privatized them completely by severing the implicit guarantee or nationalized them by allowing their equity to go to zero, as the market was headed. (My preference is the former, but even the latter has advantages over what policymakers did.) Instead, our nation is now reaffirming a model that does not work, almost guaranteeing a repetition of this problem down the road.
Fannie, Freddie rescue pushes housing aid
A foreclosure aid plan that was facing a sluggish trip through Congress has a powerful new engine behind it: the Bush administration's urgent request to rescue mortgage giants Fannie Mae and Freddie Mac.
Lawmakers have little choice but to give the government power to send a lifeboat to the two companies to prevent an election-year economy from drowning in mortgage defaults. The quicker they do it, the sooner 400,000 strapped homeowners could get new, cheaper loans instead of losing their homes.
"The silver lining on this cloud is that it dissipates any question about how this bill is going to get passed," Rep. Barney Frank, D-Mass., the Financial Services Committee chairman, said of a broader housing package. The House approved its version in May and the Senate followed suit on Friday, but a veto threat from President Bush and lawmakers' disputes over key details were threatening to sap its momentum.
Now it's clear the package — which also includes modernizing the Federal Housing Administration and creating a new regulator and tighter controls for Fannie Mae and Freddie Mac — has to move quickly. Frank said the House would act by Friday to resolve lingering differences and add authority for the government to prop up the mortgage giants if needed, in hopes that the Senate would agree and clear the measure for Bush next week.
"I'm confident we're going to get this done," said Sen. Christopher J. Dodd, D-Conn., the Banking Committee chairman. "Unfortunately, these events over the last few days have probably increased the importance of this in the minds of some." The administration, which has criticized key elements of the broad housing package, now has a powerful incentive to work out differences with Democratic leaders, who relish the prospect of claiming credit for a homeowner rescue plan just months before voters go to the polls.
And holdout Republicans, including Minority Leader John A. Boehner of Ohio and Whip Roy Blunt of Missouri, will find it more difficult to bash a plan that includes measures their own president calls crucial. Shortly after Treasury Secretary Henry M. Paulson announced his plan to offer help to Fannie and Freddie, the two issued a statement saying they "stand ready" to work with him and congressional Democrats "to take appropriate steps to ensure the soundness of our mortgage markets."
"I think people understand the urgency of needing to get this (housing) bill done. And it's fortunate that we have this vehicle to be able to tack this on," said Dana Perino, a White House spokeswoman. Still, GOP conservatives concerned about the government sending aid to the private companies will likely try to slow the legislation. In a letter to Frank and House Speaker Nancy Pelosi, D-Calif., Rep. Jeb Hensarling, R-Texas, called for hearings.
"We appreciate that our housing finance and capital markets are at a critical juncture due to scarce liquidity and waning investor confidence. However, given that a decision of this magnitude will affect the lives of each and every American for years, even decades, to come, it is essential that Congress fully consider these proposals and all the alternatives," Hensarling wrote in a letter circulated Monday.
Republicans have consistently bristled against the idea of allowing what they call a government bailout of irresponsible homeowners who borrowed more than they could afford and unscrupulous lenders who preyed on unwitting or reckless buyers.
That's how many of them describe the mortgage rescue plan, which allows the FHA to back an additional $300 billion in new mortgages so homeowners who can't afford their payments and would normally be considered too financially risky to qualify could refinance into more affordable, fixed-rate loans. The program would guarantee some payoff for lenders who took substantial losses on the distressed loans, in many cases letting them recover more than they could in a costly foreclosure.
Critics have struggled to explain their opposition to the plan in light of the government's actions earlier this year to rescue failing investment bank Bear Stearns. Now, with the Federal Reserve and Treasury making it clear they would swoop in to offer similar help to Fannie and Freddie, the homeowner aid program appears to have gained more legitimacy.
Frank argued Congress isn't just handing out credit; it's also moving to prevent a future market meltdown like the one officials are hoping to head off with the newly announced plan. "We are not simply making the credit available, we are simultaneously making sure it won't happen again," through stricter regulations on Fannie and Freddie and allowing more homeowners to borrow safely through the FHA rather than with shady subprime mortgages.
SEC's new red herring
Psst! Here's one you can trade on: The Securities and Exchange Commission, buffeted on all sides from the great leverage collapse of 2008, is now going to get to the bottom of the age-old dilemma of the trading desk rumor.
In a press release Sunday night that coincided with the opening of Asian markets, the SEC announced it was conducting examinations at brokers and hedge funds to determine if false information is being deliberately spread by traders to manipulate stock prices.
Philosophically, there's little argument against cracking down on those who knowingly develop or pass on bad info. After all, such bald attempts to manipulate the market have long been illegal. But given that sharing of rumors and information - some of it good, some not - occurs constantly across trading desks, there appear to be some truly head-scratching aspects to the SEC's move.
The first is that the agency's overburdened enforcement unit is already looking into, to name just a few - mortgage originator fraud, investment dealer disclosure on auction-rate securities, and broker valuations of the arcane vehicle known as collateralized debt obligations (CDOs) that has been the source of so much misery on Wall Street. Now the watchdogs are going to chase down down trading desk rumors too?
The second is that much of the impetus of this investigation appears to have come from senior executives at several Wall Street brokerages outraged over the effect rumors are having on their companies' stock prices. Last week, for example, Lehman Brothers saw its share price hurt last Thursday when a story made the rounds - and was picked up by CNBC - that stock-trading giant SAC Capital and giant bond manager PIMCO had ceased trading with the firm.
A likely death-blow if true, but it was easily disproved. The stock, which closed at $19.74 on Wednesday, dropped to $15.79 before rallying to close at $17.30 on Thursday. Whatever the story is behind the origination of the rumor, shorting Lehman's stock that day proved to be a pretty volatile - if not outright crummy - trade for those who piled on.
More important, while Lehman chief executive Richard Fuld has a well-documented antipathy towards shortsellers who question his firm's financial health, he and his deputies made decisions that have saddled the company with big losses and required it to make repeated trips to the markets to raise more capital.
So which has proven more painful for Lehman shareholders: the quick-buck artist who passes on some bogus tip - or Lehman's decision to become the most aggressive investment bank to speculate on Southern California real estate?
Is It Time to Pull the Rug Out From Short-Sellers?
Short-sellers and rumors. In the popular imagination, you rarely have one without the other. Short-sellers, who borrow money to make bets that a stock will drop, appear to be the agreed-upon villains of the current markets. If you put the problem into the context of law-enforcement forensics, it is time to suss out the short-sellers’ motive, means and opportunity.
Of course, you can’t argue with their (profit) motive. (Unless you are against capitalism). But, since many people seem to agree that too many rumors are flooding the markets because of short-sellers, can or should you take away their means and opportunity? Our question was prompted by a research report from David Trone, brokerage analyst at Fox-Pitt Kelton Cochran Caronia Walker, who suggested today that Lehman Brothers Holdings’ best hope of survival is to avoid the public markets completely.
Trone endorses blocking short-sellers from brokerage sales completely: “We still believe that an emergency prohibition of short-selling in brokerage shares is imperative.” Trone made his case thusly: Until the current crisis passes, short-sellers wouldn’t be allowed to borrow and sell stock in the brokerage sector, including Lehman Brothers, Merrill Lynch and Morgan Stanley.
These companies, unlike regular banks, have “the unique vulnerability of a type of company that doesn’t have hard assets–it’s built on confidence,” he said to Deal Journal in an interview. Rumors “create an artificial impairment of the business” because the same people and firms that react to the rumors are the ones that are doing business with Lehman. Trone envisions the restriction lasting as long as, say, the Federal Reserve discount window is open to the investment banks.
When the crisis passes, the window closes and short-sellers can roam free once more. “Desperate times call for desperate measures,” Trone said. “When London was bombed, they had to turn the lights off.” Trone says the borrowing of the stock is a mechanical process that is tracked and is recorded and can be monitored. He reasons that, if you bar short-sellers from the brokerage sector, you would have a more balanced free market:
“You’re free to sell the stock if you already own it. The true purpose is to have balance in the marketplace. Around 90% of the time the short-seller is taking that step based on the fundamentals of the company.” That isn’t true in this case, Trone says. Trone isn’t arguing for a general prohibition of the short-selling practice. There once were limits, contained in the so-called uptick rule that banned shorts from selling their shares while a stock was falling. That rule was in place from 1929 through 2007.
Still, his proposal is just one of several in discussion designed to tackle the apparent influence of short-selling rumors. For some, the ideal solution would be the enforcement of laws already in place concerning rumor mongering; technically, it is illegal to talk down a stock while profiting on its demise.
Stop Wall Street Rumors? Sure
Bank stocks swooned again Monday as rumors flew around trading desks about which bank would be the next to be taken out. But wait a minute Weren't we reassured on Sunday that the Securities and Exchange Commission was going to try to put a stop to rumormongering on Wall Street? Turn up the laugh track, please.
Rumors are as much a part of trading culture as spitting is a part of Major League Baseball. And like insider trading, intent is difficult to prove. One trader's rumor is another trader's conventional wisdom, and it doesn't take long for sentiment to grab hold, particularly when the slightest inkling of news is picked up and repeated ad nauseum on cable television.
No one wants to be the trader who has to tell a client he ignored a rumor as the stock plummeted. The market volatility and downward selling pressure of recent weeks make it all the more likely for a trader to sell first on hearing any hint of bad news and ask questions later.
Case in point: National City, the Ohio banking company that was besieged Monday by speculation about its future that sent its shares down more than 30% at one point. The company was forced to issue a statement that offered little relief. "National City is experiencing no unusual depositor or creditor activity," it said in the statement. "As of the close of Friday's business, the bank maintained more than $12 billion of excess short-term liquidity."
That's the kind of statement made by several financial institutions in recent months, some of which turned out to be, well, premature
Washington Mutual also fell Monday, down 34%, and the two lead regional banks were in a slump following the weekend's federal seizure of IndyMac Bancorp . WaMu came out after the closing bell and said it also has excess liquidity. Last week, Lehman Brothers and the government-sponsored entities Fannie Mae and Freddie Mac were the targets of rumors.
The SEC, which itself has been attacked for failing to stop the over-leveraged and speculative conditions that led to the credit crisis to begin with, is picking the most politically expedient but least effective way to show it's dealing with the financial markets crisis. The agency can't even enforce its existing rules regarding trade settlement for short-sellers, and has been dragging its feet on new rules that would tighten the activities of short-sellers in both the stock and options markets.
Fears grow of a global plastic meltdown
More than $1 trillion (£500 billion) is held on credit cards in America. In the UK, debts of more than £50 billion have been run up on the plastic. Across the world, somewhere between $2 trillion and $3 trillion is owed on credit cards.
Up to now, the credit crisis has passed by without plastic going into meltdown. Statistics have shown steady levels of arrears, and suggested that many consumers have been successfully paying off part of their balances. Now there are increasing signs that this last breakwater, shoring up the economies of the western world, is about to crack under ever-increasing strains.
“One of the indicators we watch very closely is unemployment as historically that has been quite closely correlated with deterioration in performance on credit cards,” said Anthony Jenkins, chief executive of Barclaycard. “Right now the employment situation in the UK seems to be relatively stable, but we’re obviously watching it carefully.”
News last week from Britain’s biggest housebuilders tells a different story, with Barratt, Persimmon and Taylor Wimpey all announcing thousands of job cuts. Industry estimates suggest the total number of unemployed brickies, plasterers and plumbers will hit 60,000 within a few short months. That comes in addition to the thousands of jobs that have already been lost in the City.
Analysts always say that “the markets get it right”. Current market prices suggest that more than 20% of the money owed on British credit cards is unlikely to be paid back. That would be almost three times higher than the previous record for bad credit-card debts, eclipsing the problems witnessed in the last housing crisis of the early 1990s.
“We are already hearing stories about people using their credit cards to keep up with their mortgage payments,” said Peter Crook, chief executive of Provident Financial, the door-to-door moneylender. “If that’s what’s happening, it’s a big red warning sign.”
The UK’s debt-strapped consumers currently owe a staggering £56 billion on credit cards. According to figures from Apacs, the payments network that supports the British banking system, this could climb to £160 billion if those 31m cards are used to the max. The figure takes account of all the measures already taken by credit-card issuers to clamp down on borrowers by rejecting card applications and cutting credit limits.
With that £100 billion cash pile, Britain’s credit-card holders would have enough money to buy Barclays, HBOS, Lloyds TSB, Royal Bank of Scotland and get about £20 billion change. On one level, this provides reassurance as it suggests that consumers still have some spare capacity in their finances. If the economy is destined for a prolonged recession, however, it is simply storing up the problem.
“Credit cards are definitely going to be one of the next big problems,” said Steve Nuttall, head of the financial-services research group at polling company YouGov. “Our research shows that everything started to fall off a cliff in about March or April and that should begin to show up in bad-debt charges by the end of the year.”
YouGov’s research suggests that 15% of the British public is now behind on at least one bill of some kind or another. Of those in trouble, 38% say they are behind with utility bills or council tax, while 31% cite credit cards as their big problem. Problems in credit-card debts have the potential to send a new wave of panic through global financial markets.
Roughly $600 billion of debts run up on credit cards around the world are swilling through the global financial system. Credit-card debts were packaged up and sold on by banks during the boom years, just like mortgages, car loans and the multiple billions of debt used to fund large private-equity deals. For the banks, it was a cheaper way to lend money to consumers at competitive interest rates.
The debts owed on thousands of credit cards were swept together and placed into a large bond, off the bank’s balance sheet. The pool of credit cards was then cut into slices, based on the likelihood that the credit-card company would get its money back. Other banks bought the best slices, which represented the money the credit-card company expected to be paid back, no matter what. The riskiest slices, which would be hit first if customers started missing their debt repayments, were sold to racy hedge funds.
Recession looms as Spain crumbles
The eurozone is tipping into a deeper downturn than America itself despite the tremors in the US mortgage industry, and may already be in full recession for the first time since the launch of the single currency.
Industrial production for the EMU bloc fell 1.9pc in May, according to fresh Eurostat data. It is the sharpest one-month decline for the region since the exchange rate crisis in 1992. Officials in Berlin have warned that Germany's economy could contract by as much as 1.5pc in the second quarter as export orders crumble.
Industrial output in both Italy and Greece has slumped 6.6pc over the past year. Portugal is off 6.2pc. "It is a very ugly picture: we're on maximum alert," said Emma Marcegaglia, head of Italy's business federation Confindustria.
Rome is now lobbying for a "New Deal" to revive Italy's economy through massive infrastructure projects. The idea is to use bonds issued by the European Investment Bank, allowing EU states to circumvent the 3pc limit on budget deficits imposed by the Maastricht Treaty.
Jacques Cailloux, Europe economist at the Royal Bank of Scotland, said a "reverse decoupling" is now under way as Europe goes down harder than the US - just as it did after the dotcom bust. "There is loss of momentum across the board. We can't exclude a recession," he said.
Spain is now spiralling into the worst crisis since the Franco dictatorship. "The economy is in dire straits," said Dominic Bryant, Spain expert at BNP Paribas."Some of the housebuilders are going to go bust, it is as simple as that. Over 10pc of Spain's economy has been building houses. This compares with 6pc-7pc in the US at the height of the bubble. The adjustment will be enormous," he said.
Fear haunted the Spanish property sector yesterday after the share price of developer Martinsa-Fadesa crashed by more than 50pc in two days, leading to a suspension in trading by the Madrid bourse. The real estate and shopping mall group has so far failed to secure refinancing for its €5.1bn (£4.1bn) debt. The board held an emergency meeting yesterday.
Finance minister Pedro Solbes said the Martinsa-Fadesa crisis was turning "more complicated" but denied that there is any risk of a chain reaction across the sector. Banco Popular is understood to be the most exposed bank.
The crunch engulfing Spain's property market is rapidly turning into a full-fledged national drama. The developers' association APCE said house prices had already fallen 15pc since September. Unemployment has risen by 425,000 over the past year, reaching 9.9pc.
Deutsche Bank said the property crisis is more serious that the collapse in the early 1990s. It expects a 35pc fall in real house prices by 2011 as the market slowly clears the vast overhang of property, now estimated at nearly 700,000 homes. In Castilla-La Mancha - Don Quixote's region - some 69pc of all houses built over the past three years are still unsold.
Spain's premier, Jose Luis Zapatero, blamed the European Central Bank for making matters worse by raising interest rates into the teeth of the crisis last week. He called the move "irresponsible". More than 98pc of home loans in Spain are priced off floating rates linked to Euribor, which has risen 145 basis points since August.
Mr Zapatero has resorted to a fiscal boost worth 1.5pc of GDP to help cushion the slump. But Spain's budget surplus is turning into a deficit as tax revenues collapse. Car sales, for instance, fell 31pc in May. The Bank of Spain is concerned about the health of smaller regional lenders with heavy exposure to the mortgage market.
Deputy governor Jose Vinals has called on banks to set aside more against bad debts. "Provisions need to keep rising throughout the year. Prudent coverage levels are needed to face this situation with confidence," he said.
The precipitous slide now under way in Europe has yet to cause investors to lose their ardour for the euro, but a number of analysts, including Bill Gross, head of the giant bond fund Pimco, say there is no justification for the euro's 25pc to 30pc over-valuation against the US dollar. "We're turning incredibly bearish on the euro," said BNP Paribas.
The counter argument is that the US has merely stolen growth from the future with this spring's one-off fiscal stimulus package. Dollar bears expect a nasty second leg to the crisis later this year, forcing the Fed to slash interest rates to 1pc or lower. Goldman Sachs said Europe is the "tie-breaker" for the whole global economy.
Who will pull out of the euro first?
Who will pull out of the euro first? Ireland, Spain or Italy? It might sound a bit far fetched to some people but actions speak louder than words. In Germany, savers are drawing money out of the bank and demanding that the euro notes are German euro notes. Is this a sign that some Europeans are starting to worry about the validity of their currency?
Each member of the Eurozone prints its own banknotes, according to its economic weight, and the notes are numbered in such a way as to make their country of origin identifiable. According to Ambrose Evans-Pritchard in the UK's Telegraph newspaper, Germans are avoiding notes with serial numbers from Italy, Spain, Portugal and Ireland, instead demanding notes with German numbers that start with an 'X'.
It may seem unusual to still think of the euro as a combination of different currencies but the same approach is applied to the government bonds issued by each Eurozone country. For instance, 10-year bonds issued by the Italian government are yielding 5.034%, compared to 4.422% for German 10-year bonds. French bonds are offering just 4.636%, compared to 5.089% for Greek bonds.
It is the financial strength of these countries that effectively combines to underpin the stability of the euro currency but there are clearly some variations in the governments doing the underpinning. However, a default on interest payments on government bonds would have a devastating effect on the currency and it is unlikely it would be allowed to happen in the Eurozone: the ECB would most likely step in.
But in the same way that investors are applying different ratings to government bonds from different issuers, German consumers are now applying the same approach to bank notes from different issues. In a world where currencies are no longer backed by hard assets such as gold, and rely completely on public confidence, it is not inconceivable that one country's people might panic and stop accepting notes that are issued by another country.
It might be wrong to do this, purely as a result of a lack of understanding of how the euro is supported by the combined strength of the Eurozone members, but crowd mentality is a powerful force and if people think they are at risk of losing all their money, they will react to save their skins. A run on the notes of a specific country is not totally inconceivable.
The most likely trigger for a run on a currency formed through monetary union is if the chances of one country dropping out were to increase significantly. There have been some weak rumours already about Italy dropping out of the euro but nothing that has caused a tangible effect.
However, the economic problems that some countries are experiencing are only going to get worse and investors need to be looking ahead. We could be on the verge of the greatest stress test the euro currency has ever undergone during its short life.
Over the past few years there has been massive expansion of the financial system in Spain, Ireland and Greece. Low interest rates, combined with a big increase in the number of available financial products on offer such as mortgages and personal loans, has propelled a huge and unprecedented take up in credit in these countries.
Borrowing has been available on a scale never seen before. Effectively the interest rate set by the ECB was too low for these high growth countries, having been kept down to support the much larger economy of struggling Germany, and this fuelled a boom in construction, housing and consumer spending.
However, higher inflation and higher lending rates brought about by the credit crunch have turned off the tap of cheap and easy credit and this is causing the economies of the PIGS countries (Portugal, Italy, Greece and Spain), along with Ireland, a great deal of pain.
These countries could now do with lower interest rates to help their rapidly-slowing economies but the ECB has to focus on the bigger picture and is compelled to fight high inflation and to take into account much better growth in Germany.
An economic recovery in Germany couldn't have come at a worse time. There has been a two-speed Europe for some time now. But the players have recently changed places and it is the former growth stars that are now in dire need of lower interest rates.
In the past, at times of severe economic weakness, a country always had the option of lowering interest rates, just as the US has done. However, even though Spanish GDP growth is expected to more than halve this year and Spain will struggle to avoid recession in 2009, it has no option but to accept the interest rates set by the ECB.
The Italian economy is also being crippled by a strong euro, and in pre-euro days it would almost certainly be considering either lowering interest rates significantly or devaluing the currency.
The real question is, how bad will things get for these countries that are suffering from a huge property crash, a sharp drop in consumer spending and declining demand for their exports? Will political pressure to do the right thing for the country be stronger than the desire to remain as part of the single currency?
UK home sales lowest in 30 years
Home sales fell to their lowest level in 30 years last month as the seizure in the mortgage market continued to drag house prices down.
Estate agents reported that they sold an average of 15 properties in the three months to the end of June, figures from the Royal Institution of Chartered Surveyors (RICS) show. That is nearly 40 per cent lower than the same period last year and the lowest figure recorded since RICS began its series in 1978.
House prices, which have been dragged down as sellers are forced to slash their asking prices to attract buyers, remain at near record lows, the RICS figures suggest. The balance of surveyors reporting house price falls rather than rises was 88 per cent in June, only a slight improvement from 92.2 per cent in May.
All surveyors in the West Midlands said prices were falling, while a balance of more than 90 per cent said prices continued to fall in Yorkshire and Humberside, the East Midlands, East Anglia and the South East. In London, 75 per cent reported price falls.
While falling house prices should be encouraging more buyers to the market, the number of new purchasers is being suppressed by a lack of home loans. Jeremy Leaf, of RICS, said: “Transaction levels remain incredibly low with many buyers cut out of the process by tight lending conditions.”
Mortgage lenders are demanding hefty deposits from first-time buyers as they attempt to protect their profits in the wake of the the credit crunch. Buyers who do not have the cash for a deposit of more than 5 per cent will find it impossible to secure a mortgage deal, while the best mortgage rates are reserved for those who have a downpayment of 25 per cent or more.
A balance of 35 per cent of surveyors reported falls rather than rises in buyer inquiries during June in England and Wales, while 14 per cent more surveyors reported falls in Scotland. The outlook for the housing market also remains gloomy, with nearly 70 per cent of surveyors in England and Wales expecting prices to fall.
However, there was a glimmer of hope as sales expectations improved for the second month in a row, although it still remains in negative territory. The lack of activity in the housing market is not only having a knock-on effect on firms of surveyors and estate agents, many of whom have had to cut jobs, but also housebuilders who are set to axe thousands of jobs.
Recent data from Halifax and Nationwide showing annual house price falls of more than 6per cent has prompted some economists to revise down their housing forecasts for the coming years. Global Insight forecasts house prices to fall by 15 per cent in 2008 and 12per cent in 2009, resulting in a 26 per cent drop in house prices since their peak in August last year. Capital Economics forecast a 35 per cent drop in house prices in the next three years.
This gloom was echoed by surveyors across the UK. Malcolm Parker, of Joplings Estate Agents in North Yorkshire said: “The market is as depressed as I have known it in over 30 years. The squeeze on lending has had a profound effect. The signs are that the rest of 2008 will be very difficult.” Jeremy Dell, of JJ Dell in Oswestry, said: “Restricted credit, high mortgage fees and expectations of lower property values equals the most difficult market for over 25 years.”
However, the Government is more upbeat about the housing market. A spokesman for the Department for Communities and Local Government said: “The long-term demand for housing remains high and the fundamentals of the economy are sound with low unemployment and historically low interest rates.”
British banks are still bleeding heavily
Why the big rush? After just a couple of days of talks, Alliance & Leicester yesterday agreed to sell itself to Spain’s Santander, for a price that would have looked pitiful even six months ago, when the two banks last discussed a possible deal. The speed with which negotiations were concluded reflects a certain urgency. And rightly so.
Last week was the scariest British banks have come through since the Northern Rock fiasco. Luckily, when private equity investor Texas Pacific Group dropped its plan to buy into Bradford & Bingley, some of B&B’s existing investors took up the slack instead. But TPG’s decision to walk away was hardly reassuring. The Santander deal solves one problem – what do to with A&L – but it’s not really all that comforting.
The British banking system is in a dreadful mess, and A&L was only a small part of that mess. Despite raising billions of pounds through rights issues, banks are still short of capital. The fresh cash from investors has done little more than replace money lost as a result of the US subprime crisis.
Meanwhile, more hits are on the way. As house prices continue to fall and consumers are squeezed by higher food and petrol prices, rising mortgage and credit card default rates will place further strain on banks’ balance sheets.
There had been growing doubts about the long-term viability of A&L as an independent entity, so at least, this time, British regulators were on the ball. In recent weeks, they have been working to ensure that neither B&B nor A&L would turn into another Northern Rock – by making sure, for example, a back-up plan for B&B was in place in case TPG pulled out.
Yesterday, A&L’s chief executive David Bennett said although the business was resilient, these were “clearly turbulent times” and the board could not see the environment improving. He didn’t really explain why the deal had to be done so speedily. But I had a picture in my head of Financial Services Authority boss Hector Sants happily making a big tick on his To Do list.
There may also be a small tick next to B&B’s name, following its fresh financing, but it still looks like a bank in need of a new owner in the long term. The fact that potential buyers are looking at the financial services sector does not mean that prices have stopped falling.
Investors such as TPG take a long-term view and know they must buy when banks need their money, rather than at the bottom of the market. For Santander, Europe’s second largest bank and owner of Abbey, A&L is a drop in the ocean.
Many UK banks can’t afford to pitch in and, in any case, putting two weak banks together wouldn’t solve any problems. It is far less likely that there would be any takers for bigger banks under pressure. So it looks as if the UK’s credit crisis has further to run. Until now, the US market has proved a fairly accurate indicator of impending doom over here.
Mortgage defaults, collapsing house prices, the squeeze on banks’ capital: you saw it there first. Emergency measures at the weekend to prop up the two US government-sponsored mortgage giants, known as Fannie Mae and Freddie Mac, helped stabilise the market, after fresh turmoil last week. But the need for the US authorities to step in quite so dramatically scuppers hopes that the worst is over.
On recent form, that is a sign that the downward slide has even further to go in the UK. There is no equivalent to Fannie and Freddie, which between them finance or guarantee more than $5 trillion of US mortgages. And the US is rather kinder to its mortgage-holders than we are: in some states, banks have no redress if homeowners simply hand back the keys to their properties.
San Diego-based You Walk Away dangles this seductive prospect: “What if you could live payment free for up to 8 months or more and walk away without owing a penny?” Despite the structural differences, the end result for both economies looks rather similar. Things are so bad that no financial institution of any significant size can be allowed to fail.
In practice, both governments – in other words, taxpayers – are implicitly underwriting big financial institutions, whether they are quasi-state mortgage lenders or banks. In other words, the market discipline which politicians on both sides of the Atlantic like to preach about has been, at least temporarily, abandoned. For now, neither government has any real choice.
The alternative is a potential collapse of confidence in the financial system. But this does not alter the fact that the situation already represents a colossal failure. For now, we are stuck with a system which allows troubled banks to post their keys through the taxpayers’ door and walk away.
UK nationalization scheme to help cash-strapped homeowners
Homeowners struggling to meet their mortgage payments would be able to sell their homes to the local authority and rent them back as tenants under radical proposals being considered by the government to prevent the misery of repossession.
Emergency measures to allow families to keep a roof over their heads are being drawn up as the scale of repossessions proceedings becomes increasingly apparent. In Newcastle upon Tyne alone, the newly nationalised Northern Rock is monopolising at least one day a week in the county court to pursue defaulting borrowers.
The latest rescue package reflects growing fears about the seriousness of the crisis, with some analysts predicting that house prices could fall by 35 per cent. Ministers are worried about the 13 per cent of fixed-rate borrowers whose cheap deals expire this year, some of whom may by then be in negative equity and therefore unable to switch to a new fixed rate with another lender.
Caroline Flint, the Housing Minister, told The Observer yesterday: 'I am looking at what more we can do with our colleagues in local authorities - what they can do as well as actually building [homes], and what support they could give to people who might be feeling under pressure on mortgages.'
Asked to confirm that she was considering rent-back schemes, enabling homeowners to become council tenants in their original houses rather than be repossessed, she said: 'We are looking at that. I have to be certain that the choices I make do actually help to limit the damage; and, importantly, is it a short-term fix or a long-term impact?'
The scheme would be expensive. Councils would need central government funds to buy the houses. But it could save on the long-term costs of rehousing homeless families and allow councils to increase their housing stock at relatively low prices.
Flint also suggested the Bank of England could increase the size of its £50bn fund designed to stimulate mortgage lending, admitting she was 'disappointed' that the cash that has been pumped in so far had not led to cheaper home loans. 'No doubt our colleagues in the Bank and the Monetary Policy Committee will also be looking at the issue in terms of whether any extra has to be provided,' she added.
She has suggested that country landowners could be freed to build cheap houses for their workers on their own land, in a return to the system of 'tied cottages'. 'It's recognising that sense of community and how everybody has a part to play,' she said.
Debt advice experts warned yesterday that, despite the Chancellor's calls for leniency from lenders, Northern Rock was now aggressively pursuing defaulting borrowers as part of its efforts to repay the £25bn rescue package it received from the government.
Chris Jary, director of Action for Debt in Durham, said: 'There used to be a small group of sub-prime lenders who you knew would always go straight to court. But recently it's Northern Rock who have become more aggressive, taking legal action as soon as they can.' House repossessions at Northern Rock are running at twice the rate they were before the bank was nationalised in February.
German confidence in economy hits record low
German investor confidence fell to a record in July as surging inflation and rising interest rates dimmed the outlook for growth in Europe's largest economy.
The ZEW Center for European Economic Research in Mannheim said its index of investor and analyst expectations fell to minus 63.9, the lowest since it was first compiled in December 1991, from minus 52.4 in June. Economists expected a decline to minus 55, according to the median of 37 forecasts in a Bloomberg News survey.
Record oil and food prices prompted the European Central Bank to raise its key rate by a quarter point to 4.25 percent this month, further squeezing purchasing power. As a stronger euro weighs on exports and the U.S. housing slump damps confidence worldwide, Germany's benchmark DAX share index has dropped 7 percent in the past month and 23 percent this year.
"The decline in stock markets as well as the second wave of negative financial market news certainly burdened sentiment," said Alexander Koch, an economist at UniCredit Markets & Investment Banking in Munich. "Freddie Mac and Fannie Mae fit into the picture perfectly." Shares in Fannie Mae and Freddie Mac, which buy or finance almost half the $12 trillion of U.S. mortgages, lost about half their value last week on concern they will run short of capital.
Treasury Secretary Henry Paulson Jr. has asked Congress for authority to buy unlimited stakes in and lend to the companies, aiming to stem a collapse in confidence. "Expectations are very negative, reflecting increased global risks," said Sandra Schmidt, an economist at the ZEW. "We have very high oil prices, the strong euro, which appreciated further, the U.S. crisis, the ECB has raised interest rates and also consumer demand should continue to weaken."
Heidelberger Druckmaschinen, the world's largest printing-press maker, said last week demand faces a "prolonged" slowdown and that it probably had its first quarterly loss since 2005 in the three months through June. The company plans to cut 500 jobs as it struggles with falling orders from cash-strapped producers of brochures and labels whose markets have been hit by a global credit squeeze.
"We can expect rather weak economic development over the coming months," said Gerd Hassel, an economist at BHF Bank in Frankfurt. "We have negative factors from the crude-oil side, the euro exchange rate is certainly weighing on exporters and Ifo business expectations have also considerably declined."
ZEW's survey aims to predict economic developments six months ahead. A negative reading means pessimists outnumber optimists.
Germany's economy probably shrank in the three months through June, Deputy Economy Minister Walther Otremba said last month. Economic growth may slow to 1 percent in 2009 from 2.4 percent this year, the Munich-based Ifo institute said June 24, a day after reporting that its gauge of business confidence dropped to a two-year low.
"The cooling of world economic activity will damp foreign sales and the stronger euro is an additional restricting factor," Ifo said. Europe's single currency has gained 15 percent against the dollar over the past year, while the crisis in U.S. subprime mortgages has roiled financial markets and damped the outlook for global growth. The world's biggest financial companies have posted more than $415 billion in writedowns and credit losses since the start of last year.
Still, Germany's gross domestic product, which accounts for about a third of the euro-region economy, rose 1.5 percent in the first quarter from the previous three-month period as companies stepped up spending on machinery and construction. Economic growth is likely to be "more subdued" in the second and third quarters before picking up again at the end of the year, Germany's Bundesbank said last month.
ECB policy makers say Europe's economic fundamentals are sound and that they're more concerned about inflation, which has accelerated to 4 percent, the fastest in more than 16 years.