Photograph: Science Photo Library
Ilargi: We’re halfway through the week, and I’m already getting tired of it all. I don’t know if that’s a good thing or not. Of course there’s a something rewarding in seeing events that you’ve predicted for a long time, come to fruition. Yes, even if the events are negative and hurtful. At least I’ve had the chance to warn a few people away from even greater harm. But it's not too exciting when life is this predictable.
Now that we see the whole stinking flower unfold, the attention for, and the amount of publications on, the topic, goes through the ceiling. And with that, so does the lying and the plain nonsense.
I don’t want to hear Bernanke anymore. He hasn’t spoken one sincere word since taking office, and he’s not going to start now. Nobody listens to Bush. Paulson is a Trojan Horse for Goldman. The SEC’s Chris Cox wails way too loudly about speculation and short selling; it’s now illegal to sell shorts in a craftfully selected 19 companies. Let’s all short the next 19, and teach them a lesson.
Many of Cox’s and Paulson’s and Ben’s and W’s friends have made fortunes shorting stock, and now they just change the laws, overnight?! Good morning America. Your new capital is called Sofia, and you’re now located on the Black Sea.
I see Consumer Price Index numbers float by, and know they are so thoroughly cooked that they’re meaningless. Manufacturing looks much better than expected, but I for one expected nothing else.
There’s not a single blot of red ink in the Dow, and that too fits all the patterns: the suckers are being sucked in again, only to be stripped of ever more of their capital. It’s doubtful the sucker rally will last even till closing time today, but late Friday is when it really counts, after Citigroup and JPMorgan have published their numbers.
Global trust in US markets is now so shaky, we have to start wondering if there is still space left for that infamous predicted rally before the tempest. The US dollar keeps on falling vs the Euro, evem while stocks are flourishing. For all I know, it’ll all be downhill from here on in. For the rest of the day, I plan to sit outside, do a little digging and stuff, have a beer and chill.
Oil is down again, and ain't we all glad? The government piles on trillions of dollars of debt on our tabs, and we rejoice when we pay a few cents less per gallon or liter. I told you, fruit flies. Put them on a pile of rotting bananas, and they're having a ball. Sound familiar?
US global funding crisis imminent
The US Treasury may have just days to act before foreign patience snaps. Merrill Lynch has warned that the United States could face a foreign "financing crisis" within months as the full consequences of the Fannie Mae and Freddie Mac mortgage debacle spread through the world.
The country depends on Asian, Russian and Middle Eastern investors to fund much of its $700bn (£350bn) current account deficit, leaving it far more vulnerable to a collapse of confidence than Japan in the early 1990s after the Nikkei bubble burst. Britain and other Anglo-Saxon deficit states could face a similar retreat by foreign investors.
"Japan was able to cut its interest rates to zero," said Alex Patelis, Merrill's head of international economics. "It would be very difficult for the US to do this. Foreigners will not be willing to supply the capital. Nobody knows where the limit lies." Brian Bethune, chief financial economist at Global Insight, said the US Treasury had two or three days to put real money behind its rescue plan for Fannie and Freddie or face a dangerous crisis that could spiral out of control.
"This is not the time for policy-makers to underestimate, once again, the systemic risks to the financial system and the huge damage this would impose on the economy. Bold, aggressive action is needed, and needed now," he said. Mr Bethune said the Treasury would have to inject up $20bn in fresh capital. This in turn might draw in a further $20bn in private money. Funds on this scale would be enough to see the two agencies through any scenario short of a meltdown in the US prime property market.
He said concerns about "moral hazard" - stoked by hard-line free-marketeers at the White House and vocal parts of the US media - were holding up a solution. "We can't dither. The markets can be brutal. We have to break the chain of contagion before confidence is destroyed." Fannie and Freddie - the world's two biggest financial institutions - make up almost half the $12 trillion US mortgage industry.
But that understates their vital importance at this juncture. They are now serving as lender of last resort to the housing market, providing 80pc of all new home loans. Roughly $1.5 trillion of Fannie and Freddie AAA-rated debt - as well as other US "government-sponsored enterprises" - is now in foreign hands. The great unknown is whether foreign patience will snap as losses mount and the dollar slides.
Hiroshi Watanabe, Japan's chief regulator, rattled the markets yesterday when he urged Japanese banks and life insurance companies to treat US agency debt with caution. The two sets of institutions hold an estimated $56bn of these bonds. Mitsubishi UFJ holds $3bn. Nippon Life has $2.5bn.
But the lion's share is held by the central banks of China, Russia and petro-powers. These countries could all too easily precipitate a run on the dollar in the current climate and bring the United States to its knees, should they decide that it is in their strategic interest to do so.
Mr Patelis said it was unlikely that any would want to trigger a fire-sale by dumping their holdings on the market. Instead, they will probably accumulate US and Anglo-Saxon debt at a slower rate. That alone will be enough to leave deficit countries struggling to plug the capital gap. "I don't see how the current situation can continue beyond six months," he said.
Merrill Lynch said foreign governments had added $241bn of US agency debt over the past year alone as their foreign reserves exploded, accounting for a third of total financing for the US current account deficit. (They now own $985bn in all.) By most estimates, China holds around $400bn, Russia $150bn and Saudi Arabia and other Gulf states at least $200bn.
Global inflation is now intruding with a vengeance as well. Much of Asia is having to raise rates aggressively, drawing capital away from North America. This may push up yields on US Treasuries and bonds, tightening the credit screw at a time when the US is already mired in slump.
Russia's deputy finance minister, Dmitry Pankin, said the collapse in the share prices of Fannie and Freddie over the past week was irrelevant because their debt has been effectively guaranteed by the US government under the rescue package. "We don't see a reason to change anything because the rating of the debt of those agencies hasn't changed," he said. Foreign policy experts doubt that the picture is so simple.
Russia is likely to use its $530bn reserves as an implicit bargaining chip in high-stakes diplomacy, perhaps to discourage the US from extending Nato membership to the Ukraine and Georgia. Vladimir Putin, now Russia's premier, has stated repeatedly that his country is engaged in a new Cold War with the United States. It is clear that Moscow would relish any chance to humiliate the United States, provided the costs of doing so were not too high for Russia itself.
China is regarded as a more reliable partner, with a greater desire for global stability. Treasury Secretary Hank Paulson has intimate relations with the Chinese elite, dating from his days at Goldman Sachs when he visited the country over 70 times. Brad Setser, from the US Council on Foreign Relations, said the Chinese have a stake in upholding Fannie and Freddie, not least to ensure that their loans are "honoured on time and in full".
David Bloom, currency chief at HSBC, said fears that regional banks could start toppling after the Fed takeover of IndyMac last week were now the biggest threat to the dollar. "We have a pure dollar sell-off," he said. "It's a hating competition: at the moment the markets hate the dollar more than they hate the euro, even though German's ZEW confidence indicator was absolutely atrocious."
Short-Seller Ackman's Plan Renews Fears For Freddie, Fannie Shares
A well-known investor suggested Tuesday a rescue plan for Freddie Mac and Fannie Mae that would render the mortgage giants' shares worthless - and, at the same time, garner him a tidy profit.
The proposal by hedge fund manager William Ackman - accompanied by a disclosure that he would gain by a drop in the value of the stocks - exacerbated the uncertainty already swirling among investors around the value of their shares.
In dumping their shares, investors appeared to shrug off the obvious conflict of interest that Ackman has - his proposed restructuring plan for government- sponsored enterprises renders worthless Freddie and Fannie stock. At the same time, with his fund's current trading position of being short the companies' stock, Ackman benefits from a fall in their stock prices.
By 2 p.m. EDT Tuesday, Ackman, who oversees $6 billion at hedge fund Pershing Square Capital Management, had already made a profit on his trading position as the companies' stocks had fallen by more than 20%.
The stocks' move comes on the back of federal support for the government- sponsored companies and after a statement Friday from Treasury Secretary Henry Paulson that the government's focus was on supporting Fannie and Freddie "in their current form."
"You'd think a statement from the Treasury secretary would have more credibility than from someone who's short the stock," said Richard Pzena, head of Pzena Investment Management LLC. In the first quarter this year, the money manager had increased its stock holdings in the two companies slightly, holding 23.83 million shares in Fannie and 31.24 million shares in Freddie, according to FactSet data.
The two companies, chartered by Congress to promote homeownership, are the dominant providers of funding to the U.S. housing market, owning or guaranteeing about $5 trillion of mortgages or nearly half of all U.S. home-mortgage debt outstanding. Therefore, their financial well-being is vital to the economy.
Ackman said in an interview Tuesday morning with CNBC television that he was betting the stock prices of Freddie and Fannie would fall. At the same time, he unveiled his restructuring plan that advocates writing off the companies' preferred and common shares.
In the interview, Ackman proposed giving holders of senior Fannie debt new debt worth 90 cents for each dollar as well as 10 cents of equity in the new company. Under his plan - outlined in a presentation entitled "How to Save Fannie and Freddie" and sent to Dow Jones Newswires - holders of junior Fannie debt would get warrants, while common and preferred shareholders would get nothing. "The same logic applies to Freddie," noted one slide in the presentation. Ackman wasn't available for comment.
"I would again reiterate that Freddie has strong liquidity and is well- capitalized. We would like to remind people that we continue to be in the market every day buying billions of dollars in mortgages from lenders and enjoy access to world's capital markets," said company spokeswoman Sharon McHale. "It is important for people to remember the facts and not the fear."
In the CNBC interview, Ackman said one of the advantages of the plan is that it would likely not cost the government anything. However, he suggested that the government agree to buy back the new Fannie equity at cost for three years. Ackman said he had spoken to senators as well as Treasury and Federal Reserve officials. Spokespersons from the Treasury and the Fed weren't available for comment.
Ackman told CNBC he began betting earlier this month that the stocks of the two companies would fall further.
"I'm hoping people see his motive, that he has an incentive for equity holders to get nothing," said one person familiar with the companies.
Ackman, 42 years old, is known for his activist campaigns involving several high-profile companies whose stocks he owned, including McDonald's Corp. and Wendy's. He also garnered a lot of attention when he publicly denounced bond insurer MBIA Inc., a company whose stock he was shorting. That position turned out to be a profitable one.
Besides buying and shorting equities, Ackman is known for limiting his risk by trading large quantities of options in the companies he invests in. His portfolio is extremely concentrated: According to his fund's most recent filings, he only has 10 long positions. Typically, investors are not required to disclose their short positions.
Ackman's plan, "though unlikely to be implemented, again brought to the forefront shareholders' concerns about what the equity is worth" in Freddie and Fannie, said one investor. Separately, U.S. securities regulators said Tuesday they are putting new restrictions in place to prevent short-selling abuses involving shares of Freddie and Fannie.
Securities and Exchange Commission Chairman Christopher Cox told the Senate Banking Committee that the SEC will require short-sellers to pre-borrow shares before engaging in short sales of Fannie or Freddie. Cox said the new restrictions are called for under an emergency order.
Short sellers borrow shares for sale in hopes of profiting by replacing the borrowed shares at a lower price. "Naked" short sellers don't borrow shares in advance of short sales, a practice that critics say can have punishing effects on a stock's price.
As of June 30, the date of the most recent data from the New York Stock Exchange, 82.8 million of Freddie's 646.1 million shares were being shorted, and 138.7 million of Fannie's 982.3 million shares were being shorted.
"As a society we need to be careful that people who are proposing solutions don't unfairly benefit from it," said Ganesh Mani, an adjunct professor at Carnegie Mellon University.
Customers furious in Day 2 of IndyMac fed takeover
Police ordered angry customers lined up outside an IndyMac Bank branch to remain calm or face arrest Tuesday as they tried to pull their money on the second day of the failed institution's federal takeover.
At least three police squad cars showed up early Tuesday as tensions rose outside the San Fernando Valley branch of Pasadena-based IndyMac. Federal regulators seized Pasadena-based IndyMac on Friday and reopened the bank Monday under the control of the Federal Deposit Insurance Corporation. Deposits to $100,000 are fully insured by the FDIC.
Worried customers with deposits in excess of insured limits flooded IndyMac Bank branches on Monday, demanding to withdraw as much money as they could or get answers about the fate of their funds. When it was clear some wouldn't get in before closing, FDIC employees apparently took down names and told them to return Tuesday.
Other customers began lining up at 1:30 a.m. Tuesday, and by dawn, tensions escalated because people on the list were getting priority. By 8 a.m., about 50 people on the list waited in one line and many more waited in another. Five people were allowed in at a time.
Customers became infuriated, and police told them they could be arrested if they didn't remain calm. Police stood by at some other branches around Southern California but there were no other reports of problems.
European, Asian stocks see fresh selling
World stocks fell towards this week's 21-month low and the dollar approached a record low versus the euro on Wednesday as investors nursed acute worries about the financial sector. U.S. crude oil fell further after posting its biggest one-day drop on Tuesday since 1991, when prices tumbled at the start of Operation Desert Storm.
But any support for risky assets quickly evaporated as investors started selling banking and other stocks, fearing the U.S. credit crisis could spur more bank failures. Such fears, prompted by troubles in U.S. mortgage firms, intensified after Federal Reserve chief Ben Bernanke said financial markets remained under considerable stress and the economic and inflation outlook was unusually uncertain.
“We've had the problems in the United States with IndyMac and Freddie and Fannie, so plenty of news but nothing very specific on policy that is addressing the core issues,” said Colin McLean, managing director of SVM Asset Management in Edinburgh.
This week's U.S. bailout plan for mortgage giants Fannie Mae and Freddie Mac and an emergency U.S. rule on Tuesday to limit certain types of short selling in financial firms also failed to stem selling.
The FTSEurofirst 300 index was down 1.4 per cent while MSCI main world equity index fell 0.5 per cent on the day, inching closer to the previous day's low. U.S. stock futures were pointing to a weaker open on Wall Street later. The dollar was down 0.1 per cent to $1.5935 per euro after falling as low as $1.6038 on Tuesday.
The rule on short selling issued by the U.S. Securities and Exchange Commission, which aims to clamp down on market manipulation that some blame for the sharp declines in financial stocks, will go into effect on Monday, July 21. “This SEC story is something that the market is focusing on, and if it actually proved successful in stabilizing the financials, it will also help stabilize the dollar,” said Paul Mackel, strategist at HSBC.
“But the dollar is still on a knife edge and the sentiment is still very, very poor.” Emerging sovereign bond spreads widened 1 basis point while emerging stocks fell 0.5 per cent to hit a new low for 2008. The September Bund future rose 25 ticks, underpinned by investor jitters over the economy. U.S. light crude was down 1.4 per cent to $136.76 a barrel after dropping as low as $135.92. Gold ticked higher to $974.40 an ounce.
US bank shares sink to 1996 levels on loss fears
U.S. bank shares fell to their lowest level since 1996 on fears of greater credit losses for an already battered sector. The 24-member KBW Bank Index <.BKX>, consisting mainly of the biggest U.S. banks, fell as much as 7 percent on Tuesday.
They closed down 3.1 percent, recovering some losses after Federal Reserve Chairman Ben Bernanke affirmed that helping financial markets return to normal functioning was a top priority for the central bank. Among large U.S. banking companies, shares of Citigroup Inc fell 4.3 percent, Bank of America Corp slid 8.1 percent, Wachovia Corp fell 7.7 percent, and even JPMorgan Chase & Co , considered among the healthiest big banks, dipped 2.1 percent.
"Skepticism remains related to all the credit issues," said Alan Gayle, senior investment strategist at Trusco Capital Management in Atlanta. More negative news came from Minneapolis-based U.S. Bancorp , which said credit losses contributed to a surprisingly large 18 percent drop in second-quarter profit.
The sixth-largest U.S. bank tripled the sum it set aside for bad loans, largely because of the declining housing market, amid what Chief Executive Richard Davis called a "challenging and stressful" economic environment. Its shares closed down 2.7 percent, despite enjoying a brief rally after Davis said he intended to raise the bank's dividend.
"Everyone was broadsided as to how quickly house prices eroded this year," Oppenheimer & Co analyst Meredith Whitney said on a conference call. She said the idea the year-long credit crisis is close to over is "factually not possible." In his semi-annual monetary policy report to Congress, Bernanke said rising energy costs, tight credit and a further contraction in housing are significant downside risks to the economy, even as inflation fears intensify.
He also said consumers and businesses are likely to be cautious with spending for the rest of the year. This could result in lower borrowing needs and higher competition among lenders for business, crimping margins and profitability. Bernanke nevertheless said that despite the "considerable stress" in financial markets, the banking sector remained well-capitalized.
Whitney also downgraded Wachovia Corp to "underperform" from "perform," saying shareholders of the fourth-largest U.S. bank face a "bleak" outlook as losses from adjustable-rate mortgages climb. "Expenses simply cannot come down fast enough thus seriously jeopardizing Wachovia's ability to grow earnings," she wrote.
Meanwhile, the slide in shares of Fannie Mae and Freddie Mac deepened, despite Sunday's plan orchestrated by U.S. Treasury Secretary Henry Paulson to extend more credit or buy stakes in the mortgage finance companies. Paulson said on Tuesday the government plan was designed as a backstop, and that the government had no intention of investing taxpayer money in the companies now.
Fannie shares closed Tuesday down 27.3 percent, and have fallen 31 percent this week. Freddie shares fell 26 percent on Tuesday, and are down 32.1 percent this week. Investors also have been on edge by speculating on which banks might be next to fail after federal regulators on Friday seized IndyMac Bancorp Inc , the nation's ninth-largest mortgage lender in 2007 and one of its largest savings and loans.
Are big-picture blues priced into the financials?
The finance-based dike has sprung a lot of leaks. It remains to be seen how many fingers are left to plug the holes.
We can discuss the moral hazard of privatizing gains and socializing losses until we're blue in the face. Much like the Iraq war, the debate whether we should be there in the first place is now moot. Pulling out at this point, in either instance, would have profound consequences for the world at large.
The government had little choice but to backstop the debt of Fannie Mae and Freddie Mac. I don't like eating the bar tab either, but given the $5 trillion of underlying mortgages, they're the textbook definition of "too big to fail." Lost in the shuffle to rescue government-sponsored agencies, IndyMac Bancorp was absorbed by the Federal Deposit Insurance Company (FDIC). That seismic shift shocked an already-shaky financial foundation desperately looking for signs of stability.
Given that 25% of the financial universe disappeared in the 1989-1991 recession and only 10% thus far vanished during our current crisis, there's no denying that real risks remain for many banks. The question for the sector -- and by extension the broader market -- is how that weeding-out process manifests. In other words, can the contagion be contained?
The DNA of the current marketplace is an historical anomaly. Policy makers never let us digest the overcapacity from the technology bubble, and cumulative imbalances have steadily built under the seemingly calm surface. There is indeed a difference between legitimate economic growth and debt-induced demand, and that dichotomy has come home to roost.
During the same period, financial engineering recreated and repackaged risk that effectively passed the buck. Our economy, once rooted in manufacturing, shifted from service-based to finance-based, dependent on the velocity of money and the prices of financial assets. Fannie and Freddie generated that velocity and their inability to execute exacerbated the current conundrum.
When the private sector could no longer shoulder the load, the government stepped in to assume the obligations.
They unleashed a litany of conduits, auction facilities, working groups and lending windows with hopes of muting the deleveraging process. On Monday, Hank Paulson took the final step of socialization when he proposed a plan to buy the equity of Fannie and Freddie.
While cracks in the financial foundation are now front-page news, the writing has been on the wall since last summer. You remember that period -- the Dow Jones Industrial Average was at record levels, the banks were 60% higher and despite obvious signs, we were hard-pressed to find a single bear on the corner of Wall and Broad streets.
Fast-forward one year. Fears of a complete market seizure are running rampant. Well-known market pundits are proclaiming that real estate will never recover. Oversold indicators, including those used by savvy seers such as Jeff Saut of Raymond James and Lowry's, were recently at decade, if not all-time, lows.
Toss in the capitulation of the analyst community -- 18 of 22 analysts have "holds" or "sells" on Wachovia Bank, 15 of 16 have a similar stance on Washington Mutual and 20 out of 21 are negative on KeyCorp -- and, baring the doomsday scenario, the stage is set for a sharp, mean-reverting rally.
Seeing Bad Loans, Investors Flee From Bank Shares
On Wall Street, the run is on. Bank stocks spun wildly on Tuesday in another bruising day for financial companies. Goaded by bearish analysts, investors seem to be abandoning American banks in droves.
While a fraction of the nation’s banks are expected to buckle under their growing burden of bad loans, federal regulators, bank executives and analysts agree that the vast majority of institutions are sound. Bank customers are not panicking, particularly since most of their deposits are insured.
But shareholders, whose investments are by no means guaranteed, are running scared. It is becoming increasingly clear that even the strongest banks will be grappling with bad loans for years — and that the outlook for the industry could worsen further if the economy and the housing market continue to weaken. The collapse of IndyMac Bancorp last week fanned long-smoldering worries that even healthy banks confront significant challenges.
The marketplace is passing harsh judgment on an industry that was a darling of Wall Street when home prices and mortgage lending boomed in recent years. The mood darkened further on Tuesday, when the Wachovia Corporation was compelled to assert that it was sound as its share price was swept lower for a fifth day. Wachovia fell nearly 8 percent, leaving it down 76 percent this year.
The 12-stock Standard & Poor’s 500 Regional Banks index sank nearly 4 percent, extending its 11 percent decline from Monday. Financial companies like the American International Group, Bank of America and Citigroup pulled the Dow Jones industrial average down nearly 1 percent.
It is a stark reversal of fortune for the banking industry, and for regional lenders in particular. Many regional banks, big enough to have some heft, but small enough to be managed effectively, rode the mortgage boom to higher profits. Many avoided the alphabet soup of complex debt investments that have cost big banks tens of billions of dollars.
Only a year ago, many of these banks looked like attractive takeover targets, and investors placed hefty premiums to their share prices. Now all of that has changed, and the missteps the banks made in good times are glaring. Investors are recoiling from banks that overreached with what turned out to be ill-fated acquisitions.
Lenders that need to raise capital are also being shunned, as are those that have made many loans to builders. “The whole allure of regional banks has gone out of fashion,” said David Hendler, a research analyst at Credit Sights in New York. “They used to have the best perfume in the business. Now, they have an odor.”
The National City Corporation of Cleveland, for example, expanded into Florida just before the bottom fell out of the housing market there. The bank recently raised $7 billion to shore up its finances, and said on Monday that its Tier 1 capital ratio, an important measure of a bank’s financial health, ranked among the highest in its class. A bank must have a capital ratio of 6 percent to be considered well-capitalized.
Despite such assurances, National City has lost nearly 90 percent of its value in the last year. It sank 4.5 percent on Tuesday Other banks that once seemed like attractive takeover targets now look like pariahs. SunTrust Banks of Atlanta, which was soaring a year ago on hopes that it might be acquired at a lofty price, has plummeted nearly 70 percent this year, as the prospect of a sale has been mired in losses.
A year ago, SunTrust, rumored to be a target of JPMorgan Chase, was trading at 1.5 times the value of the assets on its books. Today, it fetches a mere 0.5 times book value. Given the turmoil in the markets, some banks are struggling to raise capital from investors. So far, most investors who have bought into financial companies in the hope that the worst was over have lost big.
Of 52 fund-raising efforts tracked by Goldman Sachs, investors have come out ahead at only two banks — Fifth Third of Cincinnati and Western Alliance of Las Vegas — where they injected money. The average deal was down 45 percent. Investors are reluctant to sink more money into regional banks, fearing their investments will be diluted if the banks sell even more stock.
Even the whiff of bad news can send a stock falling. Zions Bancorporation, a Utah-based lender which barreled into construction lending in once-hot markets like Nevada and California, planned to use its in-house brokerage arm to raise $150 million in a series of deals. But when it raised only about $47 million in its first attempt, investors concluded the bank was struggling to raise cash.
“The stock has literally cratered,” said Richard X. Bove, a prominent banking analyst. “It has just fallen apart.”
There were some bright spots on Tuesday. Shares of the First Horizon National Corporation, the largest bank in Tennessee, jumped nearly 17 percent after the bank’s chief executive offered assurances that the bank has enough capital. The stock is still down 67 percent this year.
As the losses deepen, many investors are asking the same question: Where’s the bottom? Chip MacDonald, the banking lawyer at Jones Day, said the rapid sell-off and the Treasury Department’s actions to shore up the mortgage finance companies might suggest the market is about to turn the corner. “I think the events of the last week might be a sign,” he said. Many others see just another false bottom.
Europe's Economy Takes a Hit
Just a few weeks ago, Europe thought it could escape the worst of the global slowdown. Now it looks like the euro zone, the world's second-largest economy, is headed for a hard landing and perhaps recession, compounding growth troubles around the world.
On Tuesday, Spain suffered its largest-ever business failure as construction group Martinsa-Fadesa SA, a company with assets of €10.8 billion, or about $17.17 billion, filed for bankruptcy protection, making it the biggest victim so far of Europe's bursting real-estate bubbles.
That same day, the euro, boosted by the central bank's inflation-fighting efforts and fears of financial-sector fragility in the U.S., briefly reached a record high of over $1.60, posing a further threat to Europe's export sector. And an index of investor sentiment in Germany, Europe's biggest economy, fell to its lowest level since the recession of the early 1990s.
The rising risk of recession in Europe shows that despite the strength of emerging markets such as Russia and China, the economic downturn that began in the U.S. last year is spreading to other regions. That is battering hopes that the global economy might have "decoupled" just enough from America's that the rest of the world could ride out a U.S. slump relatively unscathed.
One sign that many investors no longer believe in decoupling: Stock markets in Europe and Asia tumbled Tuesday in the wake of the U.S. government's rescue package for mortgage behemoths Freddie Mac and Fannie Mae. Analysts say investors fear the rescue indicates that troubles in the U.S. are severe and will hit economies elsewhere.
In Tokyo, shares in Sumitomo Mitsui Financial Group, Japan's largest bank by market value, fell 6.1%, helping to send the Nikkei 225 Stock Average Index down 2% to a three-month low. London's FTSE 100 index fell 2.4% to 5171.9.
Europe's banking and property sectors are increasingly feeling the fallout from the housing-market and financial-sector turmoil across the Atlantic. Although Europe had little subprime lending of its own, many European banks lost money on U.S. mortgage-related securities, causing bank funding costs to rise and forcing banks to rein in their property lending at home.
Earlier this year, the euro zone's $12.2 trillion economy, second in size only to America's, was looking fairly solid. Exports to emerging markets and business investment were healthy, especially in Germany, the zone's largest single member economy.
French household spending, a longtime source of growth, hadn't sputtered. Spain's red-hot housing market was cooling off gradually. The European Central Bank remained relatively optimistic about the bloc's prospects. And Europe's main stock markets began recovering, driven by hopes the Continent would weather the global storm.
But since mid-May, the European stock markets have slid. "All of the sources of growth are in trouble. It's not clear where the recovery is going to come from," says Michael Hume, European economist at Lehman Brothers who believes there's a 40% chance of an outright recession in the euro currency area this year.
The critical change has come in Germany. Stung by the strong euro and rising costs, Germany's previously booming manufacturers have suffered declining new orders for six months in a row. "I'm asking myself: Which markets are still functioning?" says Rainer Hundsdörfer, director of Michael Weinig AG, a midsize German company that makes wood-processing machines used to build furniture and fittings.
He says new orders from the rest of Europe "are crumbling," weak business in the U.S. has been made worse by the high euro, and many customers in Asia and Latin America have stopped investing in new machines because they rely on exports to the slowing U.S. economy.
The ECB continues to predict the 15-nation euro zone will suffer only a gradual slowdown. At a news conference earlier this month, President Jean-Claude Trichet admitted second-quarter euro-zone growth would disappoint and warned "the third quarter will probably not be particularly flattering either," but stressed the bloc's "sound" fundamentals.
The bank's official forecast is that the euro-zone economy will "trough" in the second quarter and expand by around 1.8% this year and 1.5% next year.
Shareholders Get Left Behind In Fannie and Freddie Rescue
I've never been a Fannie Mae or Freddie Mac shareholder, but I know people who are. They're not high-rolling speculators. On the contrary, they seemed to view Fannie and Freddie shares as being in pretty much the same category as U.S. Treasury bonds, and even safer than the typical utility.
This is because Fannie and Freddie debt carried with it an implicit government guarantee, ensuring low borrowing costs. I'm not sure many shareholders understood this, but they were encouraged in this belief by their brokers and financial advisers, who were in turn encouraged by Wall Street and Congress to believe that the big mortgage firms, in performing a vital national service, would be protected.
Now that their shares have lost more than 80% of their value this year, they're stunned and disillusioned. Can you blame them? For years Fannie and Freddie followed prudent banking policies, limiting their mortgage purchases to those that met a reasonably strict list of criteria, including a minimum down payment, proof of income and a conservative loan-to-property-value ratio. They had no subprime, jumbo, Alt-A or other exotic and innovative mortgages in their portfolios.
When their overpaid chief executives were caught up in shameful accounting practices, they were ousted, previously lax government oversight was increased, and capital requirements were imposed. Then came the mortgage and credit crises. Most financial institutions responded by tightening their standards. Fannie and Freddie should have done the same, or at least held to the status quo.
Instead, with Congress's encouragement, the mortgage buyers loosened theirs. Jumbo mortgages (and bigger risks)? No problem. Alt-A mortgages? Bring 'em on. The companies have an estimated $80 billion in what were once considered nonconforming mortgages -- and are now considered toxic waste -- on their balance sheets. As for the higher capital requirements meant to reassure investors, they were reduced.
All this was done in the name of propping up real-estate values, a strategy that has been a manifest failure as home prices continue to plummet in most parts of the country. This was the flip side to Fannie's and Freddie's Faustian bargain with the federal government.
Having bought into the notion that the companies were quasi-government institutions, shareholders found no solace in this week's emergency rescue plan, which seemed aimed entirely at bondholders and lenders. The plan was ominously silent about equity shareholders, with only vague reference to possible equity purchases by the government if necessary (which would presumably dilute or even wipe out existing shareholders).
The plan may reassure lenders that they'll be repaid and will surely keep credit lines open. But even an unlimited ability to borrow doesn't mean the firms will be profitable anytime soon or can avoid turning to the government for more capital.
It's no wonder there's been a crisis in investor confidence and that longtime shareholders have been fleeing, handing the company over to speculators. I won't be among them, and if I did own shares, I'd sell, even at current depressed levels.
Unlike Bear Stearns, which found a white knight in J.P. Morgan Chase, no one seems likely to come to the rescue or speak up for Fannie and Freddie shareholders. The companies are too big and carry too much baggage to be rescued by anyone other than the government.
Politicians are interested in homeowners and borrowers, not shareholders, who aren't numerous enough to form a critical voting bloc and are in any event presumed to be affluent and able to absorb their losses.
I don't think anyone wants to see Fannie and Freddie nationalized, but if they manage to stay private, the government should allow the companies to maintain prudent lending standards and respond to market discipline, even if that doesn't always coincide with the political goal of expanding homeownership.
None of that will be much consolation to the conservative long-term investors who were many of Fannie's and Freddie's shareholders. We've all learned that quasi-governmental is only quasi-safe.
Mortgage Giants' Aid Faces GOP Skepticism
Some lawmakers expressed doubts yesterday about the wisdom of the federal government's plan to prop up mortgage finance giants Fannie Mae and Freddie Mac, with one Republican senator complaining it was tantamount to writing a "blank check" to save the troubled companies.
Treasury Secretary Henry M. Paulson Jr. is seeking permission from Congress to temporarily increase the amount the companies can borrow from the Treasury and enable the government to invest directly in the firms if conditions worsen. In addition, the Federal Reserve has said it would allow Fannie Mae and Freddie Mac to borrow from its so-called discount window on an emergency basis, at least until the Treasury plan is enacted. So far, no such borrowing has occurred.
The often-outspoken Sen. Jim Bunning (R-Ky.) railed against the plan during a hearing before the Senate Banking Committee. "When I picked up my newspaper yesterday, I thought I woke up in France. But, no, it turned out it was socialism here in the United States and very -- going well," he said, raising his voice.
"The Treasury secretary is now asking for a blank check to buy as much Fannie and Freddie debt, or equity, as he wants."
Bunning said he would do "do everything I can to stop it."
Many in the Senate expect lawmakers to move on the legislation soon. But the banking panel's ranking Republican, Richard C. Shelby (Ala.) expressed reservations and is said to be contemplating changes. House Majority Leader Steny H. Hoyer (D-Md.) raised the prospect of holding hearings first before taking up the measure next week.
Paulson defended the plan as a "bazooka" that federal officials could hold in reserve but would probably not have to use because it was so potentially potent. Its mere existence, he testified, should give confidence to the financial markets that the government was standing behind the firms.
"Let me stress that there are no immediate plans to access either the proposed liquidity or the proposed capital backstop," Paulson told the committee. "If either authority is used, it would be done so only at Treasury's discretion, under terms and conditions that protect the U.S. taxpayer and are agreed to by both Treasury" and the mortgage finance companies.
Next Taxpayer Bill: FDIC?
The U.S. taxpayer's tab for financial-market turmoil is mounting. Along with the $300 billion or so the Federal Reserve has lent, the $29 billion dowry it offered J.P. Morgan Chase to wed Bear Stearns, and the untold billions of dollars it may have to pump into mortgage lenders Fannie Mae and Freddie Mac, it now may have to stump up as much as $8 billion to pay off depositors at failed bank IndyMac Bancorp.
Sure, this last is a form of insurance paid out by the Federal Deposit Insurance Corp., not an overt handout, so taxpayers may not be too worried. In normal times, the FDIC is actually a tidy little earner. Last year, it raked in $2.2 billion. Like any good insurance company, it has stashed some of that for a rainy day.
Still, it only holds $53 billion of assets against the $4 trillion-plus of bank deposits it insures. That could be swamped by the expanding housing crisis. IndyMac alone will absorb upward of 15% of the FDIC war chest. The agency believes it has enough capital to weather the storm, saying the assets of the 90 banks on its "troubled" list total only roughly $26 billion -- less than IndyMac's.
News coverage of the run on IndyMac has savaged the stocks of other lenders, such as National City, Washington Mutual and Wachovia. So far, their depositors haven't fled. Of course, IndyMac's customers didn't start thinking their deposits might be at risk until rumors of its troubles escalated a couple weeks ago.
If the FDIC's quick and so far competent-looking moves at IndyMac soothe the nerves of other banks' customers, it may yet head off further bank-run contagions without additional taxpayer expense. If more banks suffer IndyMac's fate, FDIC's limited resources will run out quickly, leaving Uncle Sam with yet another check to write.
The Securities and Exchange Commission's decision to tweak the rules for shorting the shares of Fannie Mae, Freddie Mac and brokerage firms shouldn't come as too much of a surprise. After all, Chairman Christopher Cox already had ordered an investigation into whether rumors have been spread to manipulate stock prices -- a reaction, perhaps, to the belief in some circles that short-sellers, who use borrowed shares to place bets that stock prices will fall, conspired to bring down Bear Stearns and then went after Lehman Brothers Holdings.
That investigation may well prove groundless. But the rule change, while it sounds like just a technicality, may be a tad more helpful. The SEC is insisting investors must have actually borrowed a stock before shorting it -- rather than being reasonably confident, after talking with securities lenders, that they can get their hands on it soon.
In essence it shuts off the gray area between shorting with stock already borrowed and so-called naked shorting -- when investors go short without even trying to borrow the stock. Tightening the rule may arrest destabilizing downward stock momentum, assuming it is caused by quick-fire short sellers who jump on the bandwagon hoping to make a fast buck.
That is because it often can take a day or three to locate stock to borrow -- longer, sometimes, for in-demand names like some in the financial sector. It shouldn't prevent investors with a fundamentally negative view from taking short positions -- and many of them probably make a habit of borrowing stock first anyway.
As such, the SEC's move may only grab a few headlines to show that it is doing something. But Mr. Cox and his fellow commissioners shouldn't be tempted to throw up any broader, permanent barriers to shorting. After all, well-argued negative views are just as worthwhile to consider, and act on, as positive ones.
FDIC Sees Big Premium Hike Over IndyMac
As it began operating IndyMac Bancorp Inc. Monday, the government estimated the failure's cost could shave 18 basis points off the Deposit Insurance Fund's reserve ratio, lowering it to 1.01%.
That would trigger a big premium increase as early as September, because the Federal Deposit Insurance Corp. is required by law to rebuild the fund once it tips below $1.15 for every $100 of insured deposits. "People have been accustomed to no reduction in the insurance fund, … and we're in a different stage of the cycle now, where it appears the fund will experience losses, and that's going to be an additional cost factor for banks," said Joseph T. Lynyak, a partner at Venable LLP.
IndyMac's failure — the second biggest, by assets — is expected to cost the Deposit Insurance Fund $4 billion to $8 billion, making it one of the costliest ever. The institution, which the agency now runs in conservatorship, holds low-value exotic mortgages and over $10 billion in Federal Home Loan bank advances, impeding FDIC efforts to sell its remaining assets.
Jaret Seiberg, an analyst with Stanford Group Co., said in a report Monday that premiums could rise to 10 to 15 cents per $100 of domestic deposits. "We expect the agency will want" its reserves "to be high to support its argument that the insurance fund is big enough to handle the fallout from the credit crisis and a taxpayer rescue is not in the making," Mr. Seiberg wrote. "A dwindling fund is not consistent with this message."
The $32 billion-asset Pasadena, Calif., thrift company — which was not even on the FDIC's "problem bank" list — went down faster than expected after depositors began pulling funds in the days after a June 26 letter from Sen. Charles Schumer, D-N.Y., warning that IndyMac could fail.
"The question is: Would a more orderly liquidation have been a less costly resolution. … If they could have kept it afloat a little while longer, could they have done a little more orderly job? That's something none of us will ever know," said Ralph F. MacDonald 3rd, a partner in the law firm Jones Day.
After a decade of premium-free insurance, all banks and thrifts began paying premiums in June 2007. That was when the agency implemented a pricing plan mandated by a 2006 law aimed at maintaining the fund's ratio at its traditional target of 1.25%. The current premium — 5 to 7 basis points for most institutions — pales in comparison to the 23 basis points all institutions had to pay in the wake of the savings and loan crisis.
The fund totaled $53 billion on March 31, up a hair in the first quarter as the FDIC increased its reserves for expected losses by 1,000%, to $525 million. FDIC Chairman Sheila Bair said Friday that the resolution would likely drive the ratio of reserves to insured deposits — now 1.19% — below 1.15%, which is a statutory trigger requiring the agency to develop a plan to rebuild the fund.
The FDIC declined a request for an interview Monday but issued a statement saying IndyMac's failure could push the reserve ratio down by 9 to 18 basis points. "Insured deposit growth, investment income, assessment revenue and other changes in loss provisions could cause the actual decline in the reserve ratio to be above or below this range," the statement said.
The FDIC board of directors will meet in September to set premiums for next year. The law gives the agency five years to get the fund back to 1.15%, and that's what industry representatives were pointing to Monday.
"FDIC doesn't immediately have to make back up those losses," said James Chessen, the chief economist for the American Bankers Association. "The beauty of the deposit insurance reform law was it gives the FDIC flexibility to rebuild the fund and not put an onerous burden on the existing healthy banks."
Camden Fine, the chief executive of the Independent Community Bankers of America, was more adamant. "There is no threat to the FDIC fund whatsoever. I don't even see one on the horizon," he said. "The FDIC board certainly has some latitude under the law, and it would be our advice that they not try to do one great big fell swoop of getting the fund at some ratio that they're trying to achieve, but rather try to bring the fund back more slowly."
There is insurance beyond FDIC -- does your bank offer it?
On Monday morning, traffic on Venture Boulevard was totally stalled as far as three blocks west of the Encino, Calif., IndyMac branch.
Slowly, as the cars came in view of the bank, drivers realized why traffic wasn't moving. Just like the scene of an auto accident, looky-loos were gawking at the line of people stretched to the end of the block, with two police officers at the head of the line. You've heard that the Feds have taken over IndyMac, which is now a federal bank. You've heard assurances that all insured deposits are covered, along with 50% of the uninsured deposits.
And, regarding the uninsured deposits, you may have heard FDIC spokesman David Barr on the radio telling people that if they have a loan plus uninsured money at the bank, the uninsured funds can be used to repay all or a portion of the loan. But who cares about IndyMac -- my money is at a different bank!
Hold on there. If you are sitting on deposits of over $100,000 at any bank, you are at risk. Do you have too much money in the bank? Don't panic. You don't need to start running around, shopping for a dozen banks to hold your money. At least, not yet.
First, find out if your bank carries additional insurance. The great news for folks in Massachusetts is that all state chartered banks are required to carry additional coverage through the Depositors Insurance Fund. DIF covers all deposits over the FDIC limits, so depositors don't have to do a thing. See this page for more information.
That's great for Massachusetts residents. What about the rest of us? It turns out there is no national insurance program for all banks. However, there is an interesting alternative. It's called the Certificate of Deposit Account Registry Service, or CDARS. If your bank participates in the program, you can have up to $50 million dollars in Certificates of Deposit and still have full FDIC coverage for your funds.
How does it work? You deposit money into CDs at your bank. Your bank spreads the CDs out among enough other banks to ensure that the part of your money in each bank is under the FDIC limits. In other words, you get the benefit of having 5, 10, or even 50 bank accounts with less than $100,000 in each account -- without the headache of opening, tracking and managing all those accounts yourself.
All you have to do is sign a document agreeing to allow the bank to spread your money around. CDARS says there are no additional fees to you. And you only get the one bank statement. Without sitting on endless hold with your bank, how can you find out whether it participates in CDARS? Just go online and see. You can look up your institution, and if they aren't listed, you can find one near you that is a participant.
Before you move your money, have a friendly chat with your banker and urge them to join the program. If they're too busy to bother, then it's time to move your money to get full protection. Incidentally, while you're looking over your finances, perhaps it's time to see which CDARS bank gives you the best rates. By staying on top of the rates of return, and letting your banker know you're doing so, you may be able to negotiate better rates right at your own home bank.
Don't forget Mom and Dad. Generally, the younger generations are a bit more active with their funds than simply leaving them on deposit with a bank. It's often your parents, grandparents, or folks on fixed incomes who rely on banks and certificates of deposits. Take the time to review your family's deposits and see whether they need to be redistributed to multiple banks, or to a CDARS member.
Fannie Mae, Freddie Mac May Halt Dividends on Losses
Fannie Mae and Freddie Mac, the beleaguered U.S. mortgage-finance companies, may cut common stock dividends to preserve capital after their shares fell 80 percent this year, data compiled by Bloomberg show.
Freddie Mac will probably halt its 25-cents-a-share quarterly payment and Fannie Mae will likely eliminate dividends after more than $11 billion in combined losses since last year, according to Bloomberg dividend forecasts. Washington-based Fannie Mae has paid shareholders for three decades, while Freddie Mac, located in McLean, Virginia, increased its payout every year since 1990 before lowering the awards in November.
The government-sponsored companies tumbled yesterday in New York Stock Exchange composite trading as investors lost confidence in Treasury Secretary Henry Paulson's plan to shore up their finances. Moody's Investors Service reduced the lenders' financial strength ratings, saying credit losses may jeopardize dividend payments on preferred shares.
"I don't know how you can justify a taxpayer-led bailout and agree to pay dividends to stockholders," said Don Wordell, a fund manager at Ceredex Value Advisors, which manages $3 billion in Orlando, Florida. Fannie Mae and Freddie Mac "need to be in capital preservation mode right now," he said. Freddie Mac paid $1.55 billion in common and preferred dividends last year, according to the 2007 annual report. Fannie Mae's payouts totaled $2.48 billion.
Fannie Mae dropped 27 percent yesterday, its biggest slump since at least July 1980, to close at $7.07 in New York, while Freddie Mac declined 26 percent to $5.26. Moody's reduced the company's so-called financial strength ratings, citing their limited ability to raise capital and the likelihood of increasing credit losses.
Fannie Mae rebounded 6.8 percent to $7.55 by 12:27 p.m. in Frankfurt as 87,772 shares traded, while Freddie Mac climbed 8.4 percent to $5.70. Fannie Mae's share slump has pushed its dividend yield up to 14.1 percent, six times the 2.5 percent average of the companies in the Standard & Poor's 500 index. Freddie Mac's yield is 18.9 percent. The yield is the annualized gross dividend divided by the current market price.
While the companies, which have the implicit backing of the U.S. government, kept their Aaa senior and subordinated debt ratings, Moody's cut the preferred stock to A1 from Aa3 and said all rankings are being reviewed for further downgrades. Paulson sought to boost investor confidence July 13 when he said he will seek authority to buy equity stakes and increase the government's credit lines to the companies.
Fannie Mae and Freddie Mac are critical to the U.S. housing market because they provide financing to banks and mortgage lenders by purchasing mortgages and either keeping them or packaging them for sale to investors. The companies own or guarantee more than half the $12 trillion of U.S. home loans.
The lenders would join 21 other S&P 500 Index companies that cut payouts in 2008, according to S&P data. That's more than the past five years combined. General Motors Corp., the biggest U.S. automaker, suspended its dividend yesterday for the first time since 1922.
Citigroup Inc., Regions Financial Corp., KeyCorp and SunTrust Banks Inc. will probably reduce payouts 50 percent this year, according to the Bloomberg data, which analyzes net income, the ratio of debt to assets, earnings per share, credit ratings and option prices to help determine potential dividend changes. Banks are reducing expenses after the worst U.S. housing slump since the Great Depression left financial companies with writedowns and credit losses of more than $416 billion.
Fannie Mae and Freddie Mac would be barred from paying dividends under restrictions proposed by Representative Barney Frank should the mortgage companies tap an increased line of credit with the Treasury. Frank's comments yesterday reflected efforts by lawmakers to introduce conditions on Paulson's request for unlimited power to provide capital for the two companies.
"If you've increased your dividend for 10 years and then stop paying, you better hold up a sign that says liquidity problem," said Howard Silverblatt, senior index analyst at S&P in New York. "Cutting a dividend is one of the last things you want to do, but we do expect more" among financial institutions and consumer companies dependent on discretionary spending.
UBS Seeks to Appease Clients With Auction-Rate Buy
UBS AG, Switzerland's largest bank, plans to buy back as much as $3.5 billion of auction-rate preferred shares after being sued in the U.S. for fraudulently selling the securities as low-risk alternatives to cash.
Clients holding the securities in UBS accounts will be able to get their money back in full, the Zurich-based company said yesterday. The offer, the first by a broker, applies to shares issued by tax-exempt closed-end funds managed by firms such as BlackRock Inc. and Nuveen Investments Inc. It doesn't include auction-rate debt from municipalities or student-loan providers.
UBS was sued last month by Massachusetts Secretary of State William Galvin, who said investors were misled by brokers and financial advisers into believing the securities were as safe as cash while paying higher dividends. At least 15 lawsuits have been filed against securities firms on behalf of investors whose money was frozen when the auction-rate market collapsed in February amid fallout from the subprime-mortgage crisis.
"It's fabulous," Harry Newton, 66, an investor in New York who owns $3.5 million in auction-rate preferred securities, said in an interview. "They were the worst of all the brokerage companies that sold this stuff." UBS said last month it will "defend the specific allegations" of Galvin's suit.
UBS shares have lost 73 percent over the past 12 months, cutting the company's market value to 52.9 billion Swiss francs ($52.5 billion). "Obviously this is constructive, but other steps remain and there is no timetable mentioned," David Chandler, 68, the lead plaintiff in a lawsuit against UBS, said in an interview from his home in San Diego.
The UBS announcement will put pressure on other brokers to make similar offers, said Joseph Witthohn, a research analyst for Janney Montgomery Scott LLC in Philadelphia. "You can be sure they're going to get calls from clients asking if they're going to do the same thing," Witthohn said.
Auction-rate securities were bought by individuals and corporations in auctions run by dealers. Dividend rates were set every seven, 28 or 35 days, a feature promoted by the brokers as providing the ability to buy or sell quickly. As much as $218 billion of the $330 billion of auction-rate bonds and shares outstanding in February remains frozen.
GM Announces Second Round of Cost Cuts in Six Weeks as U.S. Economy Continues to Slump
General Motors Corp. yesterday (Tuesday) announced a series of cost-saving measures aimed at fighting waning domestic sales fueled by a weak U.S. economy and the soaring cost of fuel.
“We are responding aggressively to the challenges of today’s U.S. auto market,” GM Chairman and Chief Executive Officer Rick Wagoner said in a General Motors company statement announcing the cuts. “We will continue to take the steps necessary to align our business structure with the lower vehicle sales volumes and shifts in sales mix,” he added, “We remain committed to bringing to market great products that target changing consumer preferences for more fuel-efficient vehicles.”
The struggling GM is being forced to make sweeping changes as it continues to lose market share to its Japanese-based competitor, Toyota Motor Corp. The measures announced yesterday are the latest in a string of desperate moves by GM to try to maintain its slim lead on Toyota, its closest global rival.
The most recent changes include eliminating an unspecified number of salaried positions, mainly through natural attrition and offers of early retirement. GM will also discontinue healthcare benefits for older retirees, pursue the sales of some of its brands, and eliminate its quarterly dividend. All told, GM predicts the measures will generate an additional $15 billion in capital by the end of 2009.
“Today’s actions, combined with those of the past several years, position us not only to survive this tough period in the U.S., but to come out of it as a lean, strong and successful company,” Wagoner said. Wall Street analysts saw bolstering GM’s capital position as a top priority, but a full-recovery for the automotive giant is tied to the U.S. economy.
“We have to see better demand for automobiles, for cars and trucks, in order for the liquidity crisis to be put to bed,” Tim Ghriskey, chief investment officer at Solaris Asset Management in New York, told Reuters. “They’re burning through about $3 billion in cash a quarter. The cash drain has to stop at some point or GM has larger problems.”
Ilargi: Yeah, well, nothing much surprises me anymore in the US’ poorly orchestrated quickstep impersonation of Bulgaria, but this one raises a few questions. Not least of all this one: how much money do we think was "earned" over the last few years, by the GSE’s and the investment banks which now seek protection from the practice, by short selling in the markets? And how many companies did they push into a danger zone by doing it?
There’s a witchhunt going on that’s just plain stupid, so much so that one has to wonder if the stated intention really is the underlying motivation. Now that the markets are turning negative, "speculators" and "short-sellers", which have been around for a long time, are branded and burned at the stake. Where was the indignation when times were plentiful?
The SEC and their entire alphabet-soup of brethern with some sort of authority are trying to remake the markets into something that is more to their liking in the present circumstances. It has zilch to do with the alleged criminal activities going on; the reality is that their buddies are bleeding, and demand help. And sure, we can talk about that. As soon as they return the profits they made over the past ten years from the same sorts of trades they now want banned. But if shorting should be illegal, maybe we need to get rid of going long stocks as well, just for the sake of balance.
Securities and Exchange Commission moves to curb Fannie and Freddie short-sellers
America's leading financial regulator is to put in place emergency measures to stop short-sellers from using "naked shorting" to target mortgage companies Fannie Mae and Freddie Mac as well as investment banks Lehman Brothers, Merrill Lynch, Goldman Sachs and Morgan Stanley.
The emergency order from the Securities and Exchange Commission (SEC), which comes into effect from Monday, July 21, will effectively force any trader who wants to short – or sell – shares in one of these entities to first pre-borrow the shares, which the lender will then take out of the market and not allow other traders to use.
Christopher Cox, the regulator's chairman, is establishing this new rule amid concern that short-sellers have been borrowing the same shares from lenders over and over again, driving down share prices at an inordinate rate. The SEC is also considering bringing in new rules to extend this requirement to the rest of the market, as part of the latest steps by the US government to attempt to bring some semblance of calm to the financial markets.
Mr Cox, appearing before the Senate Banking Committee, separately revealed that the SEC is undertaking more than 48 separate investigations into wrong-doing at mortgage lenders, investment banks and credit agencies as part of the sub-prime mortgage collapse.
The SEC is also targeting hedge funds, and is believed to have sent subpoenas to more than 50 of them, reportedly including Citadel and SAC Capital, in relation to negative rumours that besieged Bear Stearns and Lehman earlier this year. The rumours led to Bear's downfall and eventual sale to JP Morgan Chase, while Lehman saws its shares fall to all-time lows and the ousting of long-time president Joe Gregory and chief financial officer Erin Callan.
Ms Callan, who was supposed to be discussing a new role with Lehman chairman Dick Fuld, yesterday announced she will join Credit Suisse from September to run its global hedge fund business. Ms Callan, still one of the most powerful women on Wall Street, will return to her roots, having held a similar role at Lehman where she helped to take Fortress, Och-Ziff and Blackstone public.
'Naked Shorting': Far More Dangerous Than Sexy
The business world is forever tossing out colorful phrases. Today's is "naked short." [Pause for requisite juvenile jokes. Yes, heard that one. And that one. Finished? Good. Back to the story.]
Naked shorting is a particularly skeevy kind of short-selling. It is so potentially harmful to shareholders that the Securities and Exchange Commission yesterday put in new protections to try to prevent naked shorting of mortgage giants Fannie Mae and Freddie Mac and major investment banks.
Regulators think that such doomsday wagering may be artificially depressing stock prices, a process that can end up wrecking a fundamentally sound company. Regular short-sellers are necessary risk-takers and play a key role in making the stock market work. They borrow stock, gambling it will go down. If it does, they make money. If it doesn't, they lose money.
In naked shorts, shorters sell shares they haven't borrowed or don't intend to borrow. Some even short phantom shares that don't exist. Which is why it's technically illegal, though lightly enforced.
It's a frenetic shadow world of postponed promises, borrowed time, obscured paperwork and nail-biting price-watching, usually compressed into a few high-tension days swirling around the decline of a company.
In short, it's the perfect job for the guy who thinks that the action on an illicit high-stakes card game is too boring, regulated and predictable.
SEC's Cox:Limits On Shorting Fannie,Freddie,Others
U.S. securities regulators are putting new restrictions in place to prevent short-selling abuses involving shares of Wall Street's primary dealers and Fannie Mae (FNM) and Freddie Mac (FRE), the federally backed housing-finance giants.
Securities and Exchange Commission Chairman Christopher Cox told the Senate Banking Committee on Tuesday that the SEC will require short-sellers to pre- borrow shares before engaging in short sales of such companies. The restrictions, required under a 30-day emergency order issued late Tuesday, will apply to 19 stocks in all.
In addition to Fannie Mae and Freddie Mac, they are: BNP Paribas Securities Corp. (BNPQF, BNPQY), Bank of America Corp. (BAC), Barclays PLC (BCS), Citigroup Inc. (C), Credit Suisse Group (CS), Daiwa Securities Group, Inc. (DSECY), Deutsche Bank Group (DB), Allianz SE (AZ), Goldman Sachs Group Inc. (GS), Lehman Brothers Holdings Inc. (LEH), Merrill Lynch & Co. (MER), Morgan Stanley (MS), Royal Bank ADS (RBS), HSBC Holdings PLC (HBC, HSI), JPMorganChase & Co. (JPM), Mizuho Financial Inc., (MFG), and UBS AG (UBS).
SEC officials said the restrictions could be extended for a longer period, or to other stocks as well. The restrictions will take effect starting at 12:01 a.m. Eastern time Monday, July 21, giving market participants time to adjust their operations, and run through July 29, the SEC said.
It said it may extend the order if commissioners determine that is in the public interest and is needed to protect investors, but for no more than 30 days. The emergency order raised concerns about "false rumors" about liquidity problems at financial firms and the unwillingness of key counterparties to deal with such firms.
Given such developments, the SEC said it has concluded "there now exists a substantial threat of sudden and excessive fluctuations of securities prices generally" which "could threaten fair and orderly markets."
Short sellers have best month in more than 7 years
Short sellers had their best month in more than seven years in June as the stock market slumped. The Strunk Short Index, which tracks a handful of managers that specialize in short selling, jumped 10.47% last month. That was the best performance since March 2001, when the index surged 12.45% during the dot-com bust.
The Index, compiled by Harry Strunk of Treflie Capital Management, climbed 19.34% during the first half of 2008. The best years for the index were in 2002, at the height of the technology stock sell-off, and 1990, in the midst of the last major U.S. banking crisis. During those years, the index gained 30% and 43% respectively.
In a short sale, traders sell borrowed shares, hoping to buy them back at a lower price and return them to the lender. The difference is kept as profit. The Dow Jones Industrial Average slumped almost 10% in June as the housing crisis and broader credit crunch deepened concerns about the health of the financial system.
Short-sellers are often blamed when a downturn in the economy or a financial crisis pushes stock markets lower. On Tuesday, Securities and Exchange Commission Chairman Christopher Cox said the regulator will try to limit "naked" short selling of shares in Fannie Mae, Freddie Mac and big brokerage firms including Lehman Brothers and Merrill Lynch.
One Million Foreclosed US Properties by Year's End
According California-based foreclosure information specialists, ForeclosureS.com, if current foreclosure trends continue, there could be $1 million foreclosed properties across the country by the end of 2008.
According to the site, almost a half million homes were foreclosed in the first half of the year, almost double the figures from the same time a year ago. This figure represents six out of every 1,000 households nationwide, which are predicted to experience foreclosure.
ForeclosureS.com also reported that REO filings for June were up 5.35 percent from May with 87,465 total filings. The second quarter also showed a jump in filings with 224,230 filings over 210,230 REOs filed in the first quarter of 2008, according to the site.
In terms of pre-foreclosure filings, ForeclosureS.com has found that these numbers have already surpassed the one million mark in the first half of the year, with 1,060,187 filings as of June 30, nearly double the figures of that time last year. The jump in pre-foreclosure filings from the first to second quarter 2008 was much less however, with 547,211 filings in the second quarter, up from 512,976 in the first quarter.
Despite these foreboding figures, Alexis McGee, president of ForeclosureS.com, saw optimism for the future in terms of buyer interest. “Americans remain optimistic on the future of the housing industry as some of the newest industry numbers indicate,” McGee said.
“Existing home sales were up 2 percent nationwide in May, according to the National Association of Realtors, and California, a leader in the numbers of foreclosure filings, reported an 18.1 percent increase in home sales in may. Dropping new construction and housing inventory numbers are positive signs, too, because that means housing oversupply is catching up with demand
Momentum Surges for Effort to Create New GSE Regulator
The Treasury Department's move to backstop Fannie Mae and Freddie Mac has dramatically accelerated legislative efforts to create a new regulator for the government-sponsored enterprises, observers said Monday.
The actions Sunday effectively upended the conventional wisdom surrounding the bill. Last week several lobbyists said House Financial Services Committee Chairman Barney Frank had little leverage to make the changes he wanted.
But the Treasury's call to add major provisions, and a growing crisis surrounding the GSEs, likely strengthened Rep. Frank's ability to overcome resistance from Sen. Richard Shelby, the top Republican on the Senate Banking Committee, and other lawmakers to further compromise.
"Anyone who sits in a position that results in the failure of the bill is taking a risk that is politically probably not acceptable," said former Rep. Richard Baker, now the president of the Managed Funds Association. "No one at this point would want to be identified as the person for not bringing the new regulator on board."
Rep. Frank still insists he wants to delay the enactment date for the creation of a new GSE regulator and add language raising the conforming loan limit. But Sen. Shelby has said he opposes both moves. A week ago the Alabama Republican was viewed as having the upper hand, because his party has enough votes in the Senate to block the bill. But the legislation is now seen as necessary and urgent for the broader economy.
That gives the advantage to Rep. Frank. The Massachusetts Democrat could use the opportunity to make the changes he was seeking in addition to adding the Treasury language. "Shelby doesn't have as much leverage as he usually does to reject anything he doesn't like," said an industry lobbyist, who spoke on the condition of anonymity. "Frank has the upper hand."
The House was expected to move quickly to incorporate the Treasury's recommendations, which would increase a line of credit for Fannie and Freddie and allow the government to take an equity stake in the companies as well as add a consultative regulatory role for the Federal Reserve Board. (See story here).
According to draft legislative language obtained by American Banker, no dollar limits are placed on the Treasury line. The secretary could purchase "any obligations and other securities" issued by the GSEs "on such terms and conditions as the secretary may prescribe and in such amounts as the secretary may determine." That authority would end Dec. 31, 2009.
Though a spokeswoman for Freddie Mac said Treasury could only buy equity shares of the GSEs with the permission of the enterprises, no such restriction appears in the language.
A full House vote is expected this week. Observers said that the Senate is under pressure to follow suit in short order, and that the bill could be approved by the end of next week. "All the tumblers have clicked into place to provide a glide path right to the president's desk," said Scott Talbott, the Financial Services Roundtable's senior vice president for government affairs. "You will see great pressure to get this done to restore confidence in the market."
Lawmakers were receptive to the Treasury's suggestions, but some adjustments are likely. "There will be some changes here and there," said Steve Adamske, a spokesman for Rep. Frank. Sen. Dodd cautioned House lawmakers not to go too far in seeking revisions to the legislation, which passed the Senate in a 63-5 vote Friday after weeks of procedural hurdles.
"My hope would be that the House would not send a bill back with provisions in it that would be met with a very hostile Senate reaction," he told reporters in a conference call. When asked what provisions he meant, Sen. Dodd would not answer. "We've been back and forth" with House lawmakers, he said. "They know there are some things that would be harder to deal with than others."
There remained doubts Monday about whether Sen. Shelby supported the Treasury's action. Though Sen. Dodd said his colleague backed the Treasury proposals, Sen. Shelby's office would not comment publicly. Several sources said he dislikes the plan but has not decided how to respond.
Some analysts said Rep. Frank may have more running room but should be careful not to push Sen. Shelby too far. "Never underestimate Richard Shelby," said Brian Gardner, an analyst at KBW Inc.'s Keefe, Bruyette & Woods Inc. "He confounds his critics. He is very good at blocking something he really opposes and doesn't want, even if it's politically popular."
Jesse Ventura: U.S. Government Out To Destroy Middle Class
Former Governor Jesse Ventura slammed the weak dollar policy as part of a war being waged on the middle class in America by the U.S. government as the greenback collapsed to an all time record low against the euro today.
Ventura made the comments before his appearance on Larry King Live last night, during which he announced he would not be running for the U.S. Senate. “The dollar has fallen through the floor, there’s half a dozen countries now that have a higher value and more than that than us,” Ventura told The Alex Jones Show.
The former Minnesota Governor identified two key factors behind dollar devaluation - the war in Iraq and the ballooning national debt. “It’s the exact two things that I’ve been harping on for the last 2 months and a half….we must do something about the $9 trillion dollars plus of debt we owe throughout the world,” said Ventura, adding that most people in America were unconcerned about the greenback’s spectacular plummet.
Asked why the establishment were not going to reverse the destruction of the dollar, Ventura responded, “Because I don’t think they really care, they’re making their money and they’re in their position.”
“To me it’s clear there is a war on the middle class in America today being waged by our own government - they’re out to destroy what was the American dream and the American dream was the middle class, we were the country where you could get a job and you could support your family….that’s being extinguished greatly today and it seems our illustrious elected officials don’t have a problem with it,” said Ventura.
The dollar fell to an all time record low against the euro today on the back of mortgage giants Fannie Mae and Freddie Mac being bailed out by the U.S. government. The dollar declined to $1.6038 per euro, the lowest since the euro’s inception in 1999, and was at $1.6004 as of 11:13 a.m. in London, from $1.5908 in New York yesterday. The greenback also hit a 25-year low versus the Australian dollar.
Ilargi: After running Lehman into the deep dark end, Callan gets "promoted away", to go do hedge funds in "Die Schweiz". Hilarious. But not a confidence booster.
Demoted Lehman Officer Leaves for Credit Suisse
Erin Callan, whose rise and fall at Lehman Brothers transfixed Wall Street, has resigned to join Credit Suisse. The move comes a little more than a month after Ms. Callan, 42, was demoted as the chief financial officer of Lehman, which has been rocked by speculation that it might founder.
At Credit Suisse, Ms. Callan will run the global hedge fund business. It is a high-profile hire for Credit Suisse and an unsurprising loss for Lehman Brothers. Ms. Callan, considered one of the most powerful women on Wall Street in her role as chief financial officer, struggled to regain investors’ confidence after Lehman reported a large, unexpected loss for the second quarter.
That loss, and Lehman’s failure to communicate effectively with investors, catapulted the firm from one of many riding out the credit crisis to one whose survival as an independent is in doubt. Ms. Callan was demoted in mid-June amid a public battle with David Einhorn, a prominent hedge fund manager who has been outspoken about his negative views of the bank (he is a short seller of the stock, meaning he makes money when the share price falls).
During her short tenure as chief financial officer, Ms. Callan, a brassy and articulate banker who started out as a tax lawyer, became a media darling, appearing frequently on CNBC and in the financial media. She pushed management to be more transparent in reporting its results and met with hundreds of Lehman investors to make the case that the firm’s business was fundamentally sound.
It is unclear whether that visibility hurt her, though it almost certainly had the support of senior management. At Credit Suisse Ms. Callan will return to her roots covering hedge funds. Before her stint as Lehman’s chief financial officer, she was head of Lehman’s global hedge fund coverage group. In that role she helped take several large hedge funds public, including the Fortress Investment Group, the Blackstone Group and the Och Ziff Management Group.
She also helped win a significant role on a debt offering for the Citadel Investment Group, a Chicago-based hedge fund, which was the first of its kind. She was at Lehman Brothers for 13 years. “The relative strength of Credit Suisse has given us the ability to attract great people,” Paul Calello, chief executive of Credit Suisse’s investment bank, said. “Hedge funds will continue to be a very important client base for the industry and for Credit Suisse.”
Credit Suisse has been building its hedge fund business to catch up with rivals like Goldman Sachs and Morgan Stanley, which have the largest market share of the prime brokerage business. Ms. Callan will work on all aspects of covering hedge funds, including prime brokerage, which is the day-to-day servicing of hedge funds and one of the rare bright spots for the troubled sector, to investment banking for hedge funds, which involves orchestrating mergers of hedge funds or initial public offerings.
That business, which was red hot in 2007, has effectively dried up. But Mr. Calello says he expects it to come back. “You will see activity in the new issuance business for hedge funds,” he said. When? “I’m not calling the markets. That hasn’t worked out well for a lot of people.”
UK interest rate cut on cards as gloom deepens
Investors are betting that the Bank of England's next move in interest rates will be down rather than up for the first time since May.
In an acknowledgement that Britain is now staring recession in the face, money markets priced in a 40pc chance that the Monetary Policy Committee will cut borrowing costs by a quarter of a percentage point early next year. The critical turnaround came on a day when oil prices plunged at the fastest rate in three years and share prices in London fell sharply.
Investors had for the past two months been anticipating a series of rate rises to bring inflation under control. Significantly, the shift also coincided with news that the key rate of inflation rose more than expected to a 16-year high of 3.8pc, indicating that traders are more concerned about the severity of the forthcoming economic slowdown than rising prices.
On a turbulent day for markets:
• Oil prices plunged more than $7 at one stage to below $137 a barrel.
• The FTSE 100 index of London's blue-chip shares dropped by 3.4pc, at one point touching lows not seen since the 7/7 terrorist attacks on London in 2005. It closed down 128.5 points - 2.42pc - at 5171.9.
• The dollar fell to a record low against the euro, with the euro trading as high as $1.6037 against the greenback, while the pound rose back above the $2-mark for the first time since July 1.
• The US Securities and Exchange Commission announced emergency plans to combat short-selling in Fannie Mae and Freddie Mac stock, following the Fed's bailout of the US mortgage institutions over the weekend.
The barrage of news cemented many traders' worries that worse is in store for both the financial system and the global economy, said Michael Saunders, economist at Citigroup. "There is a real sense in the markets today of the economy falling off a cliff," he said.
"I think we are probably in recession already, or if not are about to enter one. The UK is perhaps more vulnerable than many other economies, which is why markets are now suddenly pricing in possible rate cuts - they are getting even more worried about financial instability." The Office for National Statistics reported a sharp increase in the Consumer Price Index to 3.8pc - 0.2 percentage points higher than expected.
However, concerns about prices were soon outweighed by evidence that European economies are now facing possible recession, above all a fall in the German ZEW survey of sentiment to an all-time low. In New York, financial markets witnessed a day of extremes, with the benchmark Dow Jones off as much as 228 at one stage before reversing losses to trade up 16 points at 11,071 in lunchtime trading.
The turnaround was helped by the fall in oil prices, as well as SEC chairman Christopher Cox's pledge to a Senate Banking Committee to institute an emergency order requiring any traders to pre-borrow stock before shorting Fannie Mae and Freddie Mac. In spite of the volte-face, shares in the mortgage institutions dropped as much as 30pc and 35pc respectively as shareholders worried that the US Treasury's planned rescue of the mortgage companies may leave them empty-handed.
The gloom was compounded by bearish comments from Federal Reserve chairman Ben Bernanke, who warned the US economy faced "numerous difficulties" this year, dwelling on an "unusually uncertain" inflation outlook during testimony to the Senate Banking Committee.
Although the Fed upgraded its growth forecasts for the current year, he said considerable uncertainty existed with regards to the economic outlook, predicting a slow housing recovery and a gradual improvement in the credit markets. US retail sales figures for June showed growth of 0.1pc last month, against analysts' estimates of 0.4pc.
U.K. Unemployment Jumped the Most Since 1992 in June
U.K. unemployment jumped the most in June since the aftermath of the last recession in 1992 as the economic slowdown forced housebuilders and banks to cut jobs and stop hiring.
Claims for jobless benefits climbed for a fifth month, increasing 15,500 from May, the Office for National Statistics said today in London. Economists predicted 10,000, the median of 29 forecasts in a Bloomberg News survey shows. The unemployment rate on that basis was 2.6 percent.
The economy and labor market face "consequences" as the Bank of England fights to bring accelerating inflation under control, policy maker Andrew Sentance says. Rising unemployment may exacerbate Prime Minister Gordon Brown's woes after the worst housing market slump since the last recession helped push his party's support close to the lowest since World War II.
"This is clear evidence the labor market is softening," said Stewart Robertson, an economist at Morley Fund Management in London, which oversees about $310 billion in assets. "If we're right on our mild recession call, then the unemployment rate will keep going up." The pound fell as much as 0.2 percent against the dollar after the data and traded at $2.0033 as of 12:50 p.m. in London.
U.K. government bonds stayed higher, pushing the yield on the two- year gilt down 3 basis points to 4.809 percent. Unemployment, based on International Labour Organization standards, was 5.2 percent in the three months through May. That compares with 7.2 percent in the euro region, 5.5 percent in the U.S. and 4 percent in Japan, the statistics office said.
Homebuilders announced more than 4,000 job cuts since the start of July, with Redrow Plc and Bovis Homes Group Plc each saying they will slash their workforces by 40 percent. HBOS Plc, the U.K.'s biggest mortgage lender, said last week that house prices fell in June from a year earlier by the most since 1992.
The collapse of the U.S. subprime mortgage market has cost financial institutions worldwide more than $416 billion in losses and writedowns and led them to shed almost 94,000 staff. Barclays Plc, the U.K.'s fourth-biggest bank, said July 8 it cut about 300 jobs because customer demand is drying up. U.K. jobless benefit claims rose by the most since December 1992 to 840,100 in June, the highest level in 10 months, the statistics office said.
The total may reach 1.3 million by the middle of 2010, the deadline for Brown to call the next election, according to a July 7 forecast by the Centre for Economic and Social Inclusion, a research group supported by the government. The government noted that the number of people with jobs is at a record.
"Employment continues to grow," said Stephen Timms, the Labour government's minister for employment. "The rise in the claimant count is a concern but needs to be seen in context. The number of people on jobseeker's allowance is lower than a year ago and just over half its 1997 level."
A YouGov Plc poll of 1,800 people showed 46 percent of them predict a recession in the next 12 months, the Sunday Times said on July 13. It also showed the opposition Conservatives have kept their 22 percentage point lead over Brown's ruling Labour Party.
While Lehman Brothers Holdings Inc. says the economy may now be contracting, the Bank of England has been unable to cut the benchmark interest rates from the current 5 percent as policy makers battle to control consumer prices. Inflation accelerated to 3.8 percent in June, the most in at least 11 years, the statistics office said yesterday.
Inflation "will take time" to get under control, Sentance said yesterday. "That will require a squeeze on spending and incomes in the U.K. and other economies, with consequences for economic growth and employment in the short term." Central bank Governor Mervyn King said this week that policy makers "cannot take for granted" that inflation expectations will stay anchored. Policy makers have said they are watching wage negotiations for signs that they could become dislodged.
Average earnings, excluding bonuses, rose an annual 3.8 percent in the three months through May, compared with 3.9 percent in the quarter through April, the statistics office said. Including bonuses, the figures were exactly the same. Today's report "points to further headwinds ahead for the consumer, on top of soaring food and energy prices and the holes that are being blown into household balance sheets by falling house and equity prices," said Nick Kounis, an economist at Fortis Bank.
The central bank, he said, "will not be able to respond to the downturn in the economy any time soon."
Canada mortgage insurers push to keep zero-down loans
Private mortgage insurers are pushing for ways to keep no-money-down mortgages alive and are set to meet with Department of Finance officials in the next two weeks to discuss possible options, sources indicate.
The move comes after Ottawa cracked down on mortgage practices that allowed consumers to enter the housing market with no money down and amortize their loans over 40 years. New rules that come into effect on Oct. 15 would demand a 5% repayment and shorten the length of amortization from 40 years to 35 years.
Sources indicate the country's major private insurers, which control about 30% of the market, have told mortgage brokers they are working on a solution which would keep the zero-down option alive and even the 40-year amortization. One insurer, PMI Canada, which has been in the market for about a year, indicated it hopes to come up with some alternatives.
"PMI Canada is still in the process of reviewing and analyzing the new mortgage insurance measures for industry and market impact. PMI Canada looks forward to meeting with the Department of Finance at the end of the month to better understand the new measures, after which we will be better able to make an informed strategic business decision as to whether or not we are able to continue to offer the 40-year mortgage insurance option," said Janet Martin, chief executive of PMI Canada, in an email to the Financial Post.
An industry source said the private mortgage insurers are looking into creating a product in which the first 95% of a mortgage is backed by the government with the last 5% securitized independently by the private mortgage insurers. The new rules from finance appear aimed as much at Canada Mortgage and Housing Corp., a Crown corporation that controls 70% of the mortgage insurance market, as its private sector competitors.
In the hotly competitive mortgage insurance market, CMHC has often been the aggressor in the marketplace. For years, the entire market was CMHC and Genworth Financial Canada which has controlled the other 30% of the multi-billion mortgage industry. In the last two years AIG United Guaranty, a subsidiary of American International Group Inc., and PMI have been trying to crack the market.
CMHC and Genworth both responded to the intrusion by insuring products with longer amortizations. CMHC's decision to insure mortgages with zero money down ended up incurring the wrath of former Bank of Canada governor David Dodge two years ago.
Mr. Dodge feared interest-only mortgages were fueling the housing market and demanded a meeting with CMHC. Some industry observers say new rules put in place last week are the long awaited response to Mr. Dodge's concerns, coming after months of consultation.
Now, the private sector is suggesting it wants to be excluded from the new rules. "It's still a little early. We know the government won't back the 100% program but will the private insurers do it themselves," said Gary Siegle, Calgary regional manager with Invis Inc., a mortgage consultant firm.
"The [private firms] are looking at trying to do the 100% insurance themselves. Brokers have been told to wait a week for more news before they can find out how to proceed."
Ilargi: I grow more convinced by the day that Canadians will be stuck in denial until it’s too late: home prices won’t follow the US because mortgages practices are so much better (that is not the issue, guys), we have all that oil, don’t we, and Canada’s banks are much stronger than others too.
Wake up, people, you’re losing very precious time, which should be used to prepare. What is happening is as simple as it will be painful: credit is vanishing on a global scale. It’s not about subprime, it’s not about mortgages, and it’s not about the US. Those are nothing but the first symptoms of a much wider and much bigger event. And the chances that Canada will be spared, or even for instance less hurt than the US, are ZERO.
'Safe and sound' Canadian banks hurtT
The credit crunch is defying the optimism of Canadian bank executives who had cautiously hoped the worst was over. But while the U.S. situation looks bleak, many in the sector believe banks on this side of the border are taking a bigger beating than deserved.
“People are averse to risk and they're putting all the banks in the same basket,” Réjean Robitaille, the chief executive officer of Laurentian Bank of Canada, said in an interview Tuesday. His company has no exposure to the United States, not to mention subprime mortgages, but its stock was whipped along with those of its competitors.
Mr. Robitaille acknowledges that news relating to the credit crunch is not good. “Frankly, it's probably worse than I expected,” he said. “A few weeks ago, I thought that the worst was behind us.” But he said he thinks investors will see, when Canadian banks publish their third-quarter results that “the Canadian situation is in better shape.”
Many analysts and bankers suggested the U.S. picture is tainting the Canadian banks, which might be taking more of a bruising than warranted. “Canadian banks continue to be well capitalized and the banking system in Canada is safe and sound,” said Rod Giles, a spokesperson for the Office of the Superintendent of Financial Institutions, which regulates this country's banks.
Scotia Capital Inc. analyst Kevin Choquette noted that, excluding Canadian Imperial Bank of Commerce, $73-billion in value has been eroded since the Canadian banks were at their peak, amounting to 29 times their cumulative writedowns of $2.5-billion. “We are surprised by the degree of panic selling,” he wrote in a note to clients. “Clearly Canadian bank stocks are suffering contagion from U.S. financial and mortgage woes.”
Another torrent of negative news snaked up from the U.S. financial sector yesterday. Stock of Citigroup Inc., the country's largest bank, sank to its lowest level in a decade because of fears there is no turnaround on the horizon. U.S. Federal Reserve Board chairman Ben Bernanke said many financial institutions remain under “considerable stress.”
“The U.S. housing sector might have been the start of the problem, but [U.S.] banks are now experiencing rising delinquencies on credit card and term loans,” Bank of Montreal chief economist Sherry Cooper wrote in a research note. “The financial crisis is spreading,” she added. “Consumers in the United States are losing confidence in their banks.”
Toronto-Dominion Bank economist Richard Kelly said concerns over Fannie Mae and Freddie Mac, the U.S. government-sponsored enterprises that finance a large swath of U.S. mortgages, “have highlighted that otherwise solvent financial institutions remain susceptible to market fears.”
“The credit crunch is not over,” Mr. Kelly wrote. He was not alone in his pessimism. “This housing situation in the U.S. is extremely dangerous and it's just going to get worse, I think, before it gets better,” said John Kinsey, a portfolio manager at Caldwell Securities.
Ilargi: Canada’s housing bubble is gone. Prepare for a correction similar to all other major rich world markets. Yes, that means 80% peak to trough. Good luck to the people in Vancouver who spend over 50% of their incomes on mortgage payments. Advice: get out while you can. And no, you won’t be "safe" because you live in a particular market.
Home prices slip for first time in nine years
Canadian home prices fell in June for the first time since January, 1999, as the number of houses for sale remained at record levels. The average price of an existing home fell 0.4 per cent in June to $341,096, compared with $342,615 the year before, according to statistics released Tuesday by the Canadian Real Estate Association (CREA).
“The fall in home prices...is a sizable dip in this indicator, given that not too long ago the Canadian housing market was witnessing double-digit price gains,” Millan Mulraine, economic strategist at TD Securities Inc., said in a research note.
Of the 25 major markets included in the statistics, average home prices declined on a year-over-year basis in Calgary, Edmonton, Victoria and Windsor-Essex. The largest decline of 2.6 per cent was in Edmonton, while the smallest was in Windsor-Essex at 0.5 per cent.
Last month, BMO Nesbitt Burns Inc. economist Douglas Porter raised the possibility of an overall drop in home prices in Canada. Most industry watchers have stayed with the view that home prices will rise slightly this year. In June, Mr. Porter said it was “unnerving” to note that Canada's housing market performance appears to be tracking that of the U.S. but with a two-year lag, although he also sees a number of differences between the two markets.
He said he was tracking prices in the “middle ground,” cities such as Toronto, Montreal and Ottawa, which still have fairly robust economic fundamentals but haven't been supercharged by the commodities boom. Prices in those cities all rose moderately year-over-year in June, up 3.7 per cent in Toronto, 4 per cent in Montreal and 6.8 per cent in Ottawa.
The Canadian and U.S. markets are still very different, CREA president Calvin Lindberg said in a statement. U.S. home prices dropped by 14.1 per cent in the first quarter of the year, according to the benchmark Case-Shiller national home price index.
As price gains cooled in most markets, the number of resale homes listed nationally has hit monthly highs in April, May and June, and sales activity has continued to fall. For the first six months of the year, listings on the Multiple Listing Service (MLS) reached a record level of 332,958, up 8.1 per cent from the previous record set the year before.
Listings in the past three months reached record, or near-record, levels in Toronto, Vancouver, Ottawa, Regina and Saskatoon, according to CREA. In Edmonton and Calgary, which had an earlier and more pronounced housing boom than in many other regions, listings continued to decline from peak levels hit in March.
Across Canada, sales activity for the first half of the year declined 13.3 per cent from a year previously, to 169,265 units sold. Sales fell most sharply in Greater Vancouver, where they dropped 42.9 per cent in June from the year before. Regina and Saskatoon also experienced declines greater than 30 per cent.
The increase in listings combined with slower sales made Vancouver, Regina and Saskatoon the “most balanced” major markets in June, according to CREA. “The frenzied pace for sales activity last year has faded, with buyers now better able to shop around before making an offer,” Gregory Klump, chief economist at CREA, said in a statement. “Price increases are expected to be modest in the second half of 2008, as sales continue easing and new listings remain high.”
Ilargi: The stories on pension fund losses will come at us at an increasing rate. I’ve already said so much about it, what else is there? This is going to hurt and shatter so many people worldwide (well, in the rich world), it will be heartbreaking.
New Jersey Teachers' pension fund loses billions in stocks
The fund that bankrolls pensions for 700,000 New Jersey teachers and government workers lost billions on Wall Street over the past year, leaving taxpayers facing the prospect of higher contributions to make up the difference.
Battered by declines in domestic and international stocks, the pension fund lost 3.1 percent for the fiscal year that ended June 30, the state Treasury Department announced yesterday. The losses left the fund with $77.7 billion in assets, almost $5 billion less than the fund contained at the start of the fiscal year. "This has just been a tremendously difficult market," said Bill Clark, director of the State's Division of Investment.
The performance ends a five-year run of positive investment returns for the fund. Over the past five years, the fund's returns had averaged 10.5 percent, capped by a 17.1 percent gain between July 1, 2006, and June 30, 2007.
Clark emphasized the fund had outperformed other major pension funds, and said even with the year's losses, the fund's average investment performance for the past five years is still above the 8.25 percent actuaries assume it will earn when they calculate how much taxpayers should contribute to the retirement system each year.
The year's subpar investment performance is bad news for taxpayers and workers enrolled in the pension system. Stung by years of skipped taxpayer contributions, the funds started the budget year with $28 billion less than experts calculated they needed to met the long-term costs of benefits promised to current and retired workers.
The new losses pushed the value of the fund below the total in the account in June 2000. But while the fund's value has been running in place for eight years, the cost of the pensions has raced ahead. In 2000, annual pension payments totaled about $3.4 billion. Today, the annual pension payments exceed $6 billion a year -- or 7 percent of the fund's total value. Without investment returns to cover the bills, the task falls to taxpayers and to the employees who are members of the retirement system.
Between 2000 and 2008, employee payments into the retirement accounts jumped from $922 million to $1.5 billion a year. Taxpayer contributions, meanwhile, rose from $218 million in 2000, when state and local governments were taking a "holiday" from pension contributions, to $2.2 billion this year.
The Best Ways to Profit From the Growing Pension Fund Crisis
Welcome to the latest offshoot of the subprime-mortgage debacle: A burgeoning U.S. pension-fund crisis.
Since the global financial crisis struck last fall, the largest 1,500 U.S. public companies have lost a combined $280 billion from their pension funds.
Assuming the stock market doesn’t move much from here, a typical U.S. company can expect its pension expense – a direct charge against profits – to increase between 20% and 30% in 2009. With such a hefty burden ahead, it’s not difficult to understand that this pension fund crisis will certainly exert a downward pressure on corporate earnings, and doubtless on stock prices, too.
But there is a silver lining: By choosing your stocks carefully, you can dodge this pension-fund crisis altogether. To make sound choices, it’s first necessary to have some knowledge of pension systems, and the funding crisis that’s brewing up like a summer squall.
The pension fund problem emanates from the huge expansion of pension funds after World War II, when companies saw additional pension promises as being cheaper than cash wage increases. And they were cheaper: Big industrial companies like General Motors Corp. were growing rapidly, meaning they had relatively young work forces who could be expected to pay pension contributions for many years before being eligible to receive pensions.
Add a certain amount of old-fashioned sloppiness in the accounting – for instance, the total value of pension liabilities didn’t have to be reported at all until 1985, and have only been brought onto the corporate balance sheets under the recent pension-focused accounting rule, SFAS 158 – and you can see why defined-benefit pension plans, in which workers got a benefit based on a percentage of final salary, were popular with all concerned.
The defined-benefit pension system got into serious trouble in the 1980s – thanks to some developments from the decade before. Under the ERISA Act of 1974, employers were forced to make payments to the Pension Benefit Guaranty Corp., so employees would be paid if the employer went bust.
As the 1970s wore on, high inflation (which led to higher wages, and therefore higher pension obligations) and lousy stock markets (which reduced the pension funds’ returns), caused many defined-benefit pension schemes to become seriously under-funded, creating a major risk to employee benefits.
The aging work force didn’t help: By 1980, GM had stopped expanding and was moving towards its current position, in which retirees outnumber active workers. The industry’s new solution was the so-called defined-contribution plans, such as today’s ubiquitous 401(K) accounts, in which employers and employees combine to fund employee pensions. These had one modest benefit for the employee: They were much more “portable” than defined-benefit plans.
Under the old pension system, if you had completed 20 years at General Motors, you were basically stuck there until retirement. And employers really liked 401(K) plans, as well, for this new format meant that they were freed from being responsible for employees’ welfare in retirement (a huge cost savings in the retirement area, thanks to the massive escalation in health-care costs, as it turned out).
Employers also could generally substantially reduce the percentage of employee wages they devoted to pension contributions. Defined-benefit plans had something of a comeback in the 1990s, when inflation declined and the stock market rocketed ahead so fast that the under-funded pensions of the 1970s disappeared, and were replaced with over-funded pension plans, so that employers no longer needed to make contributions.
The result was that many companies took holidays from making pension contributions, boosting their earnings, their stock prices and the value of their top management’s stock options by doing so. General Electric Co.even went further; it figured out a way in which it could make negative pension contributions, essentially withdrawing money from the pension fund, and boosting its earnings still further by doing so.
GE Chief Executive Officer John F. “Neutron Jack” Welch (whose tenure at GE was from 1982-2001) never missed a trick - as that company’s unfortunate shareholders, employees, and customers are only now discovering. Since 2000, stock market returns have been lousy. What’s more, bond yields have declined.
That’s had the effect of raising the nominal value of pension liabilities, which are calculated 30-40 years ahead and then discounted back to the present day by some appropriate bond rate. When you factor in the recent downturn, it’s easy to see why defined-benefit pension contributions will be zooming up.
Human consumption: Flying in the face of logic
In 1968, six years after Rachel Carson published Silent Spring - the book regarded as marking the beginning of modern environmental consciousness - a young American entomology professor at Stanford University, California, published The Population Bomb.
The tenor of Paul Ehrlich's book echoed the revolutionary sensibility and pervasive anxiety of the time. In it, Ehrlich and his wife, Anne, presented a neo-Malthusian scenario of imminent population explosion and ensuing disaster. "The battle to feed all of humanity is over," the Ehrlichs warned.
"In the 1970s and 1980s, hundreds of millions of people will starve to death in spite of any crash programmes embarked upon now. At this late date, nothing can prevent a substantial increase in the world death rate..." Not surprisingly, the second part of his message - that society must find ways to limit population growth - drew howls of protest.
The left saw it as immoral, and feared that the right would use the idea of overpopulation to promote only the right kind of social or ethnic bloodlines. The right worried that population control might limit the rights of individuals. And virtually every one objected to the discussion of human reproduction as a condition of food and habitat as if discussing, say, a population of fruit flies.
Forty years on, the message from Ehrlich, now 76 and the Bing professor of population studies in the department of biological sciences at Stanford, has barely mellowed. He and his wife have just published a new book, The Dominant Animal, the central theme of which is how one species, Homo sapiens, has become so powerful that it can significantly undermine the Earth's ability to support much of life.
It is undeniably timely as we lurch from one grim realisation to another: a climate crisis, then an energy crisis, now a food crisis. And underlying them all is the issue of population. When Ehrlich wrote The Population Bomb, there were 3.5 billion people on Earth; there are now 6.7 billion.
"The connections are so obvious it's appalling that they're not made," he says. "Each person we add now disproportionately impacts on the environment and life-support systems of the planet." There is a growing sense in the environmental movement that population will again emerge as a central component of the debate on global warming.
But it's a discussion that's open to distortion on one side by fringe groups who use the issue as cover for positions on race and immigration, and on another by superstitious thinking that technology will arrive to support and improve living standards for ever greater numbers of people, or that some kind of natural phenomenon - such as a disease, perhaps with a moral or spiritual component - will take the problem out of our hands entirely.
Ehrlich says: "There was a period when people saw the connections - connections that are often quite complex. Obviously, if the US still had the 140 million people we had at the end of the second world war we wouldn't be dependent on foreign oil, and we'd be emitting far less carbon dioxide in the atmosphere."
He believes that studying our cultural evolution - "where we came from, how we came to dominate the planet, and what that dominance means for our future" - is key to opening a more realistic discussion. "It's absolutely incomprehensible to me that we're in a [US] presidential campaign and no one is discussing any of the issues in The Dominant Animal, issues that are the concern of the majority of the scientific community."
For Ehrlich, though, the critical scalding he received for The Population Bomb and the problematic timeline of its central prediction forces him frequently to revisit and defend his ideas. Except for some developing countries, the globe was not racked by food shortages through the 1970s because advances in farming and technology were able to sustain larger populations.
In 1968, environmental studies was still fringe science. The intervening years have seen not only a boom in the field, but also in the variety and breadth of the issues at hand. "When I wrote The Population Bomb, I knew there would be a problem with climate, but I thought I'd be dead by the time we started to worry," Ehrlich says. "One thing after another has come up - the biodiversity crisis, ozone depletion ... all of which means I have to know more about more things."
Yet the issue of overpopulation and its equally thorny partner, overconsumption, remain near the centre of Ehrlich's study. Reiterating what environmental scientist James Lovelock stated recently, Ehrlich says: "We have grown in number to the point where our presence is perceptibly disabling the planet like a disease."
No longer is it clear that technology, so often cited as means of maintaining growth, isn't ecologically counterproductive and fostering a population bubble that must sooner or later burst. The charm and the curse of the population debate is that one must inevitably return to the subject of fruit flies.
When a female finds a pile of rotting bananas, she lays her eggs and the population explodes. When the bananas are used up, the population crashes. Some females find another pile of fruit, and the process starts over. "Our problem is we only have one pile of bananas," Ehrlich says.
The issue of consumption, Ehrlich believes, may be more thorny even than population. So entrenched is the culture of consumption, that debate in the US tends reflexively to skip over the question of curbing domestic energy use and carbon emissions to the question of how to curb growing Indian and Chinese pollution.
"Over 50 or 60 years, we turned the US from a country for people to a country for cars," Ehrlich argues. "We should be spending the next 50 years reversing that." Part of an effective effort, Ehrlich holds, would be to add what economists call the "externalities" to the cost of energy.
With the price of petrol reaching over $4 (£2) a gallon and Americans rapidly rethinking their love of huge cars, the price still does not reflect its true cost. For example, Ehrlich says, "we don't pay our share of the US military budget that goes to keeping the flow going, and we don't pay for the treatment for cancers caused by the particulates from burning fossil fuels. We don't pay the full costs of our behaviours."
There is cause for guarded optimism. He says: "If you look at it historically, the rise of environmental consciousness has been extremely rapid. We're only 40 years into it. The trouble is, the environment has been going downhill far faster."