Sorting tobacco on the porch near Near Douglas, Georgia. The program to eliminate the risk and uncertainty of a one-crop system meets the approval of this sharecropper: "You don't have to worriate so much and you've got time to raise somp'n to eat."
Ilargi: When people in the street are surveyed about their feelings concerning the economy, their personal place in it, and their future expectations, the results are more often than not surprisingly accurate; even though that is mostly not recognized till later.
Since 3 such polls were released in one day, I thought it might be good to start with them. As you can see, the sentiments are horrid. No matter what politicians, analysts and media may say, nothing beats real life as a barometer for what goes on. One might argue that people don't know enough or read enough to gauge their present or future situation, but that misses the point: people don't need to be informed, they need only feel.
American personal debt levels are at unprecedented highs, home prices are dropping like so many dead flies, and everyone knows ever more people who don't have a job, and often can't find one. Fannie and Freddie shares can rise by 30%, but that's only after they lost 80% in one month. Compared to share values 4 weeks ago, yesterday's rise was just 5-6%. And anyway, that is not what street sentiments are based on.
The first indicator below is the National Association of Homebuilders' (NAHB) builder sentiment index, and it has a special place even among these surveys, because of its predictive value. Two years ago, the following graph was published. It superimposes the S&P, with a 12-month time lag, on the homebuilder sentiment index. Back then, I found the result so stunning, I never forgot. The index has continued its downward trend unabated in the past two years. Translated into practical terms: very few homes will be built in the US in the foreseeable future.
The fear that prevails among average people is palpable in the global financial markets as well. No matter the rally yesterday, investors are scared, and they are so worldwide. Spain reports the worst finance crisis in its existence, China’s stocks plummet, England is hell in a handbasket, Holland real estate is bleeding; there's no end to it, and it's hardly begun.
Fear can be a good sentiment, a saving grace: it warns us away from trouble. As such, these polls are a simple reality check. And if history is any guide, they point to patterns that will soon emerge in our daily lives, as well as in financial markets. It's all just a question of how bad it will get. I think Professor Roubini lifts an important part of the veil: he says no investment bank on Wall Street, none, will survive the current crisis. I strongly doubt many commercial banks will either.
And I fully agree with Meredith Whitney that none of this will be resolved, neither the crisis itself nor the sentiments about it, until ALL hidden risk and toxic paper is dragged out into the daylight. And that will be the end of all banks but a handful, plus the vast majority of mutual funds, hedge funds, and pension funds. Which means it's very doubtful that even the Federal Reserve, the Bank of England and the ECB (and the EU itself, for that matter) will exist in their present form 5 years from now.
Rumor has it that the next big bomb to drop will not be a bank, but an entire country. Sit tight, but sit back. Relax, and have a beer. You'll need all your awareness and energy soon enough.
Homebuilder Confidence in U.S. Reached Record Low in July
Confidence among U.S. homebuilders dropped to a record low in July, signaling the housing recession will continue. The National Association of Homebuilders/Wells Fargo sentiment index decreased to 16 from 18 in June, the Washington- based group said today. Readings under 50 mean most respondents view conditions as poor.
All of the gauge's three components were the lowest ever and pessimism grew in three of four regions. Rising unemployment, soaring food and energy costs and the prospect that property values will keep dropping may continue to hurt sales in coming months.
Housing "is going to be in the dumps for a while," Ellen Zentner, an economist at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York, said before the report. "Prices are going to be depressed for some time." Economists forecast the index would be unchanged at 18, according to the median of 43 projections in a Bloomberg News survey. Estimates ranged from 16 to 19.
The gauge, which was first published in January 1985, averaged 27 last year. The survey asks members to characterize current sales as "good," "fair" or "poor" and to measure prospective buyers' traffic as well as to assess the outlook for six months from now. The measure of current single-family home sales fell to 16 from 17 in June. Projections for sales six months from now dropped to 23 from 27.
"Given the systematic deterioration of job markets, rising energy costs and sinking home values aggravated by the rising tide of foreclosures, many prospective buyers have simply returned to the sidelines until conditions improve," David Seiders, chief economist at the builders' group, said in a statement.
Tomorrow, the Commerce Department may report that housing starts dropped to a 960,000 annual pace in June, the weakest since March 1991, according to the median estimate of economists in a Bloomberg News survey. Builders may have to further limit new projects as declining home sales have kept inventories elevated. The supply of homes on the market in May increased to 10.9 months, the government said June 25. New-home sales fell 2.5 percent that month.
M/I Homes inc., a homebuilder concentrating in Florida and the Midwest, said July 10 it delivered 478 homes in the second quarter, down from 755 in the same period of 2007. The number of new contracts signed fell to 530, from 688. The NAHB index of buyer traffic fell to 12 in July from 16. The measure represents the number of prospective buyers visiting properties.
Sentiment declined in three of four regions. It dropped to 10 from 16 in the Midwest, to 13 from 16 in the West, and to 20 from 21 in the South. The gauge rose to 14 from 12 in the Northeast. Rising defaults on loans are among the reasons housing has continued to falter. Foreclosure filings increased 53 percent in June from a year earlier, with one in every 500 U.S. households entering the process, RealtyTrac Inc., a seller of default data, said July 10.
The Federal Reserve this week issued new mortgage rules aimed at shielding consumers from lending abuses. The rules ban lenders from making loans without considering a borrower's income and assets in determining ability to repay. They also require lenders to create an escrow account for property taxes and homeowners' insurance.
Poll: Deep economic insecurity
Americans are deeply worried about their economic prospects and they want government to invest in expanding economic opportunity and assisting those in need, according to a new poll released today.
The Rockefeller Foundation/Time magazine poll of 2,008 Americans, conducted between June 19 and 29, found significant increases in economic anxiety, especially among young people and minorities, and dissatisfaction with the federal government’s response.
The percentage of Americans concerned with their own economic situation, at 47 percent, has nearly doubled from 24 percent in January 2007 when the Rockefeller Foundation conducted a similar study. The percentages of Americans who fear losing their job and have failed to pay a bill in the past year also rose since last January.
Seventy-eight percent of respondents said they are facing greater financial risk than in the past and 55 percent say that Congress is hindering them from achieving economic security. Generation Y, defined as 18 to 29 year olds in this survey, was the most pessimistic age cohort, with the bleakest view of the future. Forty-nine percent say America was a better place to live in the 1990s and will continue to decline, compared to 40 percent or less for every other age cohort.
“There was really surprising data on how many young people feel so badly about their financial future,” said Teresa Wells, chief media strategist for the Rockefeller Foundation. “Half [of young people] think America’s best days are behind us,” said Margot Brandenburg, associate director of foundation initiatives at Rockefeller. “They have good reason to.”
She noted that half reported having gone without health insurance in the last year. Sixty-two percent said that they have failed to pay a bill on time because they could not afford to. They are more likely than older people to have not gone to a doctor because of cost, to worry that they are not saving enough for retirement and to have borrowed money from a friend.
And young Americans seem readier than older Americans to turn to government for the solution. Eighty-six percent say more government programs should help those struggling under the current economic conditions. African-Americans and Latinos feel especially hard hit by recent economic turmoil, according to the survey. Ninety-six percent of African-Americans and 88 percent of Latinos believe the economy is on the wrong track.
Congress is not the only political institution that gets a share of the blame:. Almost 80 percent of African-Americans say the president is hindering their pursuit of economic security. “What we see is things are worse for everyone but more so for black and Latino workers,” said Brandenburg.
“They are more likely to be uninsured, to think that they aren’t saving enough for retirement and lack the savings to handle an emergency. And they are more vocal in calling for government to play a role.” For example, 93 percent of African-Americans and 87 percent of Latinos favor public works projects that would create jobs. One notable trend is the emerging popularity of environmental regulation as an economic imperative.
Stricter pollution limits and tax credits for alternative energy development were both supported by 84 percent of all respondents, the highest of any proposal. Increasing the minimum wage, expanding public works projects were nearly as popular, with 83 and 82 percent approval respectively.
Increases in unemployment benefits, government-funded childcare, and government programs to provide health insurance were also supported by more than two-thirds of respondents as well. “If you look at what Americans are trying to say to their government leaders,” said Wells, “they are very interested in environmental solutions that can help the economy,”
Confidence drops in U.S. economic policy
Public confidence in U.S. economic policy dipped this month as unstable markets and shaky financial institutions left Americans uneasy about the future, according to a Reuters/Zogby poll released on Wednesday. The Reuters/Zogby Index, which measures the mood of the country, dropped to 88.7 from 90.4 in June as five of the 10 measures of public opinion used in the index fell at least slightly and three remained steady.
The index fell to near its record low of 87.7, recorded in March, as optimism about personal finances waned and approval ratings for the Bush administration's economic and foreign policies dropped. The rating for economic policy suffered the sharpest fall, earning positive marks from just 10 percent of Americans -- down 4 percentage points from June.
The drop came amid a continuing housing crisis, pledges of government help for the top two mortgage finance agencies and the collapse last week of IndyMac Bancorp -- the third-largest bank failure in U.S. history. "Public confidence took a dip all around as Americans have settled into a recession mentality here," said pollster John Zogby. "That only serves to make the real recession fester -- people are much less likely to buy anything or do anything."
President George W. Bush's approval rating was 25 percent, up one percentage point from June, and the number of Americans who believe the country is on the right track nudged up to 18 percent from last month's all-time low in a Zogby poll of 16 percent. The approval rating for Congress remained mired at its all-time low of 11 percent. Most of the changes were statistically insignificant in a poll with a margin of error of 3.1 percentage points.
Americans' confidence in their children's futures dipped two percentage points to 59 percent, and the number of Americans who feel safe from foreign threats and approve of U.S. foreign policy fell by one percentage point each. Zogby said there was room for public confidence to fall more this summer amid the continued flood of bad economic news and gasoline prices that continue to rise. "We've got further to go here. There is the potential that this goes further down," he said.
The index combines responses to 10 questions on Americans' views about their leaders, the direction of the country and their future. Index polling began in July 2007 and that month's results provide the benchmark score of 100. A score above 100 indicates the public mood has improved since July 2007. A score below 100, like the one this month, shows the mood has soured.
Feds fight the fear factor
Washington is tying itself in knots trying to shore up confidence in the financial sector. In just the past week, officials have moved to curtail short-selling, promised a crack down on market rumor mongers and cooked up a rescue plan for beleaguered mortgage companies Fannie Mae and Freddie Mac - while taking pains to argue that the institutions are sound even as investors dump shares.
Trouble is, banks and brokerage stocks aren't being done in by a cabal of bad guys on trading desks. Bankers who made increasingly reckless bets on the housing market engineered this train wreck. And the damage they wrought on their companies' balance sheets is going to take time - and a lot more pain - to undo.
"This is the unwinding of our bubble economy," says Euro Pacific Capital strategist Peter Schiff, a longtime critic of U.S. fiscal policy and credit market excesses. "Anybody can make loans. But banks are finding the problem right now is getting the money back."
The Securities and Exchange Commission stunned Wall Street this week with an emergency order that would limit short sales of 19 financial companies, including Fannie Mae and Freddie Mac as well as brokerage firms Merrill Lynch and Lehman Brothers.
In a short sale, an investor borrows stock, hoping the price falls so he can profit by returning the shares at a lower price. Up till now, shorts have needed only to show they have made an effort to locate shares to borrow. Now they'll need contracts for them.
The new rules, which would take effect Monday and last as long as a month, come on top of SEC Chairman Christopher Cox's announcement Sunday that the agency would "immediately" move to find out the source of untrue rumors about stocks.
The basic message: the SEC's cops on the beat will make sure no one is manipulating stock prices. For now, Cox's announcements seem to be working wonders. Financial stocks did indeed regain their stability Wednesday, soaring as short-sellers bought shares to cover their positions and Wells Fargo posted a stronger-than-expected second quarter.
Hard-hit stocks such as Fannie, Freddie and Lehman surged as much as 20%, and the S&P 500 financial index posted its biggest-ever gain. But the relief is likely to be short-lived. Bank and brokerage stocks were at multiyear lows before Wednesday's rally because their books are bloated with mortgage loans whose value will plunge as U.S. home prices continue to fall, and because many firms have borrowed heavily to make these bad bets, thus magnifying their losses.
Sooner or later, investors will turn their focus away from scheming short-sellers and back to crummy balance sheets. Oppenheimer analyst Meredith Whitney, a longtime skeptic of the financial sector, has predicted that share prices will continue to fall, as firms struggle to sell assets and bring down expenses.
She wrote Tuesday that the industry's failure to anticipate the steep fall of home prices could lead to "a material and protracted writedown and capital pressure scenario for the banks well into 2009." She doesn't expect to see a rebound till banks "get real" about the value of the mortgage-related assets on their books.
The banks aren't the only ones that have failed to get real. Indeed, Cox's offensive against short-selling can be seen as just the latest federal effort to downplay the depth of the credit crunch that started last summer. Back then, Fed chief Ben Bernanke and Treasury Secretary Henry Paulson said the crisis - then linked exclusively to the collapse of subprime mortgage securities - would be contained without damaging the economy.
Since then, credit problems have gotten progressively worse. This spring saw the collapse of Bear Stearns, the mortgage-heavy investment bank that was rescued in a Fed-brokered sale to JPMorgan Chase, even as Cox said Bear had sufficient capital.
Then there was Paulson's statement of government support for Fannie Mae and Freddie Mac over the weekend. Their shares had lost nearly half their value over the course of a week as investors fretted over their thin equity cushions and their hefty exposure to souring home mortgages.
The executive branch isn't the only place Pollyannas reside, of course. "These institutions are fundamentally sound and strong," Sen. Christopher Dodd, chairman of the Senate banking committee, said at a Capitol Hill press conference last week, in reference to the steep selloff in Fannie and Freddie shares.
Those who believe Fannie and Freddie are fundamentally unsound have no shortage of ammunition, however. Both firms have more than $800 billion in mortgage loans and other assets on their balance sheets. But Fannie has just $38 billion of shareholder equity - a measure of net worth - and Freddie $16 billion.
With the two companies and other mortgage industry players suffering heavy losses as home prices fall, it's easy to see why some investors might be tempted to bet against the companies, whatever their motives.
JP Morgan’s Dimon: Prime Mortgages Look "Terrible"
While second quarter earnings Thursday from JP Morgan Chase & Co. beat analyst expectations and helped set the stage for another rally in stocks ahead of market open, executives at the company sounded a strong warning bell over growing trouble in the nation’s mortgage market.
JP Morgan said that net income for the second quarter was $2 billion, or 54 cents a share, a drop of 53 percent from year-ago totals; analysts had been expecting 44 cents per share, according to a Bloomberg News report. The firm recorded markdowns of $1.1 billion related to leveraged lending and mortgage-related positions; it also absorbed $540 million net loss on the late May merger with Bear Stearns.
While investors took heart in the second major financial company to report better-than-expected earnings — Wells Fargo & Co. set the stage for a market rally on Wednesday by beating analyst estimates — JP Morgan’s no-nonsense CEO Jamie Dimon was clearly trying to temper investors’ newfound enthusiasm with a dose of market reality.
“Our expectation is for the economic environment to continue to be weak – and to likely get weaker – and for the capital markets to remain under stress,” he said in a press statement. “We remain conscious that since substantial risks still remain on our balance sheet, these factors will likely affect our business for the remainder of the year or longer.”
Part of that weak economic outlook can clearly be attributed to mortgages. In a surprisingly short conference call with analysts, Dimon suggested that losses in JP Morgan’s prime mortgage book could triple in the foreseeable future as the credit mess moves out of subprime and into Alt-A and jumbo loans. “Prime looks terrible,” he told analysts on the call. “And we’re sorry, and there’s nothing else we can say.”
The company currently holds $34.4 billion of jumbo mortgages, along with $2.5 billion of Alt-A mortgages. Net charge-offs among prime loans in the second quarter rose to $104 million, more than double the $50 million recorded just one quarter earlier. JP Morgan jumped in headlong into jumbos and Alt-A mortgages during 2007 — obviously an ill-timed bet, given where the market has headed.
“We were wrong, we obviously wish we hadn’t done it,” Dimon told analysts. “We’re very early in the loss curve.” Home equity loans are also proving to be problematic; JP Morgan holds $95.1 billion in the category, and saw net charge-offs rise to $511 million in Q2 from $447 one quarter earlier. High CLTV seconds in particular are “performing poorly,” according to the company’s investor presentation.
Chief financial officer Michael Cavanagh suggested that roughly 10 percent of the seconds on JP Morgan’s books are currently underwater — meaning that the borrower owes more on their combined mortgages than their home is worth. “That could be headed to 20 [percent],” he said on the earnings call. “We can’t predict how homeowners will react when they go into negative equity. “We’re assuming they won’t act well, but it’s possible things aren’t as bad as we expect.”
Subprime losses aren’t going away, either, thanks to housing price declines; net charge-offs in Q2 reached $192 million, up from $26 million one year earlier and $149 million in Q1. 30-day delinquencies also continued to post increases, suggesting that more losses are yet in the offing.
Total provisions for credit losses — including mortgages — hit $3.46 billion during Q2, more than double year-ago totals, although a $969 million drop from first quarter’s provision charges. Despite headwinds in mortgage credit quality, the company’s mortgage banking operations turned in a solid second quarter.
Mortgage loan originations were $56.1 billion, up 27 percent from the prior year and 19 percent from the prior quarter; total third-party mortgage loans serviced were $659.1 billion, an increase of $86.7 billion, or 15 percent.
There's Nothing Sacrosanct About U.S. AAA Rating
Over a plate of pasta on a January afternoon at Cecconi's restaurant in London, Pierre Naim outlined his plan to make money by betting that the U.S. government's financial reputation would crumble like Parmesan cheese.
Naim, who has owned the Nassau, Bahamas-based hedge fund Rainbow Advisory Services for more than a decade, was considering credit-default swaps. He didn't need the U.S. to default. If his peers shared his view on Uncle Sam's creditworthiness, the derivatives would jump in value.
The swaps had traded infrequently at less than 2 basis points, making for a very cheap bet. Naim put a $50 million trade on at 12 basis points -- ``I was a bit late," he says. This week, concern the U.S. is becoming addicted to financial bailouts drove the swaps to 18 basis points. Naim still isn't selling.
Sensible, sane people are starting to question whether the U.S. can hang on to its AAA credit rating. The prospect of an extra $5 trillion or thereabouts leaking onto the U.S. government's tab from Fannie Mae and Freddie Mac has spooked investors. As the man almost said, a trillion here and a trillion there, and pretty soon you are talking about real money.
``Where does the government stop?" asked economist Dennis Gartman in his Gartman Letter research report this week. ``Shall all farmers be bailed out? Shall General Motors and Ford, who are seemingly heading toward oblivion, be bailed out? Where does this mission creep end and how much shall it cost, and how badly shall the dollar be battered in the process?"
Fannie and Freddie shares have declined by about 80 percent this year. The slump in the two mortgage agencies has sparked a new catchphrase -- ``Too Chinese to Fail" -- based on the $974 billion of U.S. agency debt held by foreign investors, a fivefold increase since 2003.
Financial markets and U.S. legislators alike have derided U.S. Treasury Secretary Henry Paulson's plan to bail out the mortgage lenders. One of the two key elements is illogical, while the second is plain outrageous. Just last week, Fannie Mae said it ``has access to ample sources of liquidity, including access to the debt markets."
Freddie Mac said it was ``adequately capitalized, highly liquid and an essential part of the nation's housing system." Either they are being economical with the truth, or the decision to let them borrow from the Federal Reserve's discount facility is window-dressing that serves no real purpose.
Worse is the scheme to allow Paulson to dip into the nation's tax revenue to purchase shares in Fannie and Freddie -- shares that investors have already deemed to be almost worthless. If the mortgage lenders can't survive in their current form, the government shouldn't be defending the indefensible.
In April, Standard & Poor's said the risk that the U.S. would have to prop up its so-called Government Sponsored Enterprises posed a bigger threat to the country's AAA rating than its willingness to underwrite securities firms. S&P estimated that even in a worst-case scenario, bailing out the broker-dealers would cost the U.S. less than 3 percent of gross domestic product, while Fannie, Freddie and Federal Home Loan Banks might drain as much as 10 percent of GDP.
Defending the GSEs ``could create a material fiscal burden to the government that would lead to downward pressure on its rating," said John Chambers, chairman of S&P's sovereign rating committee. Nikola Swann, S&P's primary U.S. credit analyst, said last week that the U.S.'s top grade isn't at risk. Steven Hess, a senior credit officer at Moody's Investors Service, also said that rescuing Fannie and Freddie doesn't trigger a downgrade.
Well, they would say that, wouldn't they? Given the threat of increased regulation in their biggest market, the raters are unlikely to give the U.S. authorities even more reason to beat them up. There is an outside chance, however, that Fitch Ratings might be more willing than its peers to take the plunge.
It has happened before. In 1998, Japan was wrestling with a belated plan to bail out its ailing financial industry, which was besieged by 77 trillion yen (then $579 billion) of problem loans and an economy in its third consecutive quarter of contraction.
Fitch was first to sanction the indignity of a rating cut, dropping Japan to AA+ in September. Moody's followed with a one- level reduction in November, while it took S&P until February 2001 to change its assessment.
Wherever you look in the world of finance, sacred cows are being slaughtered. Asia is exporting inflation instead of deflation. Governments are nationalizing companies -- the rail network in New Zealand, Northern Rock Plc in the U.K., Roskilde Bank A/S in Denmark, and IndyMac Bancorp Inc. in the U.S. General Motors Corp. is suspending its dividend for the first time since 1922 and risks losing its berth in the Dow Jones Industrial Average after 83 years in the benchmark stock index.
One by one, the axioms of commerce are snapping. There's nothing sacrosanct about the U.S.'s AAA rating, no matter what dogma and orthodoxy might suggest. Many financial assets that claimed AAA status before the credit crunch turned out to be irredeemably tarnished; there's a non-negligible risk that Treasuries will prove to be similarly spoiled
America is lone bright spot as fund managers flee stocks
Fund managers across the world are dumping stocks and retreating to cash in a mood of extreme pessimism, fearing that the looming economic crunch is an even greater threat than inflation. The latest survey of investors by Merrill Lynch shows that an unprecedented 41pc now think that a world recession is either likely or very likely. The majority dismiss hopes of double-digit earnings growth next year as "fantasy".
"People are a lot more scared about the macro-outlook. The survey has never seen anything like this before since it began a decade ago," said David Bowers, the organiser of the report. "Recession risk has taken over from inflation risk. Fund managers believe the global economy is deteriorating so fast that a wage-spiral is never going to happen, at least in developed markets," he said. The survey is based on 191 funds managing assets worth $610bn (£305bn).
The US is emerging as the one bright spot in the global gloom, despite the credit mayhem. A net 7pc of investors are overweight in US equities, clearly betting that most of the bad news is already in Wall Street prices. The figure was negative in May.
With the tailwind of 2pc interest rates and a cheap dollar, America stands to benefit from the "first-in, first-out" principle. Others have yet to take their full punishment from the cycle. "The US has now become the country of cheap manufacturing. You've got 20pc wage inflation in emerging markets so FDI (foreign direct investment) is flowing back there," said Karen Olney, Merrill's chief European equity strategist.
The investor love affair with India, China, and Asian markets over the last nine months has turned sour. "That trade is off," said Mrs Olney. A net 75pc are underweight Indian equities as the country's inflation reaches double digits. Chile (-69), Taiwan (-50), Korea (-50), Malaysia (-44) are not far behind. Mr Bowers said investors had woken up to the nasty reality that emerging markets have let rip with inflation and will now have to jam on the brakes.
Those with dollar pegs or dirty floats like China have, in effect, been "destabilised" by the US Federal Reserve's rate cuts.
"These countries have used the Fed as their anchor. Rates of 2pc have challenged their economic models," he said. Russia (+75) remains the darling of the emerging universe, but for how long? Almost two thirds of investors say oil is fundamentally overvalued. They appear to be hanging on to their oil and gas exposure as a late-cycle "momentum play".
A net 42pc think the Bank of England has kept interest rates too high given the housing slump and the consumer squeeze. Not a single respondent thinks that the UK is going to get better over the next year. They are ditching bank stocks (-83) and property (-92).
Europe is not faring much better. Some 96pc think the economy will get worse over the next year, up sharply from the June survey. A majority believe inflation will fall, and a net 24pc say the European Central Bank is engaging in overkill. Not surprisingly, a record 32pc are now underweight eurozone equities.
Few see stocks as cheap even after the rude sell-off this summer. "Investors think earnings are going into a free-fall," said Mrs Olney. "Healthcare companies offer immunity from the three horrors that are bugging investors: a rising oil price, the slowing economic cycle and the credit crisis."
Japan is sneaking back into favour after years in the wilderness, if only by default. "Japanese banks are the winner from the credit crunch. Japan now has the capacity to be the monopoly supplier of capital to the world once again," said Merrill Lynch.
How Bad Is It?: The Bank Liquidity Problem
Because of the mortgage crisis, banks need liquidity–desperately. The need is so dire, in fact, that regulators are trying to push banks to issue more mortgage-backed securities.
It seems counterintuitive, but it is the kind of mortgage-backed securities that makes the difference. Specifically, regulators are talking about covered bonds, a much safer kind of mortgage-backed security that give investors a very high chance of getting paid back in the event of a default. Banks can easily issue covered bonds backed by their own mortgage holdings to raise cash.
Today, the Federal Deposit Insurance issued a statement supporting the expansion of a market in covered bonds here in the U.S. There have been only two such bonds issued in the U.S.: one by Bank of America and one by Washington Mutual. (By comparison, there is a $2.75 trillion market in Europe.)
(Not everyone is a fan. Law firm Morrison & Foerster, in a client note, the firm compared the FDIC’s cautious approval to “new socks on Christmas morning when you were expecting the latest model bike (or, for adults, a new flat screen TV)—the Policy Statement dashed all expectations.” They continue: “We ask whether this is really the time for a wait-and-see approach. Are baby steps going to get us toward a new model for financing mortgage originations? Is this 4% solution, a solution?”)
In any case, the FDIC is right to worry about bank liquidity. The banks need short-term cash to cover themselves in case of deposit withdrawals. And without that cash, they may pull back on lending and hurt the economy further. “In many cases banks are de-leveraging or shrinking or are reluctant to raise the extra capital needed to take advantage of business opportunities,” Scott M. Polakoff, senior deputy director at the Office of Thrift Supervision told the Senate.
The capital-raisings that banks have done have suffered. There have been five failures of banks and thrifts this year, and Goldman Sachs Group analyst Richard Ramsden intoned darkly in a recent research report, “failure is becoming an option.” U.S. banks–and we are taking deposit-taking bank, not investment banks–have raised $125 billion to date, compared with the $59.3 billion in write-downs they have recorded. The U.S. banks will need to raise another $60 billion, Ramsden predicted.
Investors that put their money into those banks, consequently, must be nervous. Of the 52 capital-raisings for banks this year, only two are in the money: Fifth Third Bancorp and Western Alliance Bancorp. All the rest have seen their stocks trade far below the issue price. On average, the stocks of banks that raised capital have plunged 45% from the price at which the shares were sold to investors, Ramsden said.
Only a month ago, the stocks of those capital-raising banks were down a relatively more-modest 21%. No wonder Ramsden forecasts a stormy outlook for the sector, which he writes may not recover for another six to nine months. In the meantime, capital will be, of course, much harder to get. One of the big problems is how to value them, since the conventional measure, book value, is now pretty much meaningless.
Traders See Banks Hurting Till 2011
Traders are betting that the credit crunch will still be hurting banks at the end of 2010 with financial institutions expected to be scrambling for cash to shore up their end-of-year balance sheets.
A popular so-called butterfly trade in the money markets is showing expectations of three to four times the stress at the end of 2010 as before the credit crisis started to bite last summer, although it implies the situation will have improved sharply compared with today. Many executives are assuming the credit crunch will not carry on that long, although the majority of financial services senior managers believe it will take more than six months, according to a CBI/PwC survey last month.
Laurence Mutkin, head of European rates strategy at Morgan Stanley, said money markets were pointing to long-running financial strains. “The market expects that these stresses will persist,” he said. “It is saying the system survives but individual institutions will have to fight hard to be among the survivors.” Butterfly trades allow traders to bet on increased stress at the end of the year, when banks typically try to borrow more money – increasing demand for cash – to clean up their balance sheets.
The trader takes long positions in money market futures before and after the year end and shorts the December contract. This is a bet that higher demand for money in December will push interest rates higher and prices lower relative to the earlier and later contracts.
Usually there is a small end of year premium on the cost of money, but in the past three months the premium for the end of this year has tripled and the 2010 premium has risen by half. “The Libor money markets anticipate continued stress for the end of the year for at least the next three years,” said Benjamin Reid, senior trader in fixed trader at CQS, a London hedge fund.
Other measures of stress are running at high levels. The spread between the overnight index swap rate and Libor, the rate at which banks lend to each other, a spread seen as a pure measure of the risk, is seven to eight times as high as before the crunch. But it remains below the spikes prompted by fears of a complete collapse in the financial system last summer, at the end of last year and just before Bear Stearns was rescued in spring.
Finance minister says Spain in worst economic crisis in history
Spain's finance minister Pedro Solbes has stunned the markets with an admission that his country faces the worst economic crisis in its history as the full effects of the property crash spread through the economy.
"This crisis is the most complex we have ever lived through given the plethora of factors on the table at the same time," he told Punto Radio in Madrid, breaking with past efforts to put a reassuring gloss on events. Mr Solbes said the Madrid bourse had suffered an "earthquake", crashing 27pc since the start of June. He blamed the toxic cocktail of high oil prices, the global credit crisis and the sharp slowdown in the key export markets of North America and Germany.
The comments follow this week's bankruptcy of Martinsa-Fadesa, Spain's biggest corporate failure. The property developer - with an empire of housing estates, hotels, shopping malls and hotels - collapsed after failing to refinance €5.1bn (£4bn) of debts. The company's demise was a textbook story of aggressive over-expansion at the top of the cycle, driven by high debt gearing. It has €11bn of assets.
Mr Solbes has pursued a rigorous "no bailout" policy, saying Martinsa-Fadesa took "excessive risks" and must now face the consequences. He has reportedly clashed with cabinet colleagues, who are now searching for any means to stop the downward spiral in the economy. El Pais reports that house prices crashed by 20pc in the second quarter compared with a year earlier, based on 183,000 completed transactions.
The Martinsa-Fadesa collapse has sent tremors through the whole property and construction sector. The share price of giant developer Sacyr has halved over the past month. The two banks with most exposure to the Martinsa-Fadesa are Caja Madrid, at €900m, and Banco Popular, at €400m.
Goldman Sachs has issued "sell" recommendations on a clutch of Spanish banks, including Bankinter, Banco Popular and Banco Sabadell, warning that the sharp turn in the credit cycle could prove worse than the recession in the early 1990s. "The consumer is more leveraged today than in any of the previous cycles," it said.
The ratings agency Standard & Poor's has not yet taken a decision on whether to downgrade Banco Popular and Caja Madrid.
In reality, this is unlikely to be the worst economic crisis in Spain's history. Philip II defaulted on his sovereign debts three times in the 16th century after he bankrupted the Spanish Empire to pay for his Counter-Reformation wars against Protestants. He crippled the Italian banking system in the process - much to the benefit of London and Amsterdam.
Who wins when banks die?
Imagine you're recently divorced and your ex-wife is still the beneficiary of a $1,000,000 life insurance policy. The local police chief holds a press conference and announces, "Murders are way up this year. Due to limited resources, we will now only investigate cop killings. Please stay honest and have a good day." You have to hope your ex-wife was an honorable person. Either that, or increase alimony payments so you're worth more alive.
Is this the position the weaker American banks are in? MSNBC quoted TCW Group analyst Jeff Gundlach as stating, "The credit crisis has obviously entered into a new phase - the government has one bailout left in them and [Fannie/Freddie] is it...One consequence is that other firms are allowed to go under. If you couldn't get your act together after four months of unprecedented financing terms, maybe you don't deserve to be thrown another lifeline."
Aside from allowing IndyMac to fail, news concerning the government 'bailout' of Fannie and Freddie does not immediately lead me to this conclusion. However, Mr. Gundlach has a corporate biography infinitely more impressive than mine so I'll take him at face value: American banks will be allowed to fail.
A failing bank - a popular example of which is Washington Mutual - has a life insurance policy called a Credit Default Swap (CDS). In its original form, a CDS was an insurance policy against an economic events including corporate failures. An investment group could buy Washington Mutual debt and a CDS; if Washington Mutual fails to pay the CDS insures them against a loss.
The counterparty, or insurance company, accepts the credit risk in exchange for a premium. If both the investment group and counterparty understood the risk, then it benefited both parties. With a CDS in play, if Washington Mutual defaults on debt obligations, someone gets paid big. To be fair, a CDS is more like homeowner's insurance than life insurance; in so much as a house fire is unlikely to occur while death is inevitable.
In recent years the CDS market has ballooned from nothing in 1995 to an estimated $45 TRILLION in 2007, as reported by the New York Times. This does not mean $45 trillion will change hands; the figure is akin to the insurance payout if every house in America simultaneously burned. So to trigger a $45 trillion pay out, every business in the world would have to go under. But, like homeowner's insurance, the CDS payout can change previously held incentives for the corporation and its investors.
This leaves troubled businesses - like Washington Mutual - in a position dissimilar to history. The company faces traditional short-selling pressures but, unlike the past, there are many CDS owners who also want the bank to fail. Many of them are speculators and don't even own and Washington Mutual debt. It's my opinion that once an institution gets into the crosshairs of short sellers and CDS speculators, it will be difficult for them to survive in today's environment.
The popular victims are currently Washington Mutual, National City, Lehman Brothers, Fannie Mae, Freddie Mac, and Wachovia. Much like Bears Sterns, they are not resigned to failure or takeover, but they're facing tremendous headwinds to survive because there are now multiple beneficiaries from their failure. The SEC's initiative to limit short selling only addresses part of them problem.
JPMorgan Profit Falls 52% on Writedowns, Bear Costs
JPMorgan Chase & Co., the largest U.S. bank by market value, said profit fell 52 percent, less than analysts estimated, on mortgage-related writedowns and costs from the takeover of Bear Stearns Cos. in March.
JPMorgan rose almost 6 percent in New York trading after the New York-based bank reported second-quarter net income of $2 billion, or 54 cents a share, compared with expectations for 44 cents a share in a survey of analysts by Bloomberg. JPMorgan has posted more than $10 billion of writedowns and losses on mortgage-tainted assets, compared with $43 billion at Citigroup Inc.
Shares of the company climbed 16 percent yesterday, the biggest gain in almost six years, after Wells Fargo & Co. raised its dividend and reported higher net income than analysts were estimating. "I'm pretty impressed," Jeffrey Davis, chief investment officer at Lee Munder Capital Group in Boston, which owns about 79,000 JPMorgan shares, said in an interview on Bloomberg Television. "It potentially could continue the rally in financials today."
Shares of the company rose $2.06 to $38 before the official open on the New York Stock Exchange. JPMorgan increased credit reserves by $1.3 billion to cover bad loans in the quarter, and wrote down the value of leveraged loans and mortgage-related assets by $1.1 billion. The acquisition of Bear Stearns resulted in a $540 million loss, the company said.
Chief Executive Officer Jamie Dimon said in the statement he expects "capital markets to remain under stress" as the economy weakens. Federal Reserve Chairman Ben S. Bernanke told Congress this week that the threat of an economic slowdown was increasing, after turmoil in the markets forced the Treasury and Fed to mount a rescue of mortgage providers Fannie Mae and Freddie Mac.
The economy grew at an annualized rate of 1 percent in the first quarter, capping the weakest six months in five years. Earnings compared with $4.2 billion, or $1.20 a share, in the same period a year earlier. Revenue fell 3 percent to $18.4 billion, beating the average estimate of $16.6 billion among analysts surveyed by Bloomberg. Return on equity, a gauge of how effectively the company reinvests earnings, was 6 percent, down from 14 percent a year earlier.
The investment-banking unit had a second-quarter profit of $394 million, versus a profit of $1.2 billion a year earlier. Consumer banking earned $606 million. The credit-card division's profit fell to $250 million, or 67 percent below last year's results, as the bank set aside more money to cover bad loans.
JPMorgan fell 28 percent during the past 12 months, compared with the 69 percent drop of Citigroup and the 54 percent decline of Bank of America Corp.
Merrill To Report Fourth Straight Quarterly Loss on Writedowns
Merrill Lynch & Co. probably will report its fourth straight quarterly loss later today because of credit-market writedowns, analysts estimate.
The third-biggest U.S. securities firm may post a second- quarter net loss of as much as $4.21 a share, according to an estimate by Oppenheimer & Co. analyst Meredith Whitney. The loss comes as Merrill dropped efforts to sell a stake in BlackRock Inc. and struck a deal to sell its 20 percent share of Bloomberg LP, people with knowledge of the decision said yesterday.
Chief Executive Officer John Thain is selling assets as analysts at Citigroup Inc., Oppenheimer & Co. and Wachovia Corp. predict the company will report at least $5 billion of writedowns. Merrill agreed to sell its investment in Bloomberg LP, the parent of Bloomberg News, for $4.5 billion, a person familiar with Merrill's plans said. New York-based Merrill is financing the sale to Bloomberg, said the person, who declined to be identified because terms haven't been announced.
"If proceeds from the sale are enough to cover the writedowns, I think it's a huge positive," said Ken Crawford, senior portfolio manager at St. Louis-based Argent Capital Management LLC, which held almost 300,000 Merrill shares at the end of March. "If it's not enough, then I think investors will wrestle with what did they report and what do they think they need in terms of capital raise going forward."
Merrill typically reports its quarterly results before trading begins on the New York Stock Exchange. The company will post the latest figures today after the market shuts. Merrill stood to gain about $2 billion on its 49.8 percent stake in New York-based BlackRock, the largest publicly traded U.S. fund manager, based on its current market value. BlackRock fell 17.5 percent in New York trading this year, partly on concern Merrill would divest its holding.
"I would prefer that they own the position in Blackrock because it's a strategic asset for them," Crawford said. Jessica Oppenheim, a spokeswoman for Merrill, declined to comment yesterday. BlackRock CEO Laurence Fink declined to comment through a spokeswoman. Bloomberg spokeswoman Judith Czelusniak in New York also declined to comment.
Merrill rose $3.31, or 13 percent, to $28 in New York Stock Exchange composite trading yesterday, trimming this year's drop to 48 percent. BlackRock climbed $14.77, or 9 percent, to $178.95. Thain, 53, has raised $17.9 billion since December from investors including Temasek Holdings Pte, Singapore's sovereign wealth fund.
Merrill's $38.2 billion of writedowns and credit losses since the beginning of last year are the third-largest among banks and brokerages hit by the credit-market contraction, after Citigroup Inc. and UBS AG, data compiled by Bloomberg show. Oppenheimer's Whitney predicted in a July 2 report that Thain would raise cash by selling stakes in BlackRock and Bloomberg before announcing earnings.
On its books, Merrill values the BlackRock holding at about $8 billion. It's worth about $10 billion, based on the company's market value. Merrill's agreement to sell its stake in Bloomberg LP back to its corporate parent, Bloomberg Inc., may be announced as soon as today, the person familiar with Merrill's plans said. Bloomberg is majority owned by New York City Mayor Michael Bloomberg.
IndyMac Is Included In FBI Fraud Inquiry
Failed lender IndyMac Bank is among nearly two dozen banks under scrutiny by the Federal Bureau of Investigation for possible mortgage fraud, U.S. officials said. The big Pasadena, Calif., bank was seized by regulators last week, the third-largest bank failure in U.S. history.
It specialized in home loans to borrowers who lacked full documentation for their income or assets and have a higher default rate than other loans. The IndyMac investigation began shortly before the bank was seized last week, a law-enforcement official said. Officials wouldn't provide further details of the IndyMac inquiry, reported earlier by the Associated Press. In other cases, the FBI has been focusing on accounting fraud, the documentation of mortgage-backed securities and insider trading.
In a statement Wednesday, the FBI said the number of banks under investigation for mortgage fraud is now 21. "We receive information from a variety of sources on a daily basis, and we have an obligation to review each allegation on its merits," the bureau said. "Given the volatility of today's subprime market, we have seen an increase in subprime-related complaints."
Few major lenders under investigation have been identified. One of them is Countrywide Financial, once IndyMac's parent company, which has since been acquired by Bank of America Corp. Countrywide has said it isn't aware of an investigation. Evan Wagner, vice president of corporate communications at IndyMac Bank, said given the size of the bank and the fact that it failed, "it shouldn't be a surprise if someone is investigating, however, we can't confirm that one way or another."
Richard Wohl, president of IndyMac Bank, referred calls to the Federal Deposit Insurance Corp., which is now running the bank. Representatives for the FDIC and the Office of Thrift Supervision, IndyMac's former regulator, declined to comment. The bank was back in business Monday. Most of its depositors were fully insured by the federal government.
Second Liens Still Lurking at Wells Fargo
Despite second quarter results that were better overall than analysts had expected, Wells Fargo & Co. remains under growing pressure from a deteriorating $84 billion home equity portfolio, bank executives said Wednesday morning.
Second quarter profit slipped 23 percent to $1.75 billion, or $.53 per share, compared to $2.28 billion, or $.67 per share one year earlier — but the bank saw its revenues rise, and boosted its dividend by 10 percent to boot. Analysts had expected earnings of $.50 per share, according to published reports.
The strong overall numbers propelled the financial giant’s shares to their largest gain in more than two decades, as investors were cheered not only by the fact that the bank beat estimates, but that it has continued to post a profit in an environment that has seen lesser competitors pushed into the red — or even into the hands of the Federal Deposit Insurance Corporation, as in the case of IndyMac Bank. Shares in Wells Fargo were at $25.07, up 22.2 percent, when this story was published.
Strength in other areas of the bank’s diversified businesses more than offset any weaknesses in the mortgage arena; the bank absorbed a provision for credit losses of $3.0 billion, including a reserve build of $1.5 billion, it said. But those losses mattered little relative to gains in both credit card fees and insurance segments.
“In Wells Fargo’s case, the benefit of the credit crisis in terms of higher assets at higher spreads has so far largely offset the negative impact of higher charge-offs,” said CFO Howard Atkins. “We are one of the few banks that have the capacity to take advantage of such opportunities.”
Despite the optimism, a burgeoning portfolio of second-lien mortgages at Wells Fargo that had in recent weeks concerned analysts and investors hasn’t gone anywhere; and, if anything, Wednesday’s quarterly result also holds evidence that the credit losses in that particular portfolio have yet to fully reverberate throughout the bank.
Wells has a substantial $84 billion portfolio of home equity loans — and half of those are located in hard hit states like California and Florida; of that total, it has carved out the worst $11 billion for liquidation, with rest remaining as part of its “core” home equity portfolio. In the second lien portfolio set up for liquidation, the percent of loans that saw borrowers miss two or more payments rose during Q2 to 3.6 percent, up from 2.79 percent one quarter earlier.
The $73 billion “core” home equity portfolio saw a similar rise to 1.88 percent in 60 day delinquencies, compared with 1.71 percent in Q1. So delinquencies continued to rise during Q2; net credit losses, however, did not. Charge-offs on second liens were actually down $104 million compared with first quarter 2008 — but don’t let that fool you.
The improvement was primarily due to a change in how the bank handles its home equity portfolio charge-offs; earlier in Q2, the bank extended its charge-off policy from 120 days to 180 days, in an effort to give troubled borrowers more time to reach a loan workout (or to protect earnings, take your pick).
“Although losses declined, the portfolio continued to deteriorate as property values search for a bottom,” Michael Loughlin, the bank’s chief credit officer. “Given the continued decline in home prices, we had more accounts move into the higher combined loan-to-value segments, which directly impacts loss levels.” As second lien borrowers see equity in their homes evaporate due to price depreciation, second liens become extremely vulnerable to loss.
Which is why this stat matters more than most: approximately $35.6 billion of Wells Fargo’s $84 billion in home equity loans had combined loan-to-value ratios above 90 percent, according to the second quarter report. And that’s a figure based on automated value models, or AVMs, that were run in March 2008; were those AVMs run again today, it’s almost a sure bet that the number has gone up even further.
Goldman accused of spreading rumours about rivals
Goldman Sachs, the most powerful investment bank on Wall Street, has found itself at the centre of a storm over the events that led to the collapse of Bear Stearns, as regulators issued subpoenas in the hunt for evidence of market manipulation.
The heads of Bear Stearns and another beleaguered bank, Lehman Brothers, confronted the Goldman Sachs boss Lloyd Blankfein with allegations that London-based traders were among those spreading rumours that were undermining confidence in their companies.
An angry Goldman Sachs denied the allegations yesterday and said it was confident that the Securities and Exchange Commission would find that the firm did not spread rumours about the two banks' financial position, and instead had actively helped to keep them trading.
The SEC has demanded trading records and emails from all the major investment banks and around 50 major hedge funds, as it examines whether traders stoked rumours that they knew to be false in the hope of profiting from the subsequent decline in share prices. Rumours that Bear Stearns was suffering liquidity problems in March quickly became self-fulfilling, when scared trading partners pulled their business.
With Wall Street's biggest firms still struggling to gauge the scale of their losses from the mortgage market collapse, the nervous atmosphere has created a toxic brew of speculation, rumour and innuendo – and no shortage of conspiracy theories.
Yesterday, though, brought the biggest-ever rally in financial company shares, after Wells Fargo, a major US bank, became the first to post results for the second quarter.
They proved not nearly as bad as rumour had suggested, and far from showing signs of a liquidity crisis, the bank increased its dividend. That prompted a rebound across the sector and, with the added bonus of a falling oil price, led the Dow Jones Industrial Average to a 2.5 per cent gain.
Bear Stearns executives have told friends that they believe a conspiracy of short sellers to have been behind the rumours that felled their company, and Alan Schwartz, Bear's short-lived chief executive, contacted the SEC and confronted Mr Blankfein with his suspicions, according to a newspaper report yesterday.
The allegations centre on Goldman's London-based trading in Bear Stearns credit default swaps – financial contracts which insured investors against a debt default by Bear Stearns. Dick Fuld, the chief executive of Lehman Brothers, has confronted traders who he believes have spread rumours about his firm's financial position.
Although Lehman shares have been pummelled, amid disappointing fin-ancial results and concerns over its future earnings potential, the company has averted a full-blown collapse in confidence. Mr Fuld, too, tackled Mr Blankfein, saying he had heard "a lot of noise" in the market about the activities of Goldman's traders.
"It is all absolutely ridiculous," a Goldman Sachs spokesman said yesterday. "Any suggestions that we started any rumours are ridiculous. The most senior executives at Bear Stearns and Lehman Brothers know that we went out of our way to help them and, in the case of Lehman Brothers, continue to go out of our way."
While Bear Stearns was a competitor, it was also a counter-party to many Goldman Sachs trades and, in some areas, a client, which meant Goldman had no interest in seeing it go out of business, the spokesman said. There was a mixed reaction yesterday to the SEC's order, late on Tuesday, that it would temporarily ban so-called "naked" short selling of shares in 19 companies considered pivotal to the financial system.
Traders will now be required to prove they have borrowed real shares before putting in a sell order. The ban will make it slower and more costly to conduct short selling and – its proponents believe – will reduce the downward pressure on stocks. One popular traders' blog called it the "Paperwork Production Act of 2008".
Who could have foreseen the credit crisis? Will it get worse?
Today I'd like to introduce you all to Nouriel Roubini, professor of economics at the NYU Stern School of Business, founder and chairman of financial information and analysis service RGE Monitor, occasional guest on financial TV stations such as CNBC and Bloomberg, but above all, Roubini is the living exception for all experts in the financial industry who, at times, try to seek solace in the fact that nobody ever saw the problems in the US housing and finance sectors coming.
Unfortunately, for these experts, some people did and Nouriel Roubini was one of them. Two years ago already Roubini started publishing columns, blog stories and analyses about how he believed the US housing market was on the brink of a serious downturn. It was only a matter of time before the US would experience a serious banking problem to be followed up by a good old credit crunch, he predicted.
The accuracy of these analyses has now made him a lauded expert who is being asked to write contributions for print media and to voice his opinion on financial television. Further adding to his credibility is the fact that Roubini anticipated the two government sponsored entities overseeing circa half of the US mortgage market would ultimately have to be bailed out by the US government.
Now that was a pretty bold prediction to make, but as we all know now, the US government is currently being forced to do just that. Roubini has also estimated this financial crisis will ultimately cause financial losses somewhere between US$1 and US$2 trillion. Apart from that last estimate, which has yet to be proved correct, it would seem economist Roubini has been pretty accurate in his predictions and calculations thus far. So what else has he been forecasting?
As the average small bank in the US has 67% of its assets in real estate, Roubini believes those investors hoping that California's IndyMac will be the only one who has to be bailed out by US authorities are in for some nasty surprises. He sees hundreds of small US banks hitting the wall, not just one or two. And while most of these banks are much smaller in size than IndyMac, it is his assessment there will be about a dozen among them similar in size to IndyMac.
The reason for thess predictions is as easy and straightforward as can be: the US had become an over-leveraged society with households, businesses and the government taking on far too much debt. As a lot of this debt has a direct relationship to the US housing market, it was always only a matter of time before the bubble would burst. Now that it has, the consequences will be dire, and far-reaching, as every example in history will show us.
US banks have thrived on the bubbling housing market over the past years. This over-exposure will now come home to roost. It's a simple numbers game, really and given that Roubini's profile has been steadfastly on the rise over the past two years, it is almost a miracle that it took this long before investors in the US share market started to catch up on the theme.
This proves, once again, that sometimes investors simply choose to ignore certain things so they can continue buying shares and hope for better times ahead. This also shows us that ultimately we can only ignore these things for so long. This is still not where Roubini thinks this financial crisis will end. He foresees there will be bigger fish that will need to be saved, including some major money center banks.
But also, predicts Roubini, this crisis will ultimately mark the end of the independent broker dealers in the US. Their business model is irrepairably broken, he says, so they will all be forced to merge with traditional commercial banks - or go bust.
If you really want to get a grip on what this is all about stop thinking about "subprime mortgages", says Roubini, this crisis has never been about some dodgy home loans provided by some dodgy sales teams trying to extend the good times into eternity - this crisis is all about a dodgy financial sector in a country that simply failed to realise its complete financial system was turning into "subprime". And now that it's too late, the consequences will be dire, very dire.
Does anyone still think US financials are offering bargains? Or that Australian banks will return to their former PE ratios anytime soon?
From Hong Kong, market strategists at GaveKal report they believe there's yet another set of bombshells to arrive for the global financial community: it has to do with the exposure of European banks to US housing and mortgages. While problems in the US are currently taking centre stage (and quite deservedly so, one might add), GaveKal fears it is only a matter of time before Europe will follow up with its own set of problems. These include the likelyhood of an outright economic recession plus similar problems for European banks as we are now witnessing in the US.
Europe has its own housing markets in crisis and GaveKal points out Spanish developer Martinsa-Fadesa filed for bankruptcy yesterday, less than one year after it listed on the stockmarket. Also, a growing number of countries including Italy, Portugal, and Spain have now had to cancel debt issues for lack of investor demand. This is not going to be over anytime soon, is it?
Maybe, suggests GaveKal, the next big bomb won't be one of the European financials, but a government instead, maybe one of the emerging markets where various countries are struggling with a large current account deficit: Hungary? Poland? Turkey? India?...
Senate investigates foreign bank tax shelters
A U.S. Senate subcommittee is scheduled to hold hearings on Thursday on a practice by UBS and other foreign banks that it says have helped wealthy Americans shield billions of dollars from taxes. The hearings follow a six-month probe by the Senate Permanent Subcommittee on Investigations into practices by Switzerland's UBS and LGT Bank in Liechtenstein. LGT is owned by Hans-Adams II, Liechtenstein's prince.
Since 2001, UBS has an estimated $18 billion in assets from 19,000 accounts in Switzerland for U.S. clients, which have not been disclosed to the U.S. Internal Revenue Service (IRS), which collects taxes for the U.S. government, the subcommittee said in a written statement late Wednesday. The IRS has identified at least 100 U.S. taxpayers with accounts at LGT, the subcommittee said.
UBS declined to comment on specific items in the report, but said Mark Branson, chief financial office of UBS's Global Wealth Management and Business Banking since 2008, would appear before the subcommittee, chaired by Sen. Carl Levin. "UBS also intends to address and correct in a responsible manner any misconduct identified in the course of the ongoing investigations by U.S. authorities," UBS said in the statement.
Offshore tax evasion costs the U.S. an estimated $100 billion a year, according to the subcommittee report. The report urged Congress to pass laws that would allow for strong penalties on banks that help U.S. taxpayers avoid paying taxes. It also urged authorities to close more loopholes in tax regulations and strengthen reporting requirements.
The issue of banks helping foreigners conceal income became an international issue last year when German prosecutors began probing hundreds of prominent people who may have hidden their wealth in Liechtenstein. In May, two former UBS European bankers, Bradley Birkenfeld and Mario Staggl, were indicted and accused of helping an American billionaire real estate developer hide $200 million in assets from U.S. tax authorities.
On June 19, Birkenfeld pleaded guilty in federal court in Florida to conspiring to defraud the IRS by assisting UBS clients in avoiding U.S. reporting requirements on income in Swiss bank accounts. According to Birkenfeld's court statement, UBS employees assisted wealthy U.S. clients in concealing their ownership of assets held offshore by creating sham entities and then filing IRS forms falsely claiming the entities owned the accounts.
Birkenfeld said in court that UBS had about $20 billion of assets under management in "undeclared" accounts for U.S. taxpayers. According to the subcommittee's report, from at least 2000 and 2007 LGT and UBS used banking practices that could help and resulted in tax evasion by U.S. clients, advising them on complex offshore structures where they could hide assets, the subcommittee said.
UBS said it has been working diligently with American and Swiss government authorities to "provide relevant information to US investigators," it said. UBS also said that it has been informed that the Senate's subcommittee has called Martin Liechti, head of UBS' Wealth Management Americas International business, to appear at the hearing.
Among those who have accounts is Frank Lowy, who survived the Holocaust and founded Australia-based Westfield Group, the world's largest shopping mall owner. Although Frank Lowy is an Australian citizen, one of his three sons, Peter Lowy, chief executive of Westfield America, holds U.S. citizenship and has been called to testify.
Lowy was asked to testify in Thursday's hearings but will be out of the country, said his attorney Robert Bennett, a partner in law firm Skadden Arps, Slate, Meagher & Flom. "He will voluntarily be appearing on July 25 at 10 a.m.," Bennett told Reuters, adding that his client did nothing wrong.
RBS is biggest loser in torrid day for UK banks
The collapse in the value of Britain's high street banks is continuing today, with Royal Bank of Scotland now worth little more than half the £49bn paid for ABN Amro last year.
In another torrid day for the sector, shares in HBOS, the owner of Halifax and Bank of Scotland, fell another 32p in trading early this afternoon to 228p - 47p below the price of new equity in the bank's £4bn rights issue that closes in two days. Subscribers to the £12bn RBS rights issue, which closed on June 6, have already seen more than 25pc, or £3bn, wiped from the value of their investment.
As fears about the health of the US economy and banking sector continued to ripple around the world, shares in RBS, which has significant exposure to the American market, were trading at less than 150p this afternoon compared with the 200p rights issue price. On paper, RBS would now be able to buy HBOS with change to spare from the £10bn it paid as the lead partner in the £49bn takeover of Dutch group ABN Amro last year.
HBOS, which was valued at more than £43bn in February last year, was this afternoon worth a fraction above £8.5bn.
Although speculation has centred on major HBOS investors supporting the bank's rights issue, fears are intensifying that underwriters Morgan Stanley and Dresdner Kleinwort will be left with a huge overhang of unsold shares.
The other British banks were also dragged lower as sentiment soured. Barclays was down 17.5p to 243p while Lloyds TSB fell 16p to 257p. Bradford & Bingley shares were trading almost 2p lower at 47p ahead of the bank's extraordinary meeting tomorrow where shareholders will vote on the group's £400m rights issue at 55p a share, which is being backed by the lead investors.
HBOS - like several of its British banking peers - was in freefall on Wednesday, down 19p, or 7.3 per cent, at 241p. Its £4bn rights issue closes on Friday. With the new stock being offered at 275p it is safe to assume there will not be many takers.
In fact the only acceptances are likely to be from those (mainly retail) shareholders who have already sent in their forms. What’s the likely take-up? On Tuesday, JPMorgan Cazenove suggested a figure of 60-80 per cent - a projection the house might want to revisit. Indeed, £2bn or more might get left with the underwriters. Will this be a place-able “rump” or a “stick”?
Either way, analysts reckon shares in HBOS are simply catching up with the view in the debt markets, where participants continue to fret about fair value adjustments to the £78bn of debt securities sitting in the HBOS treasury division becoming permanent. There’s also the little matter of falling UK house prices. From Cazenove:14% of HBOS’ mortgage book has an LTV over 80% based on the most recent securitisation data (a sample representing 45% of the total) and therefore £33bn of the book is vulnerable to negative equity if house prices fall by 20%. This would lead to a double effect on the group’s capital from a higher impairment charge (higher loss given default) and higher risk weighting from the pro-cyclical effects of Basel II. Another 22% or £52bn has an LTV between 70-80% and so vulnerable if house prices nationally fall 30% as they did in several regions in the early 1990s.
And a growing sense that liquidity will once again become a key issue:Customer deposits provide only 42% of total group funding of £512bn (including conduits), leaving it reliant for £297bn from the wholesale markets. We feel that this issue had subsided in importance in recent months but that the continued tension in the credit markets and, in our view, the recent speculation about the possible disposal of HBOS Australia has seen liquidity begin to return as an investor concern. We feel the relevance is that it restricts HBOS’ ability to grow to its level of success in attracting customer deposits; the June trading update suggested little overall growth with some encouraging progress on retail deposits after a dull first quarter but corporate deposits were unchanged. Thus far, HBOS remains confident the net interest margin will begin to recover from the second half of this year as the re-pricing of assets begins to work through. The risk is the continued rise in the cost of both deposits and wholesale delay that recovery.
Bank of England chief sees rocky ride ahead for economy
The Bank of England's new chief economist warned that the UK is facing its toughest economic prospects in over a decade, as unemployment increases at the fastest rate since 1992.
Spencer Dale, who succeeded the newly promoted Deputy Governor Charlie Bean this month, told the Treasury Select Committee that rising joblessness should help keep inflation and wage increases under control, but said the economy is facing a rocky ride.
It came after the Office for National Statistics said the claimant count of people out of work and claiming the jobseekers' allowance rose by 15,500 in June to 840,100. It is the biggest one-month increase in 16 years, and fuelled fears that Britain could face a 1990s-style increase in unemployment.
George Buckley at Deutsche Bank warned that the actual rise in overall unemployment may be even bigger than the 15,500, since many foreign workers may be returning home to booming labour markets in Eastern Europe rather than claiming benefits. Although house prices have fallen and many economists think the UK is facing a recession, unemployment has so far remained low.
However, Capital Economics warned yesterday that unemployment could rise by 900,000 over the next 18 months, as the fall in available positions combines with a further increase in the size of the overall available workforce, due to higher immigration and more elderly people continuing to seek work.
Reassuringly for the Bank, the ONS also said that the rate of wage inflation remained low at 3.8pc - below its "danger level" of 4.5pc. However, the ONS's alternative wage measure currently shows wage inflation of over 4pc. Mr Dale, 41, a former close adviser to Mervyn King, echoed a number of the Bank Governor's comments in his appointment testimony before the Treasury Committee.
He warned that the Bank remains vigilant about tackling inflation, which he expects to rise further from its current 3.8pc level over the coming months. He also said: "We do see the housing market starting to slow. We see house prices falling since the autumn of last year. We see housing market activity also falling.
"If we think that the adjustment in the housing market is causing output to slow to an extent that will lead to a very pronounced downturn in the economy which will threaten the medium-term inflation target then I think it appropriate for the Monetary Policy Committee to respond to that." Economists expressed relief that Mr Dale appeared measured in his approach to the fight against inflation.
China's Stock Markets Go from World's Best to Worst in 2008
The Shanghai Composite's latest retreat on Wednesday pushed Chinese equities to rock bottom in the global rankings, replacing Vietnam as the worst-performing stock market.
The Shanghai Composite index closed down 2.7% at 2,705 on Wednesday. It has now fallen 48.6% year to date, the biggest decliner among stock markets globally. In Vietnam, the benchmark VN index gained 1.4% on Wednesday, putting its year-to-date retreat at 47.5%.
"We're at a rocky period," said Robert Lutts, president and chief investment officer at Cabot Money Management, referring to Chinese equities. "The valuation and the technical condition of the market are trying to set a bottom," he said. After the Shanghai's market's strong performance in recent years, "the corrective phase is not unexpected," Lutts said.
What a difference a few months makes. The Shanghai Composite index has tumbled this year after being the best performer among major global stock indexes in 2007, when it recorded an astronomical gain of 97% for the year. The Shanghai index has now fallen nearly 55% from its peak over 6,000, reached in October 2007.
By comparison, the Dow Jones Industrial Average and the S&P 500 index have both lost about 21% from their October highs.
Chinese shares "had risen at such a rate that it was not really based on economic fundamentals or the value of the equities," said Rachel Ziemba, an analyst at RGE Monitor.
"Chinese investors, many of whom rushed into the equity markets last year, are increasingly wary of putting their assets in equities," Ziemba said. She emphasized that the government's role in the equity market is key. A majority of shares are still held by government institutions.
"We still see a market that, because of government involvement, is a speculative market," Ziemba said. "It's very difficult to get information on these equities, so it's hard for value-based investors. Growth remains robust, but [the economy] is growing at a slower pace. Inflation remains elevated."
China says inflation falls to 7.1 percent
China's inflation fell to 7.1 percent in June, the government reported Thursday, possibly easing pressure on Beijing to raise interest rates or take more drastic steps to cool sharp rises in consumer prices.
The economy, meanwhile, grew by 10.1 percent in the three months ending June 30, a decline from the previous quarter's 10.6 percent expansion, but in line with government controls imposed to prevent runaway growth and higher inflation, the National Bureau of Statistics said.
While still high, the June rise in consumer prices over the same month of 2007 was down from May's 7.7 percent rise. The decline followed months of government efforts to cool inflation by increasing food supplies and imposing price controls on food, fuel and other basic goods. Prices are "still running at a fairly high level," statistics bureau spokesman Li Xiaochao said at a news conference, giving no indication that Beijing considered the problem under control.
The communist government is especially worried about the impact of fast-rising prices on China's poor majority, who spend up to half their incomes on food. Bouts of high inflation in the 1980s and '90s sparked protests, a scene the government is anxious to avoid ahead of next month's Beijing Olympics, which it hopes will showcase China as stable and prosperous.
"In 2008, China is facing challenges from both inside and outside. But the national economy maintained stable and fast growth," Li said. "We are moving in an effective direction. The result is really hard-earned."
Chinese consumer prices began to rise sharply in mid-2007 due to shortages of pork and grain. The government initially expressed confidence inflation would start to fall by the end of that year. But efforts to rein in prices were hampered by severe winter storms that wrecked crops and disrupted shipping.
Opposition, From Both Parties, Over Bailout Plan
The Bush administration’s plan to rescue the nation’s two largest mortgage finance companies ran into sharp criticism in Congress on Tuesday as some lawmakers questioned the open-ended request for money that could be used to help the companies.
The criticism prompted House leaders to push back their timetable for approving emergency housing legislation, saying final action would take at least until early next week. A growing number of Republicans had voiced skepticism and, in some cases, angry opposition, to the administration’s proposal to help the two companies, Fannie Mae and Freddie Mac.
It was unclear whether the criticism was hand-wringing before Congress ultimately adopted the rescue package or whether it meant a delay or that major changes to the proposal were in the works. The Republican opposition threatened to incite an ugly intramural fight with the White House. In a high-stakes election year, the resistance reflected the deep fear among some lawmakers that the plan could set off a large taxpayer bailout, touching off a wave of voter anger in November.
For some lawmakers facing tough re-election contests, opposing the rescue plan is a way to reaffirm their identity as budget hawks while publicly breaking with a deeply unpopular lame-duck administration. The rescue plan, which was hastily prepared over the weekend after a punishing week in the stock market for Fannie Mae and Freddie Mac, calls on Congress to give the administration the authority for up to 18 months to inject billions of dollars into either company through investments and loans.
Henry M. Paulson Jr., the Treasury secretary and the proposal’s architect, insisted on Tuesday that he had no plan to make any immediate investments or loans, but that he simply wanted to send a signal to jittery financial markets that the companies had the support of the United States government.
While administration officials continued to express confidence that Congress would act soon, the day’s events suggested that the lawmakers might impose some limits on the plan. President Bush told reporters at a news conference on Tuesday morning that it was vital for Congress to act soon. “I urge members to move quickly to enact the plan in its entirety,” Mr. Bush said. “These two enterprises play a central role in our housing finance system.”
His views were supported by Senator Mitch McConnell of Kentucky, the Republican leader, who said he expected that the administration’s proposal would be included in the housing package and that he expected it would be approved sooner rather than later. “I’m optimistic we are going to complete the process this week,” Mr. McConnell said, “and also optimistic that the administration’s recommendations are going to be part of it.”
As other Republicans voiced their concerns, however, Steny H. Hoyer of Maryland, the Democratic majority leader in the House, said he expected that hearings would have to be held and that the House would not vote on the bill before next Tuesday. At a Senate hearing Tuesday, Mr. Paulson found himself on the defensive as Democrats and Republicans repeatedly asked him how he could expect Congress to give him — and his successor — a blank check.
Mr. Paulson walked lawmakers through his logic. By giving him the authority to spend an unlimited amount of money, he said, the markets would accept that the government’s commitment is solid, and that would increase confidence. In turn, that would significantly decrease the odds that the government would need to spend any money at all.
“If you’ve got a squirt gun in your pocket you may have to take it out,” he said. “If you’ve got a bazooka, and people know you have it, then you may not have to take it out. By making it unspecified, it will greatly expand the likelihood it will not have to be used.”
But the logic did not seem appealing to several Republicans and Democrats on the banking committee, who raised concerns about taxpayer exposure, and left unspoken the view that Congress would not quickly surrender the power of the purse.
“You don’t want to put a dollar amount — I understand the reasons for ambiguity and not stating things,” said Senator Richard C. Shelby of Alabama, the senior Republican on the committee.
“I think you are risking taxpayer dollars here. To give you — we have respect for you at Treasury — a blank check? I’m not so sure. We’ll have to talk.” Mr. Shelby added, “I fear we’re sitting on a financial powder keg.”
Fannie, Freddie spent millions on lobbying
For years, mortgage giants Fannie Mae and Freddie Mac tenaciously worked to nurture, and then protect, their financial empires by invoking the political sacred cow of homeownership and fielding an army of lobbyists, power brokers and political contributors.
New attention is being focused on the bruised mortgage companies as the Bush administration presses its rescue plan to Congress. Some lawmakers have challenged the plan's open-ended nature and expressed fears of a potential big taxpayer bailout in an election year.
Over the past decade, both Fannie and Freddie made the list of Washington's top 20 lobbying spenders. They spent a combined $170 million to cultivate allies during that period, a bit less than the American Medical Association and a bit more than General Electric. At the same time, their executives have consistently led the mortgage-banking sector in campaign giving to members of Congress, contributing a combined $16.2 million since 1997.
People who have lobbied on their behalf have played or are playing roles in the presidential campaigns of both Republican John McCain and Democrat Barack Obama. Defenders, including President Bush and Treasury Secretary Henry Paulson, say the nation's two major mortgage companies — which own or guarantee roughly half of the nation's $12 trillion in outstanding mortgage debt — are more vital than ever to the smooth functioning of the nation's jittery financial markets.
The two companies were set up by federal law as "government-sponsored enterprises" that operate as private companies with profits and stockholders. Critics say they have used their clout and unusual status to create a sort of regulation-free zone around their businesses. When times are good, shareholders and executives of the companies are richly rewarded. When times are bad, as now, taxpayers could be left holding the bag.
"Congress created this problem by creating special rules at Fannie Mae and Freddie Mac and ignored the problem for years," said Sen. Jim DeMint, R-S.C., a sharp critic of what he sees as a looming federal bailout. Fannie Mae — the Federal National Mortgage Association — was established in the 1930s to encourage homeownership by buying mortgages from banks. That freed cash for the banks so they could make new loans.
Fannie and Freddie Mac (Federal Home Loan Mortgage Corp.), created later but with basically the same mission, hold some of the mortgages in their own portfolio and package the rest as bonds and other securities, which they sell. Neither one makes loans on its own, and they were not directly involved in the subprime mortgage fiasco.
But the housing downturn is so steep that they have been seeing increasing delinquencies on their conventional mortgages and have been exposed to investor flight from financial assets. Furthermore, because of their special status, they can keep smaller capital reserves on hand than other financial institutions. They need to raise cash to stay afloat.
Fannie and Freddie have long been distinguished by their outsized influence. They spend heavily on lobbying and hire liberally from Capitol Hill's revolving door and their executives give top dollar to political campaigns. They've also funneled contributions into select charities and think tanks.
"They have always understood that the political risk was huge for them, and they put millions of dollars into using contributions, jobs and consulting contracts to stay in the good graces of people in power," says Wright Andrews, a veteran banking lobbyist. "They had both parties — and particularly the Democrats — under incredible control."
Fannie, Freddie: Taxpayers on the hook
Saving Fannie Mae and Freddie Mac could cost the U.S. taxpayer. But so could letting the two mortgage giants collapse.
A rescue plan that uses federal dollars would risk increasing the deficit and possibly lowering the U.S. debt rating, making it more expensive for the government to borrow in the future. A decision not to intervene could lead to deep pain in the mortgage market and the parts of the economy tied to it. The Bush administration is betting the first option is preferable to the second.
A proposal outlined by Treasury Secretary Henry Paulson - if approved by Congress - would offer explicit backing for the two government-sponsored enterprises (GSEs). It has three main elements.
- Increase each company's $2.25 billion line of credit with the Treasury by an unlimited amount for the next 18 months.
- Let the Treasury have the option of buying an unlimited amount of Fannie and Freddie stock over the next 18 months.
- Give the Federal Reserve a consultative role with the GSEs' regulator to assess the companies' capital requirements.
In any rescue, Treasury would likely have to borrow billions of dollars. Exactly how much it would cost taxpayers is impossible to gauge because of several unknowns. Among them are extreme volatility in the companies' stock prices coupled with falling home values and rising mortgage default rates, which affect the value of the GSEs' assets and debt.
"Stuff's happening to the portfolio that we don't know about," said Lee Sheppard, a contributing editor at Tax Analysts. "It's a fluid situation." And maybe the biggest unknown: just how much the government might spend on Fannie and Freddie.
"Let me stress there are no immediate plans to access either the proposed liquidity or the proposed capital backstop," Paulson told the Senate Banking Committee on Tuesday. Paulson said he had a reason for not proposing a cap on the new line of credit or on the amount of GSE stock the Treasury could buy.
"By having something that's unspecified, it will increase confidence and decrease the likelihood that [the liquidity and capital backstops] will ever be used," he said. "If you have a bazooka in your pocket and people know it, you probably won't have to take it out." Without specifying how, Paulson added that if and when the government does commit money, "we have to look carefully at ways to protect the taxpayers."
A number of senators on the banking committee - from both parties - characterized Paulson's request as asking lawmakers for a "a blank check," and they were none too keen on the idea, knowing they have to answer to taxpayers.
How lawmakers might alter the Treasury's proposals isn't clear yet. But if the government uses federal dollars to help Fannie and Freddie, the cost to taxpayers could be minimal if the rescue plan works. That is, if government efforts bolster the companies, they likely would be able to pay back what they owe.
"Taxpayers may get it all back with interest," said Rudolph Penner, a former director of the Congressional Budget Office and currently a senior fellow at the Tax Policy Center. But the taxpayer cost could increase if Fannie and Freddie default on their debt or if their stocks lose value. This year, they've already fallen over 80%, with the bulk of those losses coming this month.
The costliest rescue potentially would be if the government decides to take over the two companies. Both Paulson and President Bush on Tuesday stressed that they want Fannie and Freddie to remain shareholder-owned companies. But if a takeover does occur - or even if the government just buys a very large equity stake - taxpayers would effectively take over the debt obligations of Fannie and Freddie.
Currently, the two companies own or back $5 trillion in debt. But the ultimate debt burden to taxpayers would likely be only a small percentage of $5 trillion because that debt is backed by assets with value - homes - and because the majority of the loans they own or back are the more stable 30-year fixed-rate mortgages.
At the end of the day, a taxpayer bill is "nothing to sneeze at - I wouldn't shrug it off," Penner said. But, he added, it's unlikely the debt from a rescue would come close to some of the government's biggest fiscal burdens, such as Medicare. The amount of general revenue that will be required to pay for Medicare in the next three years alone approaches $600 billion, according to the Concord Coalition, a deficit watchdog group.
And that's on top of the premiums and Medicare taxes Americans will pay in to the system. Long-term, the potential downside of a Fannie-Freddie intervention could increase taxpayer costs in other ways. One of them: It could help drag down the government's top-notch credit rating.
A report issued this spring by the credit rater Standard & Poor's estimates that if the U.S. economy hits a long recession, government help for the GSEs "could create a material fiscal burden to the government that would lead to downward pressure on its rating."
The danger to the credit rating wouldn't necessarily come just from the Treasury stepping in. Rather, it would result from a confluence of events stemming from problems at the GSEs, such as slowing economic growth and a reluctance among foreigners to buy more U.S. debt, said John Chambers, managing director and chairman of S&P's sovereign rating committee.
A downgrade in the U.S. credit rating would make it more expensive for the government to borrow. And that means the cost of public debt - currently $4.5 trillion - would grow more expensive. Practically speaking, it's unlikely taxpayers would feel an immediate pinch from any unreimbursed costs of a rescue.
"Would the taxpayer notice it? Probably not. But it will increase the amount of federal debt," Penner said. And that will increase pressure on future administrations to either raise taxes or cut spending, or both.
Terminate Fannie Mae and Freddie Mac
I am a minority of one, or a very small number, in thinking that the failures of Fannie Mae and Freddie Mac are good news. These two companies should not exist.
No private companies should have lines of credit to the U.S. Treasury, that is, U.S. taxpayers. No private companies should be linked to a government mandate that they facilitate affordable housing by buying up mortgages. No private companies should issue debts that investors believe may have an implicit guarantee provided by taxpayers.
The only bad thing about these failures is what the Federal government may do next to keep them alive. The only bad thing is that the Federal government will probably make matters worse. This is a golden opportunity to end these enterprises once and for all. And doing that is incredibly simple!
Any Wall Street investment bank can, in short order, produce a plan to restructure these companies and charge the appropriate (high) fees for carrying out that plan. The possible ways to restructure include sales of the assets, creating subsidiaries and selling them, spinning off subsidiary companies, and breaking up the company into several companies. Fannie Mae and Freddie Mac could also put their entire companies up for sale.
Such restructurings are Wall Street’s bread and butter. The equity values of these companies have already fallen considerably. Their value in a restructuring may be quite small, but control does have a non-negligible value. The markets are already pricing the debts of these two giants at less than face value, despite the chance of an implicit guarantee or a taxpayer bailout.
The debt-holders took a chance buying this paper. They should bear the consequences. Restructuring will reveal the true worth of these debt securities. Investors in these enterprises, both debt and equity holders, should not be bailed out by the taxpayers. These two companies made bad investments by buying mortgages that have gone bad.
These two companies also issued too much debt to finance these investments, which gave them very shaky financial structures. The worth of their assets is less than the worth of their liabilities, which makes them insolvent. They are not yet bankrupt. They still have the cash to service their debts. These debts are by no means worthless. About 11.6 percent of money market funds are invested in agency debt.
At current prices of these debts, news of money market troubles has not surfaced. If those prices fell by 10 percent, the money market losses would be a modest 1 percent. Any restructuring presumes what is not in evidence, which is that the Federal government has to sever completely its relationships with housing markets and specifically with Fannie Mae and Freddie Mac.
There’s the rub. Congress won’t do this, unless seized by some unforeseen miracle of rationality. There are millions of Americans who may fear the dissolution of these companies. They will wonder where they will get mortgages from. There are hundreds of columnists who share this fear. Some will pretend to hold their nose while supporting a government bailout.
Some will want to maintain the government’s interference in housing markets or even expand it as a matter of public policy. There is nothing to fear. The amount of money on the sidelines that is available for funding mortgages is tremendous. It can be coaxed into mortgages if the interest rates paid are high enough. A free market in mortgages will easily provide capital to creditworthy borrowers. But that too is the rub.
The government wants to keep mortgage rates low so as to keep the housing industry going and to satisfy the voters who take out mortgages. The government does not want a free market in mortgages, and that is because neither voters nor the housing industry want a free market in housing. As long as there is a government that is empowered to interfere, the pressure to interfere will overcome the free market.
Democracy just does not work, my friends! Sooner or later, in this case 70 years later, 70 years after Fannie Mae began, the system starts to break down. Call it what you will, democratic socialism or democratic fascism or both, democracy does not work. It doesn’t work in agriculture, in the military, in the space program, in the banking system, or in any other part of an economy. Sooner or later, depending on various particulars, blowups occur.
Without the government in the picture, there is no way that Fannie Mae and Freddie Mac could ever have grown so large. Their balance sheet assets (and liabilities) total about $1.6 trillion. They have off-balance liabilities of another $3.5 trillion or so. How big is $5 trillion? The national debt of the U.S. is $9.5 trillion!
It is almost unbelievable that these two companies could have run up debts that are more than half the size of the country’s national debt. But that is inherent in the chemistry of government + housing + debt guarantees. The housing market is huge, especially over time as the housing stock accumulates.
By giving Fannie Mae and Freddie Mac an advantage in issuing debt, these companies came to dominate the housing finance market. There is no better time than now to end this absurdity. Freddie Mac faces huge losses, as much as $775,000,000. Its equity can easily be wiped out. That means bankruptcy. That is nothing to fear, either. That means that restructuring will be forced upon the company.
The point is to let it happen and happen quickly and get the government out of the picture altogether. Naturally, this has not been what the government has been doing. Instead, it has done the opposite so far. Congress has passed a bill that awaits the President’s signature or veto. There will be a deal. The bill increases mortgage loan limits drastically. Smart move, guys. Pelosi wants them even higher, $730,000 instead of $625,000.
Mr. Corruption himself, Chris Dodd, is the lead sponsor of the bill. Even as the stocks of these two companies approach $0, he reassures the public that the CEOs of Fannie Mae and Freddie Mac and Ben Bernanke tell him that they are not at risk of default. This is a bald-faced lie.
Failure to face and state truths is a national addiction. The predilection to lie in the face of bad news is so ingrained that our leaders no longer can even detect the difference between what is true and what is false. They lie and they know they lie. But they also believe their lies because they believe their lies to be political necessities.
Can liars even begin to think straight about what should be done that is in the long-run interest of the American public? If they could think straight, could they summon the courage to act? Democracy encourages lies, liars, and cowardice in the face of voters and payoffs. Democracy just does not work, my friends.
Terminate Fannie Mae and Freddie Mac. Sever the relations with the government and let Wall Street, or investment bankers in San Francisco or Austin or Boston or Tallahassee do what they know best, which is restructure these companies. All the mortgages held or guaranteed by them will still be held and serviced, but by new companies and new investors. Problem solved.
Finance and the Fed: the battle is not over
On Sunday, the US Treasury secretary Henry Paulson offered a package of unprecedented financial support for the tottering mortgage groups Fannie Mae and Freddie Mac, which quietly included an equally unprecedented extension of the Federal Reserve’s supervisory authority over them.
It followed an agreement between the Fed and the Securities Exchange Commission on July 7 that implicitly raised extending Fed scrutiny over investment banks in the wake of Bear Stearns. This, in turn, came after a suggestion by the New York Fed president Timothy Geithner in June to enhance the Fed’s overall regulatory role and a proposal by Mr Paulson in March to promote the Fed to a central financial scrutiny role.
This is the latest chapter in a 200-year-old US struggle between private finance and the elected officials bent on controlling it. What is being proposed is that the clock be turned back to invest a 20th-century central bank with authority over 21st-century financial institutions. History shows that attempts to alter the Fed’s role attract strong political resistance and considerable policy consequences.
The 20th century saw the growth of public control over US financial policies. In 1913 the Fed was created as a compromise between the needs of private finance and the demands of democratic government.
The Fed’s political independence and its intimacy with private finance frustrated many elected officials, who in the 1930s successfully revisited this public/private compromise by transferring policy control towards more democratically accountable executive branch agencies, such as the Treasury, the SEC and others. These recent proposals aim to redress the balance in favour of the Fed.
As private finance’s traditional champion, the Republican party has historically opposed financial regulation, preferring a system administered by an independent central bank: Mr Paulson’s suggestions fall in this vein. Conversely, the Democratic party has been historically suspicious of finance, preferring a financial system subject to executive branch accountability.
Thomas Jefferson, father of the Democratic party, began this trend in 1802, writing: “I believe that banking institutions are more dangerous to our liberties than standing armies.” More than two centuries later, anti-finance feelings still win elections for Democrats: only 20 months ago Eliot Spitzer rode his reputation as the sheriff of Wall Street into the New York governor’s office.
Some of the most extraordinary moments in US history have sprung from the battle between finance and democracy. In an infamous 1790 dinner deal with Jefferson, Alexander Hamilton bartered away the US Capitol, moving it from Philadelphia to Washington, DC, in return for the federal assumption of the revolutionary war debt and the creation of a US central bank, a deal Jefferson later called the greatest mistake of his career.
Andrew Jackson fought and won a presidential election in 1832 over the issue of a US central bank, shouting: “The Bank is trying to kill me but I will kill it!”
During the current mortgage crisis, the NY Fed was granted authority to lend extraordinary funds to Fannie Mae and Freddie Mac if necessary. This evokes a sense of déjà vu back to when the NY Fed ruled the Federal Reserve system. In the 1920s, the NY Fed under Governor Benjamin Strong was so influential that it served as the de facto US central bank.
Strong so dominated national monetary policymaking that Rep?ublican President Herbert Hoover blamed him for leading the entire Fed astray, calling him “a mental annexe to Europe”. Hoover had attempted to “inject some sanity and protection of American interests into the Reserve System ... [but] the consequences of the Federal Reserve Board action were disastrous to our economy”. He was referring to the Great Depression.
Centralising financial scrutiny in the Fed is unlikely to occur because new US presidents are unwilling to accept suggestions from preceding ones. But it is critical to recognise these proposals’ historic context and the preferences they show. As a Democrat, Barack Obama may be more likely to favour stronger executive branch scrutiny than to empower the Fed, while the Republican John McCain could question the Fed’s judgment regarding the credit and mortgage crises.
The Bush administration’s recent recommendations reveal that any attempt to change the Fed’s purpose re-engages the contest between finance and democracy and the powerful forces on both sides.
Growing disparities in life expectancy
Rising economic inequality is often discussed as a significant social problem. Too often, that claim remains unsubstantiated. Why is rising inequality so problematic? What negative impacts does it have on our living standards? One compelling example comes from research on growing socio-economic disparities in life expectancy.
While life expectancy has grown across the United States between 1980 and 2000, the degree to which people live longer has become increasingly connected to their socio-economic status. The Chart compares life expectancy by socio-economic decile of the most well-off to the least well-off.
In 1980, those with the highest socio-economic status had a life expectancy 2.8 years higher than those with the lowest status (75.8 versus 73.0 years, respectively). By 2000, that gap had grown: those in the top decile had attained a life expectancy of 79.2 years—4.5 years more than those in the bottom decile. Disparities in life expectancy also increased between the top and the middle decile and between the middle and the bottom.