"Mrs. Sam Cates, wife of Cow Hollow farmer. Malheur County, Oregon."
Ilargi: These days in the US, more than 8,000 properties enter foreclosure proceedings each day, 740.000 in the second quarter of this year. This means that close to 3 million homes will be subjected to foreclosure filings in 2008.
220.000 homes were actually repossessed by banks in the quarter. That is almost triple the number repossessed last year.
25 million homeowners are expected to soon owe more on their mortgages than their homes are worth. Many of them will face the same proceedings. Home sales and prices keep falling; the only number that grows is inventories.
The $300 billion provision included in the heavily publicized and contested housing rescue bill that Congress accepted Wednesday is designed to help 400.000 home-owners stay in their houses. Wait, $750.000 per home? At that rate, this’ll be a costly operation.
Mortgage payments for Alt-A and option-ARM loans won’t hit the height of their scheduled -sharply upward- resets until 2010-11. Hence, unless home prices start rising soon and fast, these resets will drive up foreclosure and repossession numbers to levels even much higher than they are today.
You can’t have it both ways: either prices go up OR sales go up. There will be no miracle that suddenly replenishes either people’s incomes or banks’ ability to lend, or both.
The only possible conclusion that does not include a fairy tale or divine intervention, is that home prices will keep falling for years to come. If they stay high or even rise, there will be no buyers. And without buyers, prices will fall.
As for the FDIC and its "problem" list of 90 of the 8500-9000 banks it allegedly insures, Christopher Whalen at Institutional Risk Analytics thinks there are "a few" more: "Of about 9,000 institutions, "we have identified about 10 percent that are in significant distress and another 10 to 15 percent headed in that direction".
This morning, a "surprise" report on durable goods sales was supposed to lift the mood in the markets (except for financials, which are taking new hits).
Durable goods sales were up a lovely 0.8% in June. Not that much of a surprise, perhaps: In May, the government started handing out $143 billion in "welfare" stimulus checks.
I think not every single American has managed to splurge their entire $800 on Belgian-owned light beers. Yet.
Some may have even used it to buy fridges, or granite counter-tops, or cars. As long as they're not American.
Why your bank manager may be about to turn nasty
The real credit crunch hasn't even started yet
24 July 2007 was when the world's stock markets finally cottoned on to what was being brewed up in the murky world of US sub-prime mortgage derivatives. From within 1.5% of its high, the FTSE 100 dropped 6% in three days.
By the end of the month, everyone working in the financial markets knew far more than they'd ever wanted to about the alphabet soup of CDOs, CLOs and SIVs. Many of the supposed 'experts' said it would all be sorted out within a few weeks. But not only was that not even close, it was just about as wrong as you can get. Because what we've seen so far is just the starter.
In fact here in Britain, the real credit crunch is only just about to begin… We may think things are tough now, but they're about to get tougher. So far, 'all' we've seen is a so-called liquidity squeeze in the money markets, as well as lots of banks incurring plenty of heavy credit losses.
OK, property prices have tanked, but as we've been saying at MoneyWeek for longer that we can remember, the UK housing market meltdown is hardly a huge surprise, because prices rose so far into fantasyland they had to crash at some stage. The liquidity squeeze simply provided the pin to burst the bubble.
And while there have been loads of media tales about consumers cutting back and their borrowing limits being reduced, here in Britain our credit card borrowings are still up by 7.5% over the last year, according to yesterday's figures from the British Bankers Association.But now things are set to turn ugly.
It's often said that credit is the lifeblood of capitalism. The amount of credit sloshing around in the system depends on two things. Firstly, the level of bank capital - broadly, that's the total of money raised through share sales, etc., added to profits made – and secondly, the 'credit multiplier': somewhere between £8 and £10 of credit is created, i.e. lent out, for every £1 of banks' risk-free capital.
Here's where all those credit losses come in. We now know that the early estimates of the overall damage were a complete joke. The first guess from US Federal Reserve chairman Ben Bernanke was a 'mere' $50bn. Now we're already up to over $400bn and counting. And we haven't seen the half of it yet.
Globally, "banks and brokers will destroy somewhere between $1,000bn to $1,400bn of their own risk-free capital owing to losses on all forms of credit in this crunch", says David Roche of Independent Strategy. This means that in theory, the planet's credit should contract by something like 8-10 times the amount lost.
In reality, it's not quite that bad, because capital will be boosted by future profits and fund-raising exercises like rights issues, but even then, "you are left with a reduction of 5%-7% in global credit". That may not sound too horrendous. But Mr Roche reckons that for every $1 of GDP growth, we need $4-$5 of new credit, "so even a standstill in total credit outstanding is a credit crunch".
Here in the UK, banks certainly aren't likely to be able to keep up their recent rates of lending, having been hit by £27bn of losses already with a further £8bn-ish of property-related write-downs on the way.
"We think that about £65bn in extra capital is needed in order to compensate for the credit crunch and to keep lending at recent levels", says Vicki Redwood of Capital Economics, "and banks are already showing signs of contracting. Just for their balance sheets just to stagnate, UK banks may have to raise £35bn."
Even that's unlikely to happen. The UK banks may so far have managed to raise about £20bn of capital, but the tap is being turned off - there are now signs of 'shareholder fatigue'. If no more cash is pulled in, the banks could have to shrink their balance sheets by as much as 7% or £180bn, equivalent to some 13% of annual GDP.
In short, all the pieces of the jigsaw are being put in place for a savage slowdown in bank lending. Indeed it looks like it's already started. Eurozone bank credit expanded by 10% per annum in the year to April, but loan growth is now plunging. In the US, total bank credit has turned negative in "the sharpest fall in over 40 years", says Ambrose Evans Pritchard in the Telegraph.
And here in Britain, one of the key measures of money, 'adjusted M4', which covers loans to UK businesses, has actually shrunk by 3.5% over the three months to May, according to Bank of England stats. What's more, over the last four months, mortgage approvals have almost halved, said yesterday's BBA figures.
There's always a bit of a time lag before this lot hits the high street. But when it does, as Vicki Redwood says, "the consequences of this squeeze on capital for the real economy could be devastating".
In other words, the real credit crunch is about to begin. That means a brutally sharp recession, with much lower company profits and many more job losses. And your bank manager could be about to start getting extremely nasty.
US foreclosures rise 200%, filings up 120%
Foreclosures continue to soar, with 220,000 homes lost to bank repossessions in the second quarter of this year, according to the latest statistics from RealtyTrac, an online marketer of foreclosed homes. That's nearly triple the number from the same period in 2007.
There were a total of 739,714 foreclosure filings recorded during that three month period, up 14% from the first quarter, and up a whopping 121% from the same period in 2007. That means that out of every 171 U.S. households received a filing, which include notices of default, auction sale notices and bank repossessions.
"Most areas of the country are seeing at least some increase in foreclosure activity," said RealtyTrac CEO James Saccadic. "Forty-eight of 50 states and 95 out of the nation's 100 largest metro areas experienced year-over-year increases in foreclosure activity."
Because foreclosure filings are growing so quickly, RealtyTrac will have to reevaluate its foreclosure forecast for the year, according to spokesman Rick Sharga. "We've been saying foreclosures will total 1.9 million to 2 million this year," he said. "But midway through the year, we're already at 1.4 million so we're going to be raising our projections."
And there is more bad news: Bank repossessions are up as a proportion of total filings, representing 30% of the notices issued during the quarter, up from 24% a year ago. "I don't think that's a surprise if you look at the general conditions out there," said Brian Bethune, chief financial economist for Global Insight.
"There have been six straight moves of weaker employment this year. The ongoing problems in the housing market are compounded by a generally weaker economy. Foreclosures won't go down until we start to see employment move up again."
California's Central Valley remains ground zero for foreclosure filings. Stockton, which is just east of San Francisco, had the highest rate of foreclosure filings of any metro area, one for every 25 homes. That's seven times the national average.
Riverside/San Bernardino, which is east of Los Angeles, had the second highest rate in the nation with one filing for every 32 households. Las Vegas, Bakersfield and Sacramento rounded out the top five. Detroit continued to suffer more than any other non-Sun Belt area, with one filing for every 66 households. And several Ohio cities were also hard hit, led by Toledo (one in 92 households), Akron (one in 93) and Cleveland (one in 108).
On the other hand, there were a handful of metro areas that remained relatively unscathed. Honolulu, at one filing for every 1,331 households had the lowest rate of all, followed by Allentown, Penn. (one for every 972) and Syracuse, NY (one for every 880). At the state level, Nevada had the highest rate with one filing for every 43 households, while California had the highest total number of filings - 202,599.
The report came as more negative news for the housing market this week. On Thursday, a report form the National Association of Realtors revealed that existing home sales had declined again as the number of homes for sale continued to rise. On Tuesday, a government agency reported home prices registered another drop in May.
All this is happening as Congress struggles to pass a housing rescue bill that will make FHA-insured loans available to many at-risk borrowers. That bill, even if signed this week, will not take effect until October. One of the sponsors of the bill, Barney Frank (D -- Mass.), released a statement on Thursday in which he encourages lenders and mortgage servicers to delay taking action against delinquent borrowers before the new law takes effect.
"I am urging the mortgage servicers to hold off on foreclosures in applicable cases," he said, "so borrowers can take advantage of the program."
25 million U.S. homeowners risk going underwater
U.S. foreclosure filings more than doubled in the second quarter from a year earlier as falling home prices left borrowers owing more on mortgages than their properties were worth.
One in every 171 households was foreclosed on, received a default notice or was warned of a pending auction. That was an increase of 121 percent from a year earlier and 14 percent from the first quarter, RealtyTrac Inc. said today in a statement. Almost 740,000 properties were in some stage of foreclosure, the most since the Irvine, California-based data company began reporting in January 2005.
"Rising foreclosures are putting downward pressure on prices, increasing the possibility that homeowners will go upside- down on their mortgages," said Sheryl King, chief U.S. economist at Merrill Lynch & Co. in New York. "That will cause more losses in mortgage portfolios and less willingness from investors to securitize mortgages and therefore fewer mortgages."
About 25 million U.S. homeowners risk owing more than the value of the their homes, according to Bill Gross, manager of the world's biggest bond fund at Pacific Investment Management Co. That would make it impossible for them to negotiate better loan terms or sell their property without contributing cash to the transaction.
Falling home values, led by states such as Nevada and California that have the biggest default rate, have prompted RealtyTrac to almost double the projected number of foreclosures this year to about 2.5 million, said Rick Sharga, executive vice president for marketing.
"The big variable here is what effect the housing bill now being considered by the Senate is going to have on foreclosure activity in general," Sharga said in an interview. "Based on market conditions themselves, we are nowhere near the end of this trip. Best-case scenario, we're looking at another year of this."
Fannie, Freddie Short Interest Rises as Paulson Plans a Rescue
Short selling of Fannie Mae and Freddie Mac jumped in the first two weeks of July as the stocks fell on concern that shareholders would be wiped out even if the government bailed out the entities.
Short interest on McLean, Virginia-based Freddie Mac rose 28 percent to 105.9 million shares between June 30 and July 15, according to data compiled by Bloomberg. Short interest on Washington-based Fannie Mae as of July 15 was 154.4 million shares, up 11 percent. Investors boosted short selling in both stocks for four months in a bet that that the two largest U.S. mortgage-finance companies don't have enough capital to survive the housing slump.
Treasury Secretary Henry Paulson has asked Congress to pass legislation granting him the power to inject capital into Fannie Mae and Freddie Mac to prevent a collapse in the firms that account for 70 percent of new U.S. mortgages. Short sellers borrow stock and then sell it in an effort to profit by repurchasing the securities later at a lower price and returning them to the holder.
Short interest is the number of shares that have been sold short and not yet repurchased. Freddie Mac has fallen 74 percent this year and Fannie Mae is down 70 percent, reaping profits for traders who bet on a drop. Freddie fell 68 percent between June 30 and July 15 and Fannie fell 64 percent during the period. Both stocks reached their low for the year on July 15.
Fannie’s and Freddie’s free lunch
By Joseph Stiglitz
Much has been made in recent years of private/public partnerships. The US government is about to embark on another example of such a partnership, in which the private sector takes the profits and the public sector bears the risk.
The proposed bail-out of Fannie Mae and Freddie Mac entails the socialisation of risk – with all the long-term adverse implications for moral hazard – from an administration supposedly committed to free-market principles. Defenders of the bail-out argue that these institutions are too big to be allowed to fail.
If that is the case, the government had a responsibility to regulate them so that they would not fail. No insurance company would provide fire insurance without demanding adequate sprinklers; none would leave it to “self-regulation”. But that is what we have done with the financial system.
Even if they are too big to fail, they are not too big to be reorganised. In effect, the administration is indeed proposing a form of financial reorganisation, but one that does not meet the basic tenets of what should constitute such a publicly sponsored scheme.
First, it should be fully transparent, with taxpayers knowing the risks they have assumed and how much has been given to the shareholders and bondholders being bailed out. Second, there should be full accountability. Those who are responsible for the mistakes – management, shareholders and bondholders – should all bear the consequences. Taxpayers should not be asked to pony up a penny while shareholders are being protected.
Finally, taxpayers should be compensated for the risks they face. The greater the risks, the greater the compensation. All of these principles were violated in the Bear Stearns bail-out. Shareholders walked away with more than $1 billion, while taxpayers still do not know the size of the risks they bear. From what can be seen, taxpayers are not receiving a cent for all this risk-bearing.
Hidden in the Federal Reserve-collateralised loans to JPMorgan that enabled it to take over Bear Stearns were almost surely interest rate and credit options worth billions of dollars. It would have been easy to design a restructuring that was more transparent and protected taxpayers’ interests better, giving some compensation for their risk-bearing.
But the proposed bail-out of Fannie Mae and Freddie Mac makes that of Bear Stearns look like a model of good governance. It sets an example for other countries of what not to do. The same administration that failed to regulate, then seemed enthusiastic about the Bear Stearns bail-out, is now asking the American people to write a blank cheque. They say: “Trust us.” Yes, we can trust the administration – to give the taxpayers another raw deal.
Something has to be done; on that everyone is agreed. We should begin with the core of the problem, the fact that millions of Americans were made loans beyond their ability to pay. We need to help them stay in their homes, including by converting the home mortgage deduction into a cashable tax credit and creating a homeowners’ Chapter 11, an expedited way to restructure their liabilities.
This will bring clarity to the capital markets – reducing uncertainty about the size of the hole in Fannie Mae’s and Freddie Mac’s balance sheets. The government should set a limit to the size of the bail-out, at the same time making it clear that, while it will not allow Fannie Mae and Freddie Mac to fail, neither will it be extending a blank cheque. There may need to be a drastic reorganisation.
There should be a charge for the “credit line” (any private firm would do as much) and, given the risk, it should be at a higher than normal rate. The private sector knows how to protect its interests; the government should do no less. As long as the credit line is extended, no dividends should be paid.
To ensure that the government is not simply bailing out creditors who failed in due diligence, at least, say, 25 per cent of any notes, loans or bonds coming due that are not lent again should be set aside in an escrow account, to be paid only after it is established that taxpayers are not at risk. Any government loans should be cumulative preferred debt: the taxpayers get paid before any other creditors receive a dime.
To discourage moral hazard the interest rate should be at a penalty rate and, reflecting the rising risk, increase with the amount borrowed. Finally, the government should participate in the upside potential as well as the downside risk: for instance, by taking shares (which it might later sell) or, as it did in the Chrysler bail-out, warrants.
We should not be worried about shareholders losing their investments. In earlier years, they were amply rewarded. The management remuneration packages that they approved were designed to encourage excessive risk-taking. They got what they asked for. Nor should we be worried about creditors losing their money. Their lack of supervision fuelled the housing bubble and we are now all paying the price.
We should worry about whether there is a supply of liquidity to the housing market, so that those who wish to buy a home can get a loan. This proposal provides the necessary liquidity. A basic law of economics holds that there is no such thing as a free lunch. Those in the financial market have had a sumptuous feast and the administration is now asking the taxpayer to pick up a part of the tab. We should simply say No.
Fannie Mae and Freddie Mac need fundamental rethinking
A US banking chief called yesterday for a "fundamental rethinking" of Fannie Mae and Freddie Mac following the Bush administration's plan to shore up the mortgage groups with government funds if necessary.
"The current balance is probably untenable over the longer term," Tim Geithner, president of the Federal Reserve Bank of New York, told legislators on the House financial services committee. "I believe there is going to have to be a fundamental rethinking of the future of these institutions."
Fannie Mae and Freddie Mac have long benefited from investors' confidence that the government would step in to save the two mortgage companies in a crisis. But this implicit guarantee became far more explicit on July 13, when the Treasury department said it would seek powers to increase its credit line to the two and invest in their equity. On the same day, the Federal Reserve opened access to its emergency cash facility for the two groups.
Mr Geithner's comments suggest that policymakers, legislators and investors in Fannie and Freddie maysoon start clamouring for greater clarity about the relationship between the government and the two companies, given the additional guarantee implied in the rescue.
On the day the plan was announced, officials had said Fannie and Freddie should continue to operate in their "current form" for the foreseeable future - as private companies chartered by the government but owned by public shareholders. Nancy Pelosi, Democratic speaker of the House, said this week: "I think, down the road, we should review the hybrid nature of Fannie Mae and Freddie Mac."
Barney Frank, chairman of the financial services committee, said hearings would be held on the issue. Mr Geithner also gave warning yesterday that the Fed could not deal with all the economic challenges facing the US today - making it clear that the government had an important role to play as well. "Monetary policy cannot bear the sole responsibility of responding to those challenges," he said.
Some Fed officials think the government should play a larger role in ensuring the continuing flow of reasonably priced housing loans and possibly help to recapitalise the banking system as well. Mr Geithner said the financial system had to be made "more robust to very bad outcomes and more resilient to shocks".
This would mean making sure that the major financial institutions were less vulnerable to shocks in future; that the system as a whole was less vulnerable to margin calls and sudden pullbacks in liquidity; and that it could better withstand the collapse of a big financial institution.
But he spoke against the Treasury plan to take away the Fed's role as a direct supervisor of large banking groups in return for giving the US central bank a new roving authority to deal with systemic risk. "Replacing our ongoing role as consolidated supervisor with standby, contingent authority to intervene would risk exacerbating moral hazard and adding to uncertainty about the rules of the game," he said.
Ilargi: I said a long time ago that mark-to market, even if the US would keep refusing to do the right thing, could come from anywhere in the global market world, and then might become unstoppable. Perhaps this Australian bank can trigger the downfall of the fantasy valuations for assets.
There is a very large problem looming on Wall Street though: most large banks won’t survive it if they are forced to get real
NAB will shock Wall Street
The National Australia Bank's decision to write off 90 per cent of its US conduit loans will have dramatic repercussions around the world. Wall Street will be deeply shocked when they understand the repercussions of what NAB has done. It is clear global banks have nowhere near provided for their exposures to US housing loans which in the words of John Stewart are experiencing a “meltdown”.
We are now way beyond sub-prime. NAB says that it is suffering a 55 per cent loss on American housing loans – an event that has never happened in the history of a developed country in recent memory. This is an unprecedented event and means that the cost of bailing out the US financial system is now far beyond the highest estimates. A US recession is now locked in, but more alarmingly, 55 per cent loan losses point to the possibility of a depression.
It means the cost of bailing out housing exposures to the two mortgage insurers will be so great that it will leave no room to bail out anything else and there are several US banks that are now in big trouble. NAB says that the dislocation in the residential market is separate from the corporate market, but the flow on is inevitable.
While global banks have been writing down their balance sheet assets, few have tackled their conduit exposures which are off balance sheet but to which they are ultimately liable.
This morning at around 6am I wrote that we had been experiencing a 'dead cat bounce'. I had no idea that NAB would trigger the downturn and confirm what I had written. And of course Wall Street will receive a deep shock when it wakes up.
How did NAB get caught in $1.2 billion mess? They had a number of big clients who wanted to invest in these US housing loans. They were sucked in by the 'triple A rating' given to the securities by the rating agencies. They did not take into account that the monoline insurers who guaranteed some of the loans had no substance. To become a player NAB took out $1.2 billion in these triple A securities and 90 per cent of it has been lost.
Many Australian institutions are very angry. NAB is paying out far too much in dividends and should be conserving capital. The American bank it purchased, Great Western, was a good idea but it is now clear it overpaid for it. Fortunately it only has a small exposure to the bad loans. But what’s happening to the NAB is not the main game.
The global banks have been marking to market the assets they held on their balance sheet, but the vast amounts held in so called 'conduit trust accounts' have not been written down because they were not marketable. NAB wrote them down when they saw the bad mortgages.
US banks have written down $450 billion in bad housing loans. The revelation from NAB means that they will now certainly need to take provisions to $1,000 billion. But write-downs of $1,300 billion and perhaps even more are on the cards.
Where will the equity come from to cover these bad loans? The world has never attempted a rescue effort of this size and it will make liquidity in the globe very tight. That’s why corporates will be hit. All Australian companies that need equity should raise it now.
European recession looms as France and Spain stumble
France and Spain may now be in the first throes of recession, economists warned after a raft of data suggested European economic growth has slumped sharply in recent months.
The Spanish government today slashed its forecast for economic growth after a sharp leap in unemployment. It coincided with a set of downbeat purchasing managers' indices and slumping consumer confidence surveys from France, Germany and further afield in the eurozone.
The news sparked warnings that the euro area may pitch into recession before the end of the year, underlining the speed with which it has declined in the wake of the credit crunch. Spain's unemployment rate jumped from 9.6pc to 10.4pc in the second quarter, driven largely by major lay-offs in the stricken construction sector.
Dominic Bryant of BNP Paribas said: "This looks pretty bad. But when one considers that the unemployment rate usually falls in the second quarter - by an average of 0.6 percentage points in the last five years - the figure looks truly terrible. "Overall, the conditions in the labour market make a recession a very likely outcome for Spain."
With the property market - a major chunk of the economy - in what even housing minister Beatriz Corredor describes as "deep crisis", Spanish politicians have blamed the European Central Bank, which raised borrowing costs earlier this month.
Finance minister Pedro Solbes said higher mortgage rates had had a clear impact, as he cut his growth forecast from 2.3pc to 1.6pc. "The economic adjustment has been much more abrupt and faster than we expected," he said.
A closely-watched set of growth indicators also suggested that the eurozone is close to stagnation. The eurozone PMI index for the manufacturing sector fell from 49.2 points in June to 47.5 in July while its services counterpart dropped from 49.1 to 48.3.
With both indicators well below the 50-mark which separates expansion from contraction, economists warned that they represent an unequivocal recession warning. Meanwhile, the German Ifo business confidence index suffered its biggest fall since the recession of 2001, dropping from 101.2 in June to 97.5 in July.
Holger Schmieding of Bank of America said: "Economic growth in the Eurozone is coming almost to a halt. The data strengthen those at the ECB who had gone along only grudgingly with the July rate hike and now want to prevent any extra rate increase. With just a bit of bad luck, any further monetary tightening could possibly push the Eurozone into a brief recession, in our view."
Business confidence also dipped lower in France, with the INSEE barometer dropping below its long-term average for the first time since June 2005. Ben May of Capital Economics said: "the latest very weak survey data from the eurozone will surely prevent the European Central Bank from raising interest rates further.
"On the face of it, the surveys suggest there is now even a risk of a technical recession in the region." However, Jacques Cailloux of Royal Bank of Scotland warned that with worries in Spain, Italy and Belgium already materialising, it remains too early to assume the ECB will cut interest rates in order to support the economy.
He said: "This is likely to remain the central bank's dominant worry, and will probably push it to raise rates again despite signs that downside risks to the economy are materialising."
Storm clouds gather over Spain
What's gone wrong? About the only thing providing any cheer to Spaniards right now is their victory in the Euro 2008 football championship earlier this year. That aside, the news is all bad. The fast economic growth (around 4% a year) Spain had begun to take for granted turns out to have been based on just the feelgood factor of the biggest property bubble in Europe and a consequent consumer boom.
Now that the property market is in freefall and the construction industry is collapsing, so is growth: consumer spending and construction were responsible for 70% of Spain's GDP last year. "The golden years of the real-estate business are well and truly over," says Reiner Wandler in Spiegel, with "the crisis now affecting the whole country". Finance minister Pedro Solbes agrees. Blaming oil prices, the credit crunch and a sharp slowdown in exports to North America and Germany, he says Spain now faces "the most complex crisis we've ever seen". The Spanish stock-market has fallen 27% since the start of June.
How bad is the housing market? Very. Spaniards are being hit with the same hideous mix of rising mortgage bills and falling house prices as the British. "More than 98% of home loans in Spain are priced off Euribor (the interbank interest rate)," says The Daily Telegraph's Ambrose Evans-Pritchard, "which has risen almost 1.5% since August" to a record high of 5.4%.
Some surveys say that Spaniards are now spending nearly half their incomes on mortgage costs. House sales fell 7% in the year to April, while mortgage lending plunged 14%. But with home values tumbling – down by 20% on last year by the second quarter of 2008, says El Pais – it's not just the Spaniards but the thousands of Britons who have bought into Spain who are feeling the pain.
And it's getting worse: last week Martinsa-Fadesa, one of the country's largest housebuilders, was forced to file for protection from its creditors (it owes €5.1bn but can't meet the interest payments), despite already collecting the money on 12,500 uncompleted homes. Solbes has pursued a rigorous "no bailout" policy, saying Martinsa-Fadesa took "excessive risks" and must now face the consequences.
Spanish economy: might things get worse? Yes. Consumers are suffering. The Bank of Spain reported that financial institutions facing missed loan payments are rising sharply, with "doubtful credits" 123% higher in May than a year ago. Car sales fell 31% in May. And higher fuel and food costs have sent inflation to 5%.
What's more, the government has been forced to cut its 2008 growth guess to sub-2.0% – the IMF expects 1.8% and has slashed its 2009 forecast to just 1.2% – while unemployment is forecast to rise to 11% in 2009 from 8.6% last year.
"The recent abysmal news from Spain reinforces our view that the economy's US-style imbalances are coming home to roost and that growth will be far weaker than generally expected," says Capital Economics. It isn't just construction: the rest of the economy "is capitulating in a way that will have surprised even the most ardent doomsayers".
How long will the misery last? Deutsche Bank expects a 35% fall in real house prices by 2011 as the market slowly clears the country's vast property overhang, now estimated at nearly 700,000 homes. "The house price correction could last several years," says the Spanish banking team at Dresdner Kleinwort, "and we see little reason why that trend should reverse over the medium term; there is even the possibility of five years of no economic growth."
Spanish banks are partly ready for the worst, having built up high provisions due to "especially stringent capital restrictions laid down by the Bank of Spain", says The Guardian, which should "help them weather an economic downturn seen lasting until at least 2010". But still, "bad debt levels could more than double to 4% by late next year".
The five largest publicly-traded property companies are sitting on combined debts of around €30bn, and "Martinsa-Fadesa's fall could create a domino effect through the sector, and then the economy", says José Garcia Zarate of 4Cast. Indeed, in Spain there's a real "danger of a meltdown, as both households and companies are extremely highly leveraged", says Edward Hugh of Seeking Alpha.
They have too much debt – extraordinarily high levels when you compare them to other eurozone peers – and as they all start either to deleverage or default, things could get much worse. "Serious financial and economic distress is almost inevitable," warns Wolfgang Munchau in the FT. "The Spanish economy may be about to fall off a cliff."
Will Spain drag the euro down?For a long time the economic environment within the eurozone has been benign, says Deutsche Bank economist Thomas Mayer, but that is no longer the case: 2008 has seen fears emerge over weaker eurozone countries' credit risks, and within the last few weeks, yield spreads for debt issued by Greece, Ireland, Italy, Portugal and Spain have jumped.
These countries' governments must now pay far more interest to raise money than the likes of Germany, reflecting the market's views on their financial stability and prospects for growth. Overall, Pimco bond fund head Bill Gross sees no reason for "the euro's 25% to 30% overvaluation against the US dollar", while BNP Paribas says: "We're turning incredibly bearish on the euro."
Selling the Family Jewels
President Bush neatly summed up the complex problems in the financial sector last week in terms he could understand. "Wall Street got drunk," he said. "It got drunk and now it's got a hangover." And to pay for the hangover cure, Wall Street is now selling Grandma's silverware and little Billy's new bicycle.
In recent weeks, American financial services companies have moved from the post-binge phase of dilutive capital raising—running around the world with a tin cup, urging well-heeled foreigners to invest in the crippled firms on purportedly advantageous terms—into the phase of selling the family jewels. Over the past year, banks have taken write-downs and raised new cash from investors, only to take new write-downs within weeks, thus turning those new investors into losers.
And so as they face the need to raise more capital, banks can no longer raise billions from Dubai gazillioniaries and Chinese investment funds, who've been burned once. Now banks are having to sell their hard assets—in some cases, extremely valuable hard assets that have been passed down from generation to generation.
Take E*Trade, the online brokerage/lending operation, which has been reporting loss after loss despite raising $2.5 billion from the hedge fund Citadel. So last week, E*Trade said it would sell its Canadian subsidiary to Scotiabank for $442 million.
Merrill Lynch has been among the biggest losers in the credit debacle. Last December, reeling from losses and with its stock trading at about $60, Merrill raised $6.2 billion by selling securities to Temasek Holdings of Singapore and Davis Selected Advisers.
A few weeks later, having suffered further losses, Merrill raised another $6.6 billion by selling preferred stock, mostly to the Korea Investment Corp., Kuwait Investment Authority, and Mizuho Corporate Bank. In the months since, Merrill reported a big loss for the 2008 first quarter, and its stock has lost about 40 percent of its value. Oops.
And so last week, as Merrill reported a $4.6 billion second-quarter loss, it announced that it was raising billions of capital the old-fashioned way: by selling valuable assets.
Merrill sold its 20 percent stake in the financial information titan Bloomberg back to Bloomberg for $4.425 billion. (Merrill had acquired the stake for pretty close to nothing back in 1985.) Merrill also announced it had "signed a non-binding letter of intent to sell a controlling interest in Financial Data Services, Inc. (FDS)," a unit that provides back-office services to money managers, for $3.5 billion.
Atlanta-based SunTrust has enjoyed a symbiotic relationship with local icon Coca-Cola for nearly a century. The bank midwifed the beverage company's initial public offering in 1919, and Coca-Cola's ultra-valuable secret formula was allegedly stored in a vault at the bank. As Coca-Cola grew—and as its stock split, time and again—SunTrust found itself with a massive stake in the company.
But during the past year, as it has been hit by credit issues, SunTrust has been selling off its shares of the real thing. In June, it sold 10 million shares, raising more than $500 million. And this month it announced it would 1) donate 3.6 million shares of Coca-Cola to SunTrust's charitable foundation and 2) enter a transaction in which the remaining 30 million shares of Coca-Cola would be sold during the next several years.
Combined, the sales will allow SunTrust to raise about $2 billion (at Coke's current price) to shore up its capital and bring to an end 90 years of profitable ownership.
There's likely more heirloom-hocking to come. The Wall Street Journal reports this morning that several regional banks, which have already raised cash from outside investors to shore up shaky balance sheets, are now looking to sell mutual-fund businesses.
National City, which in April raised $7 billion by selling shares to existing investors and the private equity firm Corsair Capital, is now looking to sell its Allegiant Funds unit. Fifth Third Bancorp, which last month raised $1 billion, has said it would raise another $1 billion through "the anticipated sales of certain non-core businesses." The Journal suspects one of those businesses might be the bank's Fifth Third Asset Management unit.
Selling heirloom assets is frequently a last-ditch alternative. In instances in which assets have appreciated massively (such as SunTrust's Coca-Cola stock or Merrill's stake in Bloomberg), the sales can generate hefty tax bills. Such moves are also recognitions that management has screwed things up so royally in the core business that it has no alternative but to sell the remaining assets that the market still likes. But in this climate, many banks may find they don't have a choice.
UK recession fears grow as GDP hits a wall
The prospect of Britain entering its first recession in almost two decades has increased after figures today showed that economic growth slowed sharply in the second quarter.
Gross domestic product (GDP) expanded by just 0.2pc in the three months to June, down from 0.3pc growth in the first quarter, official figures showed today. The anaemic growth is the weakest since the first quarter of 2005 and reflects the steep drop in consumer spending and housing market activity.
The slowdown was most acute in construction, with output down 0.7pc. Manufacturing fell by 0.4pc. Paul Dales, economist at Capital Economics, now believes that even if the Bank of England cut interest rates before the end of this year, it would still be too late to prevent a recession.
"The 0.2pc rise in UK GDP in Q2 shows that the economy has weakened dramatically even before the full impact of the credit squeeze and housing downturn has been felt. An outright recession is now our central scenario," he said.
The news will only intensify the political pressure on the Labour Government as voters get squeezed by the combination of slowing growth and rising prices for basic staples such as food and petrol. "A recession is probable," said Steven Bell, chief economist at GLC. "We'll get negative growth for the next two quarters. We're now looking at quite deep interest rate cuts next year."
UBS is in deep freeze
Swiss banking giant UBS duped its customers into buying complex securities that were billed as safe, even as it became clear to UBS executives that the securities were risky, according to a lawsuit filed by New York Attorney General Andrew Cuomo.
The lawsuit, filed in state court, charges UBS with misrepresenting the $330 billion auction-rate securities market as being nearly as safe and liquid as money-market securities. Cuomo's investigation also discovered, through subpoenaed e-mails, that the bank's top executives sold $21 million in personal holdings as the auction-rate market began to freeze up.
"Not only is UBS guilty of committing a flagrant breach of trust between the bank and its customers, its top executives jumped ship as soon the securities market started to collapse, leaving thousands of customers holding the bag," said Cuomo.
Wall Street has long promoted auction-rate securities - which are backed by loans to students, hospitals, cities, and other relatively safe borrowers - as both liquid and safe. And before the credit crunch hit, investors were able to freely move in and out during regularly scheduled weekly and monthly auctions.
But in February, the auction-rate market began to seize up as buyers of these short-term instruments began disappearing. That drove up interest rates on the securities and left many investors stuck. Cuomo's suit follows one filed last month by the Massachusetts Secretary of State, who similarly accused UBS of failing to warn investors that the securities were at risk of becoming illiquid, or not easily traded.
UBS spokeswoman Karina Byrne said UBS "categorically rejects" any claim that the firm attempted to free itself of the securities by dumping them into clients' laps. An internal investigation "found cases of poor judgment by certain individuals," but nothing illegal, she said.
"It is frustrating that the New York attorney general has filed this complaint while we [at UBS] have been fully engaged in good-faith negotiations with his office to bring liquidity to our clients holding auction-rate securities," said UBS in a statement. "We will vigorously defend ourselves against this complaint."
More charges could follow as Cuomo's office has subpoenaed other firms for information about sales of these securities, including Citigroup, Goldman Sachs and Merrill Lynch. Cuomo said he wants the bank to return defrauded customers money to them at par.
WaMu's Stock Down As Investor Confidence Drains
Investors have been pounding the stock of Washington Mutual Inc. (WM), the nation's largest thrift, for the past two days. Bonds and shares of Washington Mutual fell sharply on Thursday, over concerns about loan losses, capital, liquidity and the company's growth prospects. Its shares were down 14% in late afternoon trading.
After an early upturn Thursday, the entire market turned red. But in Washington Mutual's case, observers said that the company's bad earnings report from late Tuesday, possible debt-rating downgrades to junk status, bad housing data, and losses from other mortgage lenders compounded to become a toxic mix.
Some pointed to the debt market as the largest cause of the stock's latest ills. "There is a major crisis developing" for Washington Mutual's bonds, and that translated into equity jitters, said Richard X. Bove, an analyst with Ladenburg Thalmann Inc. "The prices of the bonds have dropped dramatically, and as a result of that there is fear that" Washington Mutual "cannot be held together," he said.
Washington Mutual's credit default swaps were trading at 12.5/13.5 points upfront Thursday afternoon, said Scott MacDonald, the research director at Aladdin Capital Holdings. The bank's swaps traded at 757 basis points on Wednesday, with no upfront fee. "After the rally over the past couple of days ( in financials), the market is back to picking at some of the problems again," he said.
Washington Mutual reported a $3.3 billion second-quarter loss late Tuesday, compared with a $830 million profit a year earlier. Its shares initially rose after the company issued the results, but started falling early in Wednesday's trading. The stock closed down 20% Wednesday in a poor market for bank stocks. On Thursday, it continued to slide at a similar rate.
Companies with a sizable mortgage business all did particularly badly Thursday. Fannie Mae (FNM), Freddie Mac (FRE), First Horizon National Corp. ( FHN), and Regions Financial Corp. (RF) were some of the biggest losers among the financials in the Standard & Poor's 500 index.
But for Washington Mutual, the issues of investor confidence is more pressing, Bove and others said. On Tuesday, Moody's Investors Service placed Washington Mutual's senior unsecured debt rating of Baa3 under review for downgrade. Any cut that would push the thrift's bonds into the speculative "junk" category.
Asked during the company's earnings conference call Tuesday about the effect of a downgrade, Chief Financial Officer Thomas Casey said, "Right now we don't have any need to go to the capital markets for any issuance of debt, and so the impact of this is quite low for us right now."
But in its annual earnings filing with the Securities and Exchange Commission, Washington Mutual said, "The loss of investment grade ratings would likely result in further reductions in the sources of liquidity available to the company."
WaMu Bond Risk Climbs to Record Amid Mortgage Losses
The cost to protect Washington Mutual Inc. bonds from default rose for a third day to a record amid concern that the biggest U.S. savings and loan won't be able to weather the worst housing crisis since the Great Depression.
Credit-default swaps on Seattle-based Washington Mutual traded at a record high after Gimme Credit LLC analyst Kathleen Shanley said yesterday that unsecured creditors are "pulling funds." Washington Mutual this week reported a $3.3 billion second-quarter loss and increased loan loss provisions 69 percent to $5.9 billion as borrowers fell behind on their mortgages.
"These guys have not done a stellar job; now they're paying the price for it," said Scott MacDonald, the head of research at Aladdin Capital Management LLC in Stamford, Connecticut. The upfront price that credit-default swap sellers demanded to protect Washington Mutual bonds from default for five years rose 6 percentage points to 20 percentage points, according to London-based CMA Datavision.
That's in addition to an annual fee of 5 percent, meaning costs $2 million upfront and $500,000 annually to protect $10 million of the bonds. The contracts earlier reached a record 21 percent upfront, CMA prices show. Mortgage-related losses through 2011 will be at the high end of a $12 billion to $19 billion forecast, Washington Mutual said July 22.
Moody's Investors Service said it may reduce ratings on the company's senior debt to below investment grade, citing the potential for "sizable quarterly losses through 2009." Shanley told clients yesterday that Washington Mutual's second-quarter results suggested that "many creditors have quietly been pulling funds" which is "presenting an increasing funding challenge" for the lender.
Washington Mutual, in a statement responding to Shanley yesterday, said it does all of its business through banking operations and "does not rely on commercial paper," one of the sources of funding that Shanley cited. "I think their capital is adequate right now, however if you cause a run on the bank and people panic, you erode the confidence and it's a dicier environment," MacDonald said. "Financials really depend on confidence."
The company has boosted liquidity by $10 billion since the quarter ended, financial news network CNBC reported, citing a company spokesman. Liquidity is now $50 billion, CNBC said. The subprime meltdown at Washington Mutual turned into a broader mortgage crisis as tumbling home prices in California, where the lender has half its loans, left an increasing number of customers unable to make payments.
Chief Executive Officer Kerry Killinger, 59, is under pressure after cutting 10 percent of the workforce, slashing the dividend twice and presiding over a 90 percent drop in the stock in the past year.
Market grim ahead of US durable goods data
A pretty grim day yesterday looks like fast forwarding into today.
The damage appears to have been done by a sudden loss of confidence in the US. The schizophrenia over banking woes reared its ugly head once more after home sales experienced their biggest drop in eight years (one wonders what the number was back then).
Banking stock, which had been looking a bit healthier, is likely to get it in the neck on the open this morning after late trading in European Banks in the US was very weak. Today there is little corporate information out in the UK, although Rentokil have popped up with yet another cut in revenue expectations to go with the long stream of similar announcements over the past four years.
I am not usually a proponent of companies changing their names but Rentokil must surely be looking into ditching the nomenclature which indicates that the whole company is built upon income from rat catching.
The Durable Goods figure out of the US this afternoon is forecast to come in at down 0.4pc. Anything worse than this would be taken quite badly and there would most likely be a continued follow through on yesterday's 280 point drop in the Dow.
The resurgence of the bears has given gold its chance to recover some of the losses of earlier in the week but the move appears to be more of a knee jerk "the markets are falling so buy precious metals" rather than anything else.
Elsewhere, oil has recovered a couple of bucks on renewed fears over Nigeria and Iranian supply but the rally is not as strong as this type of rumour would have achieved just a week or so ago. September Brent is opening at just under $127 still 20 bucks off the highs of just last week.
Buyers are coming back into the market on hopes of something of a rebound but they are keeping their stops very close just in case of a return to the weakness of Monday to Wednesday.
Russian production remains weak but the problems over TNK-BP do not seem to have threatened supply further. The tacit Russian State approval and aid of just four super rich individuals over the entire world wide share holders in BP is another chilling indication of the problems involved in being 'over there' and matches the sort of problems that foreign financial institutions have historically experienced in doing business in the States.
On the currency front the pound did indeed fail to challenge the 127-128 euro resistance as feared in yesterday's comment and the cross has fallen back to 1.2639-1.2643 this morning. Sterling has now had yet another abortive attempt to get above $2 and stay there and our clients are once more in the pink having sold virtually everything above this mark.
Cable is now back below 1.99 once more and profit taking seems to be the order of the day with clients taking back shorts late last night and early this morning. The euro is attempting to recover some of the reaction losses after it failed for the second time to remain above 1.60 earlier in the week and shorts who sold above the 1.60 level (as with the 2 buck mark in cable) are now closing off positions.
The "double top" formation is still intact though so we expect to see some new position building after the Durable Goods number this afternoon.
Orders for Durable Goods in U.S. Unexpectedly Advance
Orders for U.S. durable goods unexpectedly increased in June, easing concern that companies would limit spending as raw-material costs soared.
The 0.8 percent gain in bookings for goods meant to last several years followed a revised 0.1 percent increase in May, the Commerce Department said today in Washington. The median estimate of economists surveyed by Bloomberg News was for a 0.3 percent drop.
Record exports, fueled by a weakening dollar and economic expansions abroad, are helping U.S. factories withstand the deepening housing slump and slowing demand at home. A separate government report later today is forecast to show consumer confidence slumped in July and sales of new homes dropped.
"The manufacturing sector is not showing typical recession- like weakness so far," James O'Sullivan, senior economist at UBS Securities LLC in Stamford, Connecticut, said in an interview with Bloomberg Television. "The weight of evidence still suggests the economy is weakening despite this positive number."
Treasuries dropped after the report, sending benchmark 10- year note yields up to 4.03 percent at 8:37 a.m. in New York, from 4 percent late yesterday. The dollar pared losses against the euro. The projected decrease in orders reflected the median estimate of 78 forecasts in a Bloomberg News survey. Estimates ranged from a drop of 2.5 percent to a 1 percent gain. May orders were revised up from no change previously reported.
Excluding orders for transportation equipment, which tend to be volatile, bookings rose 2 percent, the most this year, after dropping 0.5 percent a month earlier. The gains reflected increasing demand for machinery, metals, autos and defense gear.
Bookings for non-defense capital goods excluding aircraft, a measure of future business investment, climbed 1.4 percent after a 0.1 percent decrease in May. Shipments of those items, which is a figure used in calculating gross domestic product, increased 0.7 percent following a 0.2 percent gain.
The government is scheduled to release its advance second- quarter growth estimate on July 31. Economists surveyed by Bloomberg forecast the economy expanded at a 2 percent pace from April through June as exports grew and consumer spending rebounded on the tax rebates mailed.
Growth probably will slow in coming quarters as the effects of the rebates wear off and the housing slump, the weak labor market and higher energy and food prices persist. Retail sales in June rose by a less than forecast 0.1 percent, the smallest gain in four months, the Commerce Department reported July 15.
Today's figures counter regional reports that indicated manufacturing was weakening. The Federal Reserve said on July 23 that manufacturing declined in "many" of its 12 districts in June and July. The Fed also said the economy "slowed somewhat" and that all of its bank districts reported "elevated or increasing" price pressures.
"Manufacturers in several districts anticipated further factory weakness in the near future," the central bank said in its regional economic survey, known as the Beige Book for the color of its cover. "While most districts expected stable capital spending heading forward, a few noted manufacturers' plans to reevaluate based on current economic conditions."
Why wasn't IndyMac on FDIC problem list?
Questions I can't get off my mind: Why wasn't IndyMac Bank, whose problems were well known in the financial community, not on the Federal Deposit Insurance Corp.'s list of troubled institutions until shortly before its failure this month?
And if IndyMac - one of the three largest institutions ever seized by the FDIC - didn't make this list, could it be understating problems in the banking system?
Each quarter, the FDIC discloses how many banks and thrifts are on its problem list. It does not name which institutions make the list because if it did, depositors would yank out their money and they would almost surely fail. In May, the FDIC reported that for the quarter ended March 31, the list had 90 companies with $26.3 billion in combined assets.
IndyMac, which by itself had $32 billion in assets at the end of March, was obviously not on the list, a fact confirmed by the FDIC after its failure. The FDIC says it was added in June. Independent analysts knew the Pasadena thrift was highly troubled long before that. "IndyMac started going to hell in the second half of last year," when it lost the ability to sell mortgages it made to investors, says bank consultant Bert Ely.
Highline Financial is one of several companies that rate the safety of banks and thrifts. Its scale ranges from 99 (best) to zero (worst). Its IndyMac rating fell from 55 at the end of 2006 to 1 at the end of last year. In March, it was rated zero. Bankrate.com gave IndyMac its lowest of five ratings in March.
Highline and Bankrate both use a rating system similar to the so-called CAMELS system used by federal regulators including the FDIC, which regulates banks, and the Office of Thrift Supervision, which regulates savings and loans. (Although they have separate primary regulators, the FDIC insures deposits in both banks and thrifts and backs up the OTS.)
CAMELS stands for capital, assets, management, earnings, liquidity and sensitivity to interest-rate or market risk. Using these factors, regulators examine institutions every year and assign ratings from 1 (highest) to 5 (lowest). Regulators get some private data that outside agencies don't. Institutions that get a 4 or 5 go on the FDIC's problem list.
The FDIC says that only 13 percent of companies on the problem list fail. Those on the list get extra attention from regulators, and many times they can recover or be sold to healthy institutions. However, 96 percent of the banks that failed between 1990 and 2002 were first on the problem list, according to an FDIC study. Why wasn't IndyMac?
FDIC spokesman David Barr said it wasn't on the list because the Office of Thrift Supervision, IndyMac's primary regulator, didn't put it there. The San Francisco OTS office was the direct supervisor. OTS spokesman William Ruberry says his agency was aware of IndyMac's problems and started its regular exam in January, four months ahead of schedule.
"We called in the FDIC to join the exam with us early on in the process," he says. Both regulators "were fully aware of everything to do with IndyMac's situation. It was not a surprise." Ruberry says the OTS could not issue a final rating until it finished the exam, which took about six months. At that point, it went on the problem list.
"We thought IndyMac had the opportunity to work through its problems," Ruberry adds.
But on June 26, New York Sen. Chuck Schumer disclosed a letter he had written to regulators questioning IndyMac's solvency. Over the next 11 days, depositors withdrew $1.3 billion, forcing the shutdown. Ely says the FDIC could have issued its own rating on IndyMac. "The FDIC has backup authority if the primary authority is asleep at the switch," he says.
Christopher Whalen, managing director of Institutional Risk Analytics, says "everyone expects regulators to be ahead of the curve, but they never are. It's hard for regulators to be proactive. If the FDIC was beating the hell out of IndyMac a year ago, the congressmen that represent IndyMac would have been all over them."
Whalen says the problem list understates the number of troubled banks. Of about 9,000 institutions, "we have identified about 10 percent that are in significant distress and another 10 to 15 percent headed in that direction," he says. Whalen says the problem list should be closer to 900 companies instead of 90.
Ely predicts that the second-quarter list "will be a lot bigger. But I have a feeling they don't want to put a real big one on there. It starts a guessing game: Who went on, who went off." Although it has been growing for five straight quarters, regulators say the problem list is much smaller than it was during the savings and loan crisis.
At the end of 1989, 1990 and 1991, there were about 1,500 institutions on the list, the FDIC shows. Between 1987 and 1992, a total of 2,100 institutions failed. This year, there have been only five failures, Barr says.
U.S. stocks face prolonged bear dance
Major U.S. stock indexes, already trapped in bear territory, face a tougher road to recovery, as more Americans crack into their nest eggs to withdraw cash to cope with rising economic pressures.
The Dow Jones industrial average and the Standard & Poor's 500, which have fallen 20 per cent or more from their closing highs of last October, qualifying them as bear markets, have taken big hits from the drastic slowdown in housing and credit as well as record oil prices.
The troubles hanging over the U.S. economy and the stock market are deep enough that a sharp rally this spring and a brief summer rebound have done little to reverse the damage. For the year so far, the Dow was down 14.4 per cent, the S&P 500 is off 14.7 per cent and the Nasdaq Composite Index is also down 14 per cent, based on Thursday's closing figures.
Even worse, stocks that have dropped to where they are seen as compelling buys get battered further by renewed fears over the stability of the banking system. “Every time the ‘long only' guys tip their toes in the water, they get whacked – it's been absolutely tough,” said Keith Wirtz, president and chief investment officer of Fifth Third Asset Management, which manages $22-billion (U.S.).
The whacking isn't going away anytime soon. Baby boomers are adding another layer of anxiety for money managers looking for a sustainable stock market recovery during the year's second half. That's because boomers, born after World War II in the economic expansion between 1946 and 1964, are increasingly withdrawing funds from their defined contribution plans as the housing debacle gets worse.
In a recent survey conducted by the AARP of more than 1,000 respondents aged 45 and older, almost 25 per cent of individuals between the ages of 45 and 64 are prematurely withdrawing from their 401(k) retirement plans and other investments.
And the Vanguard Group, the fund company that's popular among retail investors because of its low fees, points to another worrisome sign: Last December, so-called “hardship withdrawals” shot up 22 per cent from a year earlier.
The increase in hardship withdrawals at Vanguard suggests “rising economic pressures on financially vulnerable households, possibly related to the national crisis in subprime and adjustable rate mortgages,” said William Nessmith and Stephen Utkus, authors of a Vanguard report on this alarming trend. For years, as home values skyrocketed, people used their houses as glorified ATMs, pulling out money for all sorts of reasons.
The trend helped support continued economic growth and recovery from the tech-telecom recession of 2001. Although the Vanguard report didn't hone in on boomers per se, some members of that famous generation are struggling financially under the strain of sinking home prices, skyrocketing food and gasoline prices and a weak job market.
Boomers are now caught in the crossfire: According to a Harvard University study, boomers make up the single largest group of home owners – 34 per cent of all home owners.
Putting the importance of American home owners to the U.S. economy into perspective, U.S. Federal Reserve Chairman Ben Bernanke warned earlier this year that consumers were bearing the brunt of the effects of the current downturn because housing wealth had been tied strongly to spending and their homes were their biggest assets.
Vanguard said that both the number of cash withdrawals and their dollar value have grown in recent years for the defined contribution plan. But Vanguard's Mr. Nessmith and Mr. Utkus added that the absolute level of withdrawals remains quite low even though the percentage rate of change is high.
Charles Schwab & Co., the largest U.S. discount broker, also has seen a similar trend. The percentage of Americans lowering the amount they are saving with regular contributions to their 401(k) plans is climbing. In the first quarter of 2008, 7.1 per cent lowered their contribution rate – up from 5.8 per cent in the year-ago period, according to Charles Schwab data.
“It certainly doesn't help matters that people are freaking out and taking their money,” said Brian Gendreau, an investment strategist in New York for ING Investment Management Americas. “This will help to contribute to a longer drawn-out down market,” Mr. Gendreau said.
During volatile periods, investors are told not to make panicky decisions and to stay well diversified. But the bursting of the credit and housing bubble has hit Americans to such an extent that they may have no choice but to dip into their savings.
So far this year, U.S. equity funds have suffered withdrawals of roughly $52.7-billion, by far the worst first half for the group since EmergingPortfolio.com Fund Research began tracking them in 2000.
“It's money chasing returns ... it happens on the way up and it happens on the way down,” Mr. Gendreau said. All told, Mohamed El-Erian, co-chief executive officer of Pacific Investment Management Co., or Pimco, which oversees $812-billion in assets, said in an interview that the American consumer will continue to be under duress.
“In the absence of significant new and targeted capital,” Mr. El-Erian said, “the current dynamics in the housing markets will force further asset disposals which, in turn, will push prices lower, causing yet another round of sales and foreclosures.”
Nationwide, more than 8,000 properties enter foreclosure each day. The broad consequences of the credit and housing crisis have been nothing short of stunning.
On Monday, American Express Co. said that its most affluent cardholders, also known as “superprime Cardmembers,” spent less on discretionary purchases in the second quarter, contributing to unexpectedly weak earnings.
“It just shows that no one is insulated from the crisis,” said Paul Hickey, co-founder of Bespoke Investment Group in Mamaroneck, New York. “This shows that even the best of the best aren't doing so hot.”
JP Morgan leads possible HBOS break-up
JP Morgan, the US banking giant that rescued Bear Stearns earlier this year, has held talks with several interested parties about forming a consortium to break up HBOS, the UK's biggest mortgage lender which includes the Halifax brand.
JP Morgan is understood to have spoken to a large Australian bank, thought to be National Australia Bank (NAB). It has also approached private equity firms. Spain's Santander could also be approached, sources said. The model bears a resemblance to break-up bid for ABN Amro last year.
JP Morgan could act as the adviser to the group, playing the same pivotal role as Merrill Lynch in the ABN deal. JP Morgan could also provide financing for a bid and pick up some assets. However, the US bank is unlikely to want to buy any of the large constituent parts of HBOS as it has no retail banking operations in the UK and is still bedding down its acquisition of stricken US bank Bear Stearns.
NAB, which owns Clydesdale and Yorkshire Banks in the UK, has been tipped as a possible buyer of HBOS's Australian division, BankWest. NAB may also be interested in HBOS' corporate banking arm, which makes up most of the Bank of Scotland business. NAB, led by John Stewart, former chief executive of Woolwich, held takeover talks with Bank of Scotland before the Scottish bank turned to Abbey National for a deal in 2001.
In the event neither deal happened, clearing the way for Halifax to snap up Bank of Scotland the same year.
Other parts of HBOS which could split off are its asset management arm, Insight, and its insurance and investment business, Clerical Medical.
A buyer could also be found for St James's Place, the asset manager in which HBOS owns a 60pc stake.
HBOS's shares have been buffeted by the credit crunch and by fears about its £4bn rights issue. The capital raising was completed this week.
Speculation about a takeover of HBOS has been growing following the dramatic fall in its share price.
Rumours earlier this week that BBVA, Spain's second biggest bank, may be interested in swooping on HBOS were wide of the mark, sources said. But several bankers have told The Daily Telegraph that JP Morgan has been working on a potential consortium bid for some time.
They added that a consortium has not yet been formed and the talks could fall through. A break-up bid for HBOS might meet opposition from the Financial Services Authority, which would not want one of Britain's biggest banks to be destabilised.
However, if the deal saw NAB and possibly Santander take the majority of the assets, the FSA might not stand in the way, observers said.
Let's just start by conceding that many stock analysts on Wall Street are well-paid B.S. artists. They are, with the exception of being well-paid, in many ways like journalists.
If the research scandal of Wall Street earlier in the decade wasn't jarring enough, the preponderance of buy ratings for companies as battered as Lehman Brothers Holdings Inc., and Wachovia Corp. that led investors off the cliff in the past six months should be enough to sober us up.
But the business of analyzing companies and stocks is important. Some analysts, such as Brian Tunic at J.P. Morgan, who covers retail, and Jeff Lindsay and Brad Hintz at Sanford Bernstein, who cover technology and brokerages respectively, are respected and insightful. Many of the rest bore you with gobbledygook as they issue report after report with companies rated neutral or hold.
Now, regardless of whether they are a waste of paper or not, analyst reports are protected free speech under the First Amendment. The funny thing is, even though most analysts can say pretty much anything they want about a public company, they usually don't.
That's why it took many in the industry by surprise when Dick Bove, a bank and brokerage analyst at Ladenburg Thalmann, was sued for defamation and negligence by BankAtlantic Bancorp Inc. In Bove's note titled, "Who is Next?" dated July 13, Bove wrote about the next possible failure after IndyMac Bancorp, the California thrift that federal regulators seized earlier this month.
When I heard about the lawsuit, I expected to see Bove's answer to be one bank and one bank only: BankAtlantic. Instead, BankAtlantic wasn't even mentioned in Bove's discussion. The bank was listed in an accompanying chart along with another 106 U.S. banks and thrifts with assets greater than $5 billion. The information was pulled from the Federal Deposit Insurance Corp.
You can see why BankAtlantic felt singled out. A spokesman for Bove's firm, Ladenburg Thalmann said "We will defend ourselves against this meritless lawsuit," but declined further comment.
As you might expect, this wasn't the first time BankAtlantic or the people behind it have been in court. Back in the 1990s, BankAtlantic's chief executive, Alan Levan, waged a nine-year battle against ABC News claiming the news show 20/20 libeled him. The show criticized his financial dealings, according to reports.
Levan won a $10 million award after he argued that the show damaged his reputation. The award was thrown out on appeal and Levan's defeat was upheld on appeal to the U.S. Supreme Court. BankAtlantic also was the target of one of the biggest money-laundering cases since Sept. 11.
In April 2006, the bank was fined $10 million for failing to detect millions in illicit drug money flowing into the bank. The U.S. Justice Department found that for years BankAtlantic "willfully and knowingly ignored its obligations." Levan told the Miami Herald, "We feel terrible and embarrassed."
The money-laundering case, along with this case against Bove, has done little to burnish BankAtlantic's reputation. And BankAtlantic was having trouble building confidence even before Bove's report hit the Street. Shares have fallen 77% in less than a year.
Carol Van Cleef, head of the financial institutions regulatory practice at Bryan Cave, reviewed Bove's report and was surprised that BankAtlantic would take offense. "I don't see any institution singled out," she said. "I don't see any particular conclusions drawn from this. It's going to take more to establish" a case.
Russian stock markets plunge
Investors piled out of Russian stocks Friday after the abrupt departure from the country of a foreign oil boss and the prime minister's unexpected severe criticism of a large steel firm.
MICEX, the exchange where the bulk of trading in Russian stocks takes place, plunged by 4.8 percent as of 12:20 p.m. Russian time, while the RTS, a top stock index, lost 4.4 percent to drop beneath the critical 2000-point barrier for the first time since March.
After Prime Minister Vladimir Putin's scathing attack on Mechel late Thursday, heavy trading in New York sent the steel and coal maker's stock down by nearly 40 percent, losses mirrored Friday morning in Russian trading.
The premier criticized the company, which is the largest supplier of coal for steelmakers in Russia, for charging much higher prices for raw materials domestically than it does for its exports, and called for an antitrust investigation into its activities.
Earlier Thursday, Robert Dudley, CEO of the embattled Anglo-Russian oil producer TNK-BP, left the country three days before his visa was due to expire. Russia has not renewed the visa on the ground that he allegedly does not have a valid work contract.
The developments rattled investors, leading to a heavy sell-off in Russian stocks. The RTS is now down more than 20 percent from its mid-May high, pushing it into technical bear territory.
China’s banks told to tighten mortgages
Chinese officials and government economists have warned domestic banks to tighten their mortgage lending criteria after the US government’s action to prop up Fannie Mae and Freddie Mac, the giant mortgage agencies.
Liu Mingkang, China’s top banking regulator, has in recent days urged the country’s state-owned commercial banks to beware of risks in the real estate sector and ordered them to tighten loan approval processes. Others among China’s policy community have also begun to express concerns about the health of the country’s banks amid signs a once-booming property sector has begun to slow.
Average house prices in China’s 70 largest cities were up 10.2 per cent from a year earlier by the end of June, according to official figures. But sales volumes in important cities, including Shanghai, Beijing and Shenzhen, have fallen precipitously in recent months. Some analysts fear steep price falls ahead.
“If financial institutions of Freddie Mac and Fannie Mae’s calibre could get into such a bad situation, then what does that mean for Chinese financial institutions?” asked Yi Xianrong, a prominent economist at the China Academy of Social Sciences. “The only reason we haven’t seen similar problems here is because property prices have continued to rise rapidly.”
Lending standards at Chinese banks are often much looser than in developed countries, in part because China is still in the early stages of building a credit rating system. “Anyone can get a mortgage loan in China, no matter who they are,” Mr Yi told the Financial Times. “There is also a huge amount of speculation in the market and insider dealing when it comes to bank officers granting loans.”
Yet, to date the default rate in China has been relatively low. China’s total stock of consumer debt remains far below of more developed economies. At the end of June, total mortgage lending in the Chinese banking sector amounted to Rmb3,350bn, or nearly 12 per cent of gross domestic product.
Apart from one or two experimental pilot projects there is no real secondary market for repackaged loans. The overall stock of household savings in China is about five times larger than total outstanding consumer debts including mortgages. More than half the population are peasants without means to invest in property.
A massive demographic shift in China is under way. Official policies aim to coax more than 150m peasants into urban jobs by 2020, a push expected to drive demand for real estate for decades. A lack of investment options in China also leads investors to speculate in the real estate market, driving prices beyond the reach of many citizens.
The government has been trying to slow rapid price rises since last year by cutting off bank credit and supply of land to property developers and blocking them from raising money in domestic stock markets.
Ilargi: Munich Re is one of the world’s largest reinsurers, menaing they sell insurance to insurance companies. And if even they can’t make a living anymore....
You see, this is not because insurers face such an increase in policy pay-outs: it’s because of their investments!
Munich Re Issues Surprise Profit Warning
Munich Re AG on Friday issued a surprise profit warning for the second quarter and set a more cautious outlook for the year, saying the continuing financial crisis has led to "substantial" write-downs to the German reinsurer's equities portfolio.
The company said it now expects full-year profit to be below its previously estimated range of €3 billion ($4.71 billion) to €3.4 billion, but that it should still be "well above" €2 billion.
Munich Re also said further write-downs were likely this year if markets don't improve, but didn't specify the amount of write-downs expected in the second quarter. Shares in Munich Re fell 12% to €102.39. For the second quarter, Munich Re now expects to report profit of about €600 million, compared with €1.16 billion a year earlier.
The company said its medium-term outlook remained positive and stood by its plan to increase earnings to more than €18 a share by 2010. Analysts called the profit warning a harbinger of things to come for the German insurance sector. "What's shocking is that the profit warning is coming from Munich Re, which is [widely considered to be] the insurer with the most defensive capital reserves," said Christian Hamann of Hamburger Sparkasse.
On the heels of the announcement, sector peer Hannover Re said troubles in the capital markets could also weigh on its full-year outlook. "If markets don't calm down, it will also be difficult for us to reach our forecast" for 2008, a spokesman for Hannover Re said.
In May, Hannover Re said it expects "another good result" in 2008, with net and gross premiums on a par with the previous year. It also forecast earnings of €5 a share and a return on equity of more than 15%. Shares in Hannover Re sank 15% to €27.40.
The great Doha trade divide
Trade talks in Geneva could collapse as soon as today in large part because rich countries are unable or unwilling to see fundamental differences that separate them from countries in the developing world. These differences are most apparent in two areas that have emerged as major stumbling blocks: farm trade and tariffs.
On the surface, the debate between rich and poor going on in Geneva at the offices of the World Trade Organization seem simple enough. Rich countries, led by the United States and the European Union, are pressing poorer countries to reduce the taxes they levy on imports, especially those on manufactured goods such as cars.
The argument is that freer trade not only benefits manufacturers in rich countries, but also consumers in the developing world, who would have access to cheaper goods. Poorer countries, led by Brazil and India, say they won't even contemplate tariff reductions until wealthy countries significantly reduce barriers to freer farm trade, including the hefty subsidies paid to farmers. These subsidies make it difficult if not impossible for farmers in developing countries to compete.
Commentators watching the talks suggest the solution is both obvious and achievable: Get rich countries to lower farm subsidies enough to satisfy the governments of developing countries, who will then chop their import tariffs. This solution, however, is based on the assumption that poor countries are essentially the same as rich countries, except that they have less money.
They are not. They are much more reliant on both agriculture and on revenue from import tariffs. Any workable solution would have to be heavily slanted in favour of developing countries to account for these differences.
The $258-billion (U.S.) that rich countries spent propping up their farmers last year, according to the Organization for Economic Co-operation and Development, disguises the fact that agriculture is an increasingly minor part of their economies.
It accounts for only 2.1 per cent of the economy in Canada, 2 per cent in the European Union, and a tiny 0.9 per cent in the United States. (All figures are taken from the most recent CIA World Factbook.) The picture is starkly different in the developing world. Although the emerging economies of Brazil, Russia, India and China have reduced their dependence on agriculture, it still forms a significant part of their economies.
It accounts for 5.5 per cent of economic output in Brazil, 4.7 per cent in Russia, 11.3 per cent in China, and 17.6 per cent in India. In Africa, even oil producers such as Nigeria, Angola and Sudan have much larger farm sectors than any rich country. Farm output in Nigeria accounts for 17.6 per cent of the economy, while in Sudan the relevant figure is 31.8 per cent.
What this means is that the benefits of freer farm trade would be felt most strongly in the developing world, where agriculture employs more people and where economies are more dependent on the farm sector, than in the developed world. This would seem to be a good reason for the governments of rich countries, which pay a great deal of lip service to helping the poor, to slash their expensive farm protection. But altruism is the rarest of commodities in trade negotiations.
Rich countries want a quid pro quo in the form of a large cut in the import tariffs imposed by the governments of developing countries. They argue that everyone would benefit from the result. But this calculus is based on the faulty assumption that tariff revenues have the same level of importance in the developing world as they do in the developed world. They do not.
Much like agriculture, tariff revenues are more important to governments in developing countries than they are to their richer counterparts. The reason is straightforward: it is easier to collect tariffs than it is to collect personal or corporate income taxes.
In countries where the tax system is weak or rudimentary, where corruption allows the elite to shield their wealth from the taxman, and where many workers are in the so-called informal economy, tariffs are the most reliable source of government revenue. Taxes on trade, which is what tariffs are, account for between 10 per cent and 20 per cent of government revenue in developing countries.
In contrast, they account for less than half of one per cent in the developed world. When rich countries cut their tariffs, they can at least hope to recoup the money through higher income tax collections (assuming that freer trade does indeed lead to higher economic growth and thus higher income). No such trade-off is open to governments of developing countries where income tax collection is a work in progress.
For poorer countries, tariff reductions often represent an absolute loss of revenue. This is why they are resisting the tariff cuts demanded by rich countries. Indeed, an analysis by the International Development Research Centre here in Ottawa said that reducing tariff income without reforming public finance systems in poorer countries would be “an invitation to fiscal calamity.”
The solution to the impasse in Geneva is not to give each side a little of what it wants, but to work out a deal that favours poorer countries and takes into account their differences. That is, after all, what they were promised after the last round of trade talks favoured richer countries. It is not, however, the most likely outcome.
Negotiators answer to politicians who answer to their most powerful constituencies. There has been little sign from the farm sector, which remains a strong force in the developed world, that its members are willing to give up any government support. Barring a sudden change of heart, developing countries will gain little or nothing in Geneva.
Ilargi: Satyajit Das is the world’s no. 1 independent expert on derivatives, and a smart observer. When he speaks, we pay attention.
We Interrupt Regular Programming To Announce That The United States Of America Has Defaulted
High levels of debt are sustainable provided the borrower can continue to service and finance it. The US has had no trouble attracting investors to date. Warren Buffett (in his 2006 annual letter to shareholders) noted that the US can fund its budget and trade deficits as it is still a wealthy country with lots of stock, bonds, real estate and companies to sell.
In recent years, the United States has absorbed around 85% of total global capital flows (about US$500 billion each year) from Asia, Europe, Russia and the Middle East. Risk adverse foreign investors preferred high quality debt – US Treasury and AAA rated bonds (including asset-backed securities ("ABS"), including mortgage-backed securities ("MBS")).
A significant portion of the money flowing into the US was used to finance government spending and (sometimes speculative) property rather than more productive investments. The real reason that the US actually has not experienced a sovereign debt crisis is that it finances itself in it own currency. This means that the US can literally print dollars to service and repay it obligations.
The special status of the US derives, in part, from the fact that the dollar is the world’s major reserve and trade currency. The dollar’s status derives, in part, from the gold standard that once pegged the dollar to the value of gold. The peg and full exchangeability is long gone.
The aura of stability and a safe store of value based on the strength of US economy and military power has continued to support the dollar. In 2003, Saddam Hussein, when captured, had US$750,000 with him – all in US$100 bills. The dollar's favoured position in trade and as a reserve currency is based on complex network effects.
Many global currencies are pegged to the dollar. The link is sometimes at an artificially low rate, like the Chinese renminbi, to maintain export competitiveness. This creates an outflow of dollars (via the trade deficit that in turn is driven by excess US demand for imports based on an overvalued dollar). Foreign central bankers are forced to purchase US debt with dollars to mitigate upward pressure on their domestic currency.
The recycled dollars flow back to the US to finance the spending. This merry-go-round is the single most significant source of liquidity creation in financial markets. Large, liquid markets in dollars and dollar investments are both a result and facilitator of the process and assist in maintaining the dollar’s status as a reserve currency.
The dominance may be coming to an end. There is increasing discussion of re-denominating trade flows in currencies other than US$. Exporters are beginning to invoice in Euro or Yen. There are proposals to price commodities, such as oil and agricultural goods, in currencies other dollars. Some countries have abandoned or loosened the linkage of their domestic currency to the dollar.
Others are considering such a move. Foreign investors, including central banks, have reduced investment allocations to the dollar. The dollar’s share of reserves has fallen from a high of 72% to around 61%. Foreign investor demand for US Treasury bonds has weakened in recent times. Low nominal (negative real) rates on interest and dollar weakness are key factors.
Foreign investors may not continue to finance the US. At a minimum, the US will at some stage have to pay higher rates to finance its borrowing requirements. Ultimately, the US may be forced to finance itself in foreign currency.
This would expose the US to currency risk but most importantly it would not be able to service its debt by printing money. The US, like all borrowers, would become subject to the discipline of creditors. For the moment, the US$ is hanging on – just. This reflects structural weakness in the Euro and Yen based on deep-seated problems in the respective economies. The artificial nature of the Euro is also problematic.
The dollar is also a beneficiary of the "too big to fail" syndrome. Foreign investors, especially central banks and sovereign investors in East and South Asia, Russia and the Gulf, have substantial dollar investments that would show catastrophic losses if the US were to default.
The International Monetary Fund ("IMF") estimated that Gulf Cooperation Council (Saudi Arabia, the United Arab Emirates, Qatar and other Gulf States) may lose US$400 billion if they decide to stop pegging their currencies to the dollar.
Every lender knows Keynes’ famous observation: "If I owe you a pound, I have a problem; but if I owe you a million, the problem is yours." In history’s largest Ponzi scheme, foreign creditors must keep supporting the US. As the old observation goes: "The only man who sticks closer to you in adversity than a friend is a creditor."
The US faces a challenge to reestablish its economic credentials. Without drastic and radical action, America’s ability to continue to borrow from foreign investors to meet its financing requirement is likely to become increasingly difficult.
The mass hysteria and panic that followed the broadcast of Orson Welles The War of the World played on fears about an attack by Germans. It is interesting to speculate whether a broadcast on a default by the US on its sovereign debt would play on the secret fears of global markets triggering a similar panic.
"We interrupt regular programming to announce that the United States of America has defaulted on its debt!"