"Auto wreck." Vehicular mishap on a wintry day on the streets (and sidewalks) of Washington, D.C.
Ilargi: It’s not really that hard: in the last few decades, credit has been seen, treated and used as money, as always during economic expansions. In fact, lately an insane amount of it has been used as such.
Now that is over, and the only way to purchase anything will soon be with money, which means cash, gold or silver, because credit will disappear. This will shake our societies to the core, like a quake measuring 9 on the Richter scale.
Wherever you look in our neck of the world, credit finances everything. Without an open credit line, 99% of businesses and governments simply cannot function. WIthout credit, home sales will become extinct, as will new car sales.
But during the sharpest contraction in US money supply in history, the president of the Federal Reserve, the secretary of the Treasury, and all the media are still incessantly talking about inflation -and stagflation- as the biggest problems in the economy.
However, looking at the numbers of the crunching credit and money supply, one thing is obvious: no matter how one defines inflation, the sharpest contraction in history cannot possibly exist alongside inflation. It is impossible.
It's so ridiculous, it is utter nonsense to even suggest it. In any and all serious economic models and schools, it’s 100% evident that this sort of contraction shouts DE-flation. And they know it.
So why do the very people like Bernanke and Paulson, who have access to better data and counsel than anyone else, continue bleating out about what they know to be a lie?
For one thing, because it allows them to make people accept increasing government expenditures, while at the same time depressing wages.
After all, higher wages would lead to inflation, or so is the argument that nobody dares question. And the government needs hundreds of billion extra, if only to fight inflation. And save the bankers without whom society would presumably collapse.
Second, it diverts people's attention away from where they are really losing money. Let them focus on $4 gas, and forget the 30% loss -with more to come- in home values, and the $1.5 trillion doled out, in their names and on their tab, to the financial industry. Just repeat the inflation mantra every day, and they'll forget about what's far more hurtful. Till it's too late.
Inflation is not a few temporary price rises. It’s a money and credit supply that expands relative to what can be purchased with it.
With individuals losing $20-30.000 per year on the value of their homes, banks too broke to write loans, companies losing trillions of dollars in writedowns and falling share prices, and various levels of governments losing money from tax revenues, investments and bonds sales, there is no expansion. Quite the opposite.
What makes the lie so easy is that people have been brought up with the concept of inflation, and what it may lead to. Nobody today has any idea what deflation will mean. Well, that is about to change.
Sharp US money supply contraction points to Wall Street crunch ahead
The US money supply has experienced the sharpest contraction in modern history, heightening the risk of a Wall Street crunch and a severe economic slowdown in coming months.
Data compiled by Lombard Street Research shows that the M3 "broad money" aggregates fell by almost $50bn (£26.8bn) in July, the biggest one-month fall since modern records began in 1959. "Monthly data for July show that the broad money growth has almost collapsed," said Gabriel Stein, the group's leading monetary economist.
On a three-month basis, the M3 growth rate has fallen from almost 19pc earlier this year to just 2.1pc (annualised) for the period from May to July. This is below the rate of inflation, implying a shrinkage in real terms. The growth in bank loans has turned negative to a halt since March.
"It's obviously worrying. People either can't borrow, or don't want to borrow even if they can," said Mr Stein. Monetarists say it is the sharpness of the drop that is most disturbing, rather than the absolute level. Moves of this speed are extremely rare.
The overall debt burden in the US economy is currently at record levels, raising concerns that a recession - if it occurs - could set off a sharp downward spiral. Household income is now 131pc of disposable income, compared with 93pc at the top the dotcom bubble, 79pc in the property boom of the late-1980s, and 62pc at the end of the 1970s.
The M3 data measures both cash and a wide range of bank instruments. It tends to provide an early warning signal of major shifts in the economy, although the US Federal Reserve took the controversial decision to stop reporting the statistics in 2005 on the grounds that the modern financial system had rendered the data obsolete.
Monetarists insist that shifts in M3 are a lead indicator of asset prices moves, typically six months or so ahead. If so, the latest collapse points to a grim autumn for Wall Street and for the American property market. As a rule of thumb, the data gives a one-year advance signal on economic growth, and a two-year signal on future inflation.
"There are always short-term blips but over the long run M3 has repeatedly shown itself good leading indicator," said Mr Stein. He cautioned that the three-month shifts in M3 can be highly volatile.
M3 surged after the onset of the credit crunch, but this was chiefly a distortion caused by the near total paralysis in parts of the American commercial paper market. Borrowers were forced to take out bank loans instead. The commercial paper market has yet to recover.
The University of Michigan's index of consumer sentiment has fallen to the lowest level since the 1980s recession. The US economy is without doubt facing severe headwinds going into the autumn. Richard Fisher, the ultra-hawkish head of the Dallas Federal Reserve, warned over the weekend that growth would be near "zero" in the second half of the year.
Large U.S. Banks To Fail Amid Recession, Rogoff Says
Credit market turmoil has driven the U.S. into a recession and may topple some of the nation's biggest banks, said Kenneth Rogoff, former chief economist at the International Monetary Fund.
"The worst is yet to come in the U.S.," Rogoff said in an interview in Singapore today. "The financial sector needs to shrink; I don't think simply having a couple of medium-sized banks and a couple of small banks going under is going to do the job."
The U.S. housing slump has triggered more than $500 billion of credit market losses for banks globally and led to the collapse and sale of Bear Stearns Cos., the fifth-largest U.S. securities firm. Rogoff said the government should nationalize Fannie Mae and Freddie Mac, the nation's biggest mortgage-finance companies, which have lost more than 80 percent of market value this year.
Freddie Mac and Fannie Mae "should have been closed down 10 years ago," he said. "They need to be nationalized, the equity holders should lose all their money. Probably we need to guarantee the bonds, simply because the U.S. has led everyone into believing they would guarantee the bonds."
U.S. Treasury Secretary Henry Paulson asked Congress on July 13 for emergency powers to inject "unspecified" amounts of government funds into the companies if necessary.
The mortgage lenders have been battered by record delinquencies and rising losses. Fannie Mae fell in European trading to the lowest in 19 years today amid concern the government-chartered companies will fail to raise the capital they need to offset losses. Freddie Mac slid 25 percent yesterday to the lowest since January 1991.
Banks repossessed almost three times as many U.S. homes in July as a year earlier and the number of properties at risk of foreclosure jumped 55 percent, according to RealtyTrac Inc., an Irvine, California-based seller of foreclosure data. U.S. builders probably broke ground on the fewest houses in 17 years last month, according to a Bloomberg News survey.
Rogoff told a conference in Singapore today that the credit crisis is likely to worsen and a large bank may fail, Reuters reported earlier. Rogoff, 55, is a professor of economics at Harvard University. He was the IMF's chief economist from August 2001 to September 2003.
"Like any shrinking industries, we are going to see the exit of some major players," Rogoff told Bloomberg, declining to name the banks he expects to fail. "We're really going to see a consolidation even among the major investment banks."
IndyMac Bancorp Inc., once the second-largest U.S. independent mortgage lender until it was seized by regulators July 11, filed for bankruptcy protection Aug. 1, three weeks after it was taken over by the Federal Deposit Insurance Corp. amid a run by depositors that left it strapped for cash. Bear Stearns collapsed in March and sold itself to JPMorgan Chase & Co. for
$10 a share.
"The only way to put discipline into the system is to allow some companies to go bust," Rogoff said. "You can't just have an industry where they make giant profits or they get bailed out." The world's largest economy is already in a recession, and the housing market will continue to deteriorate, Rogoff said. The U.S. slowdown will last into the second half of next year, he said, predicting a faster recovery in Europe and Asia.
The Federal Reserve, which has left its key interest rate at 2 percent after the most aggressive series of rate reductions in two decades, risks raising inflationary pressures, he said. "Rates are too low," Rogoff said. "They must realize we're going to get inflation if things stay where they are. They need to raise rates but I don't think they are going to because they're way too nervous."
U.S. housing slump deepens
Construction of homes and apartments in the United States fell in July to the lowest level in more than 17 years, the U.S. government said Tuesday.
The Commerce Department said that builders broke ground on 965,000 housing units on an annualized basis. That was down from a pace of 1.08 million in June and the weakest showing since March 1991. However, July's performance was better than analysts expected.
Wall Street economists forecast housing starts would drop to a pace of 950,000. Still, the latest housing figures continue to show a badly battered housing market, one of the biggest problems plaguing the already shaky national economy. The report showed that construction of single-family homes in July fell by 2.9 per cent to a pace of 641,000. That was the lowest since January 1991, when the economy also was in distress.
Construction of apartments and other multifamily dwellings also fell sharply in July, after a large jump in the previous month due to a change in New York City's building codes. That change, which went into effect July 1, gave a rare lift to overall housing construction in June.
Housing permits in July fell to a rate of 937,000, a 17.7 per cent drop from June, but still above analysts' expectations of 925,000. Permits are considered a reliable sign of future activity.
Homebuilders are hoping the housing rescue package approved by Congress last month will boost the dismal real estate sector. The law includes a temporary $7,500 (U.S.) tax credit for first-time homebuyers that essentially works out to a 15-year, interest-free loan.
The National Association of Home Builders/Wells Fargo housing market index, released Monday, remained at a record low of 16 in August for the second consecutive month. Readings below 50 indicate negative sentiment about the market. But one measure of longer-term sentiment improved slightly: a measure of builders' sales expectations in six months rose two points to 25.
Still, homebuilder Toll Brothers Inc. reported dismal quarterly results last week when its revenue fell 34 percent and its order backlog plunged 52 percent. Shares of several homebuilders, including Toll Brothers, D.R. Horton Inc. and Pulte Homes Inc., dropped Monday, partly due to renewed fears about the financial health of mortgage giants Fannie Mae and Freddie Mac.
Future of Freddie, Fannie still in doubt
Fannie Mae and Freddie Mac tumbled to about 18-year lows in New York on concern the government will be forced to bail out the mortgage-finance companies, wiping out common stockholders.
Fannie and Freddie each slid as much as 20% after Barron's reported that the Bush administration is anticipating the government-chartered companies will fail to raise the equity they need to offset credit losses, prompting the US Treasury to act. The companies' stock market values are well below the minimum of $US10 billion ($11.5 billion) in capital that each would need to raise to "have any credibility," Barron's said in its story.
"We agree with the call for Treasury intervention and think it is very, very likely to happen before the end of the third quarter," said Ajay Rajadhyaksha, the head of fixed income strategy for Barclays Capital. "Without government help, we think there is very little chance of Freddie completing a significant capital raising."
The government plans to recapitalize Fannie and Freddie with taxpayer money should their capital raising fail, Barron's said, citing a person in the Bush administration it didn't identify. A rescue of the companies, which own or guarantee 42% of the $US12 trillion in US home loans, would include preferred stock with a seniority, dividend preference and convertibility that would wipe out common stockholders, Barron's reported.
Treasury Secretary Henry Paulson, who on July 31 received the unprecedented authority he requested from Congress to help the companies if needed, has said a bailout won't be necessary. "We aren't going to comment on speculation," said a Treasury spokeswoman, Jennifer Zuccarelli. "As the Secretary has said, we have no plans to use these authorities."
Fannie was down $US1.48, or 19%, to $US6.43 in New York Stock Exchange composite trading. Freddie fell $US1.18, or 20%, to $US4.67. Fannie has lost about 84% of its market value this year. Freddie's has fallen 86%.
"The Barron's article significantly overstates our financial situation," said Sharon McHale, a spokeswoman for McLean, Virginia-based Freddie. She said the company is "adequately capitalized" and believes "we will get through the current housing market crisis." Brian Faith, a spokesman for Washington-based Fannie wouldn't comment immediately.
The companies have been battered by record delinquencies and rising losses amid the worst housing slump since the Great Depression, posting four straight losses totaling $US14.9 billion. Both cut their dividends this month and announced plans to slow growth after bigger-than-expected losses for the second quarter.
Freddie Chief Executive Officer Richard Syron said on Aug. 6 that the US housing market is still "searching for a bottom" and that most of the company's expected losses have yet to be realized. The US mortgage delinquency rate has set a record every quarter since March 2007 while the rate of late payers going into foreclosure is also at an all-time high, Freddie said.
Fannie was created as part of Franklin D. Roosevelt's New Deal in the 1930s, a time when the US economy was struggling to emerge from a stock market crash, industrial production had tumbled 50% and the unemployment rate reached 30%. Freddie was started in 1970 primarily as competition for Fannie.
Fannie has raised $US14.4 billion in new capital since last December to offset credit losses. Freddie, which sold $US6 billion in preferred stock in November, is struggling to raise $US5.5 billion more that that company said in May it planned to sell.
Syron said on Aug. 6 Freddie would have to pay "double- digit" rates to issue preferred stock, compared to the 8.75% Fannie paid for its preferred stock issue in May. The task is made even more difficult now that Freddie's market value has dropped to about $US3 billion from $US42 billion a year ago.
"If they're unable to tap the markets to raise capital, I think we're talking a matter of quarters before the government has to step in," Joshua Rosner, an analyst with independent research firm Graham Fisher & Co. in New York, said in an interview this month. Both companies will need to raise as much as $US15 billion, Paul Miller, an analyst at Friedman, Billings, Ramsey & Co. in Arlington, Virginia, said earlier this month.
Fannie paid a record high yield in a $US3.5 billion sale of three-year benchmark notes last week that drew less demand from Asia, the second-biggest buyer of Fannie's debt and mortgage- backed securities. Asian investors bought 22% of the issue, almost half the demand of three months ago and about two- thirds of Asia's usual buying.
Treasury data show that private and government investors in Japan slowed purchases of their debt to $US770 million in June, from $US4.5 billion a month earlier. China bought $US9.6 billion in Fannie Mae and Freddie Mac debt, down from $US14.9 billion in May. Standard & Poor's cut Fannie and Freddie's preferred stock and subordinated debt ratings by three levels last week to A- from AA-. S&P affirmed the companies' AAA senior debt rating, reflecting perceived government support.
A rule that made it harder for investors to bet against Fannie and Freddie's shares also expired last week. The Securities and Exchange Commission on July 21 imposed a temporary order that tightened rules for 19 stocks, including Fannie and Freddie, prohibiting firms from so-called naked short selling, where they sell shares without actually borrowing them.
The cost to protect the subordinated debt of Fannie Mae and Freddie Mac from default climbed to a record. Credit-default swaps on Fannie's subordinated debt increased 47 basis points to 325 basis points, while contracts on Freddie Mac jumped 52 basis points to 329, according to CMA Datavision.
Contracts on the senior debt of the two companies were unchanged at 49 basis points, with the gap between the credit- default swaps on the senior and subordinated debt now at the widest ever.
Credit-default swaps are financial instruments based on bonds and loans that are used to speculate on a company's ability to repay debt. They pay the buyer face value in exchange for the underlying securities or the cash equivalent should the company fail to adhere to its debt agreements.
When Henry Met Fannie
There's no rest for a Treasury Secretary in a financial meltdown, as Hank Paulson is discovering. Fannie Mae and Freddie Mac continue to bleed mortgage losses, and so the Treasury chief may soon have no choice but to pull the trigger on his new authority for taxpayers to recapitalize the mortgage giants.
Fan and Fred shares took another header yesterday, in the wake of a Barron's article predicting that a Treasury recap was "almost inevitable." When a single story in one day can take nearly 22% off Fannie shares, and nearly 25% off Freddie's, you know investors are scared to death.
They should be. Two weeks ago the companies added another $3.1 billion in losses to the $11 billion they'd already reported in recent quarters. Both companies slashed their dividends and warned they'd buy fewer mortgages, while being more selective about those they do buy. So much for the assertion -- made so confidently this year by Barney Frank, Chris Dodd and Chuck Schumer -- that Fan and Fred would rescue the mortgage market from the housing slump.
Instead the companies have dug an even deeper hole than have many subprime lenders. Their current run of losses are based in so-called Alt-A loans, aka "liar loans," that didn't require enough proof of borrower net worth. Fan and Fred piled into Alt-A mortgages in recent years as a way to gain market share amid the late, unlamented housing mania. No one knows how many of those loans will go belly-up before the housing market starts to turn, presumably in 2009.
Both companies insist they have adequate capital to ride this out, but they also said this before Treasury and Congress felt obliged to make explicit what had been an implicit taxpayer guarantee. Freddie still says it will raise another $5.5 billion from investors, and good luck with that. Freddie has a negative corporate net worth and a market capitalization -- after Monday's losses -- below $3 billion. Freddie holders, who have lost more than 90% of their investment in the last 12 months, may not want to double down.
Meantime, Treasury claims it has no plans to inject taxpayer money directly into the companies. Even so, Mr. Paulson has quietly hired Morgan Stanley, the investment bank, to look into "appropriate capital structures" if he does decide to sign the blank check that Congress has given him.
Robert Scully, the Morgan banker who will lead the effort, is by all accounts a straight shooter. And he will need to be, given the enormous political pressure he will soon face from Fannie Mae's defenders, both at Morgan and in Washington. Morgan Stanley says it is forgoing any other investment banking business with Fan and Fred while it works for Treasury. But until recently it was among the banks advising Freddie on that elusive $5.5 billion capital infusion.
Morgan Stanley is also home to Kenneth Posner, one of the biggest Fan and Fred cheerleaders on Wall Street. Only last March, the analyst crowed about the "complete defeat" of the "anti-GSE ideologues" -- that is, the people who had been right all long about the reckless risks the companies were taking. Mr. Posner also predicted that Fannie and Freddie would return to breakeven by the third quarter. Mr. Scully shouldn't be caught in the same intellectual area code as Mr. Posner.
A taxpayer recap for Fan and Fred would be far different than most Wall Street deals. Typically, the banker's job is to balance the competing interests of the existing shareholders with the need to raise money at a price the market will bear. That can't be the priority here. If taxpayers have to ante up, the only justification is to protect the larger financial system.
Existing Fannie and Freddie shareholders should be wiped out and managers and directors lose their jobs. We think Mr. Paulson should already have eliminated managers and private holders as a price of the recent bailout legislation. But if he lets either survive after taxpayers are forced to inject cash, the Treasury chief should be run out of town.
The new law also creates a new regulator for Fannie and Freddie, and the nominee for that job hasn't yet been named. The current acting director of the newly created Federal Housing Finance Agency, Jim Lockhart, has done a capable job with the limited tools available to him and would be a fine choice. But the Bush Administration needs to act now so the Senate can vote to confirm someone in September -- not wait six months or a year hoping that the crisis will go away.
A taxpayer recap for Fan and Fred can't be a get-out-of-bankruptcy-free card. As a de facto nationalization, any plan should rein in their riskiest operations with a goal of selling their profit-making businesses to the private sector, and perhaps handing what's left of their "affordable housing" mission back to Housing and Urban Development. It's time Mr. Paulson put taxpayers ahead of Wall Street.
Fannie Mae, Freddie Mac Are Pounded
Share prices of Fannie Mae and Freddie Mac plunged Monday amid growing fears that the two largest providers of funding for U.S. home mortgages won't be able to avoid a government bailout.
In 4 p.m. trading on the New York Stock Exchange, Freddie shares were down 25% to $4.39. Fannie stock dropped 22% to $6.15. Both stocks are down more than 90% from a year ago. Many investors and analysts fear the two companies may not be able to raise more capital by selling shares, amid gloom over the huge losses they face on mortgage defaults.
On Monday, some preferred shares previously issued by Fannie and Freddie were quoted at dividend yields of more than 16%, up from 14% Friday. With investors demanding such high yields, raising money through new preferred shares may be too expensive.
Selling common shares also would be difficult, because the companies' market values have shrunk drastically. At Monday's close, Fannie's market value was $6.6 billion and Freddie's $2.8 billion. Raising even a modest $5 billion would mean severely diluting the value of existing shares.
The latest price declines came after an article in the financial weekly Barron's asserted that a government bailout is likely and could wipe out the value of common shares in Fannie and Freddie. In early July, a previous plunge in the companies' shares prompted the U.S. Treasury to announce a package of measures aimed at shoring up investor confidence.
Among other things, the Treasury said it would lend money to the companies or make equity investments in them if needed. "As the secretary has said many times, we have no plans on using the authority," Treasury spokeswoman Jennifer Zuccarelli said Monday, referring to Treasury Secretary Henry Paulson. She declined to comment on "speculation" that Treasury might inject some capital into the firms.
Investors fear that a Treasury purchase of preferred stock in the companies would come with conditions that would leave previously issued common and preferred shares with little or no value. "I think every day that goes by without the companies raising capital, the possibility of the Treasury stepping in increases," said Paul Miller, an analyst at Friedman, Billings, Ramsey & Co.
Representatives of Fannie and Freddie reiterated that their capital remains at levels above the minimum required by their regulator. But many analysts consider that minimum level too low to withstand the potential credit losses ahead.
Fannie and Freddie bond prices also fell Monday, and their yield spreads over safe Treasury securities increased significantly as investors saw greater risk to holding the companies' debt.
Yields on two-year Fannie bonds rose by 0.055 percentage point to 0.9 percentage point over Treasury yields, a gap last seen in mid-July. Their subordinated debt was harder hit; spreads on two-year Freddie subordinated notes increased by around 1.7 percentage points to 4.9 percentage points.
As defaults on home mortgages soar, Fannie and Freddie have recorded combined losses of about $14 billion in the past four quarters. Those losses are expected to continue for at least another few quarters, and some analysts don't think the companies will return to the black before 2010 or 2011.
Freddie has said it plans to raise at least $5.5 billion of capital, likely through offerings of common and preferred stock, but it is waiting for market conditions to improve. Fannie raised $7.4 billion through common and preferred offerings in May but said recently that it may need to raise more capital eventually.
In a research note, Merrill Lynch said it doesn't expect any "sustained recovery" in Freddie shares until investors get a clearer view of the losses the company will sustain and the government response.
Freddie and Fannie fix under market pressure
The interim rescue plan for Fannie Mae and Freddie Mac unveiled by the US Treasury last month is coming under severe strain in the market, putting pressure on the government to consider further intervention to help the mortgage financiers.
On Monday, shares in both government-sponsored enterprises (GSEs) plunged following a report in Barron’s magazine that the Treasury would inject capital in the form of preference shares on terms that punished existing investors if the firms failed to raise new equity.
The Treasury dismissed the report as “speculation”. It told the Financial Times it still had no intention of using its newly authorised power to invest in either the debt or equity of Fannie and Freddie. The question is whether it may be forced to do so. The logic of the plan unveiled on July 13 was that the market would be reassured by the Treasury obtaining authority to invest in Fannie and Freddie, reducing the likelihood that the government would actually have to bail them out.
But Ira Jersey, interest rate strategist at Credit Suisse, said the Treasury plan did little to reassure investors in their equity or junior debt. “Hank Paulson’s gamble is that if the Treasury commits to investing in Fannie and Freddie [if required] it will never have to put money in,” said Alex Pollock, a fellow at the American Enterprise Institute. “I would say it still has a good chance of succeeding but it may get lower odds than it would have a month ago.”
There are four main reasons why the Treasury could be forced to intervene further against its inclinations: capital adequacy, debt spreads, contagion and liquidity fears. Fannie and Freddie sustain $5,200bn of mortgage credits with a small capital base. Most analysts believe they will have to raise new equity or risk breaching even their low capital requirements.
But with their stock prices heavily depressed and volatile, equity-raising on the scale needed is likely to be difficult, particularly for Freddie. With losses realised over many months, erosion of regulatory capital will not take place overnight. In the near term, the bigger issue is what is happening to Fannie and Freddie debt and mortgage-backed securities, which in turn influence mortgage rates.
Benjamin Cheng, analyst at UBS, said: “The now near-explicit government guarantee behind GSE credit should theoretically have caused agency spreads to tighten.” Instead, spreads have continued to widen as capital constraints have prevented the traditional buyers of mortgage products from participating in the market.
Some investors have also begun to perceive agency debt as more, not less, risky. Asian investors, traditionally a mainstay of the market, have become net sellers in recent weeks. As a result, the average rate on 30-year fixed rate mortgages is 6.69 per cent, according to Banxquote.com, almost as high as it was in the middle of last month, putting new strain on the battered housing market.
Monday’s trading also suggested Fannie and Freddie’s woes had contaminated other financial stocks. There is some danger that Fannie and Freddie could face a liquidity crisis. Both have huge bilateral positions in the interest rate swaps market. Karen Shaw Petrou, managing partner at Federal Financial Analytics, said their counter-parties could demand higher collateral in response to perceived credit risk. This would be very destabilising.
For now, the Treasury appears to hope that market strains will abate. But if the pressures mount, it could be forced to consider injecting capital, or nationalisation.
Credit crunch will take out large US bank, warns former IMF chief
The deepening toll from the global financial crisis could trigger the failure of a large US bank within months, a respected former chief economist of the International Monetary Fund claimed today, fuelling another battering for banking shares.
Professor Kenneth Rogoff, a leading academic economist, said there was yet worse news to come from the worldwide credit crunch and financial turmoil, particularly in the Untied States, and that a high-profile casualty among American banks was highly likely.
“The US is not out of the woods. I think the financial crisis is at the halfway point, perhaps. I would even go further to say the worst is to come,” Prof Rogoff said at a conference in Singapore. In an ominous warning, he added: “We’re not just going to see mid-sized banks go under in the next few months, we’re going to see a whopper, we’re going to see a big one — one of the big investment banks or big banks,” he said.
Rising anxieties over “worse to come” in the credit crisis sent shares tumbling in Europe and Asia. In London, the FTSE 100 index extended opening losses as widespread fears over the financial sector's woes led to another battering for bank stocks. The FTSE was down 74.8 points, or 1.4 per cent at 5375.4 in early dealing, but later pared its losses to stand down some 60 points. Germany's Dax also shed 1.4 per cent, while the CAC 40 in Paris lost 1.9 per cent.
Professor Rogoff, who was chief economist at the IMF from 2001 to 2004, predicted that the crisis would foster a new wave of consolidation in the US financial sector before it was over, with mergers between large institutions. He also suggested that Fannie Mae and Freddie Mac, the struggling US secondary mortgage lending giants, were likely to cease to exist in their present form within a few years.
His prediction over the fate of Fannie and Freddie came after investors dumped the two groups’ shares on Monday after reports suggested that the US Treasury may have no choice but to effectively nationalise them. The professor also sounded a warning over rising US inflation, which rose last month to its highest since 1991, and criticised the Federal Reserve for having cut American interest rates too drastically.
“Cutting interest rates is going to lead to a lot of inflation in the next few years in the United States,” he said. As investors' edginess over the threat of further financial turbulence sent equity markets into a further spin, bank shares were hit hardest.
Among the biggest fallers in London morning trade were HBOS, down almost 6 per cent, Royal Bank of Scotland, whose shares plunged by 4 per cent, while HSBC fell 1.5 per cent. In continental Europe, Spain's Banco Santander was off 2.5 per cent, and BNP Paribas lost 3.6 per cent.
Persistent worries over the rapidly deteriorating economic outlook in the UK also saw sterling succumb to fresh losses. The pound lost almost a cent against the dollar, dropping back to $1.8565, not far above near-two year lows plumbed on Friday.
Earlier, there were fresh jitters in Asia, with the region's leading bourses in sharp retreat after a dire overnight performance by Wall Street left the Dow Jones Industrial Average down by more than 180 points. Both Asian markets and Wall Street were unnerved by suggestions over the prospects for Fannie Mae and Freddie Mac.
While Japanese banks have remained relatively under-exposed to sub-prime mortgage products, many fear that they would be heavily exposed to a nationalisation of Fannie and Freddie. The large Japanese financial houses hold around Y9.6 trillion (£47 billion) in bonds and mortgage-backed paper issued by housing finance groups in the US.
“If the recapitalisation talk is realised, there are no assurances that the securities that have been issued [by U.S. mortgage firms] will be 100 per cent guaranteed,” said Yutaka Shiraki, a senior equity strategist at Mitsubishi UFJ Securities.
Financial sector shares were particularly badly hit in Tokyo, where they led the Nikkei 225 Index into a 300-point decline. The selling continued throughout the day, and peaked after a declaration by the Bank of Japan that the world’s second largest economy was now looking “sluggish”.
Although the central bank’s downbeat economic report included vague predictions of a return to growth over time, traders said that the comments had shattered any last hope that Asia’s export-led economy might somehow “decouple” from the woes in the US.
The picture was somewhat more stable in Shanghai, which spent a day in relative limbo following Monday’s 5.3 per cent nosedive. With Chinese stocks beating a daily retreat, investors are focused on the 2001 index high of 2,245-points. Some believe that level will hold up as a technical floor on the selling, others believe that it may shortly fail and unleash a much deeper collapse in stock values.
No Limit to Greenspan's Once-In-A-Century Events
Alan Greenspan has presided over more hundred-year events in the last 20 years than the rest of us do in a lifetime.
As chairman of the Federal Reserve from August 1987 through January 2006, the Maestro was ahead of the pack when he sniffed out a secular increase in productivity growth, the result of a "once-in-a-lifetime" technological boom. Of course, if he was right about productivity, he was wrong about the policy prescription.
"Prices should have fallen" as companies are able to produce more with less, said Paul Kasriel, chief economist at the Northern Trust Corp. in Chicago. "He fought it tooth and nail. The money had to go somewhere. It went into Nasdaq stocks."
The burst tech-stock bubble exposed a rash of corporate malfeasance and accounting scandals. An "infectious greed seemed to grip much of our business community," producing a "once-in- a-generation frenzy of speculation that is now over," Greenspan told Congress on July 16, 2002.
Even as he was declaring an end to that generational frenzy, another one was already unfolding. Millions of condo flippers were riding ultra-low interest rates to ultra-high profits, extracting equity from their homes in the process. Now many homeowners find themselves owing more than their house is worth.
Of course, Greenspan argued against the idea of a "bubble in home prices for the nation as a whole," conceding only "signs of froth in some local markets." At the time, home prices were rising at a 15 percent annual rate. Interspersed with the big bubbles in stocks and residential real estate were some singular events for which the cure was always lower interest rates.
Following the near-collapse of hedge fund Long-Term Capital Management in the fall of 1998, Greenspan cut the funds rate by 75 basis points to address the "seizing up of financial markets." Once again, he misjudged the seizure's effect on the economy, which didn't miss a beat. The Nasdaq was the beneficiary of the Fed's largesse, rising 86 percent the following year.
Greenspan's ability to identify asset bubbles -- by his own admission, impossible when he was at the Fed -- improved markedly in the last two years. Everywhere you turned he was identifying a housing bubble, handicapping recession odds, spouting the wisdom gleaned from half a century of following the U.S. economy.
"He's like the forensic pathologist brought in as an expert on how to fix things when in fact he played a large role in causing the problems," said Bill Fleckenstein, president of Fleckenstein Capital in Seattle, and author of "Greenspan's Bubbles." Last month, Greenspan showed up on CNBC with Maria Bartiromo and Paul McCulley, managing director at Pacific Investment Management Co. in Newport Beach, California.
Pimco happens to be one of Greenspan's three main consulting clients, a relationship that was never disclosed to the audience. It was positively quaint to see Greenspan and McCulley talking shop -- discussing the likelihood of U.S. recession, slowing global growth and concerns about solvency -- for the benefit of bond investors, er, the viewing audience. All that was missing was a phone number on the bottom of the screen: Call 1- 800-4PIMCO.
And yes, the solvency crisis is a "once-in-a-century phenomenon," according to Greenspan. Last week, Greenspan showed up on the front page of the Wall Street Journal -- just like old times -- with a forecast for a bottom in housing. "Home prices in the U.S. are likely to start to stabilize or touch bottom sometime in the first half of 2009," Greenspan told the Journal.
Lest he be too clear, the master of garblements qualified his forecast, saying "prices could continue to drift lower through 2009 and beyond." "It's a flexible bottom," said Tim Iacono, who devotes a blog to "The Mess That Greenspan Made."
What doesn't seem to have dawned on Greenspan or those who interview him is the thread that connects all these disparate events: Greenspan himself.
He presided over two bubbles, one bust and lots of little easy-money rescues. In a stroke of impeccable timing, Greenspan left the Fed in January 2006, a month that holds the once-in-a- century record for single-family housing starts.
Greenspan was widely criticized, inside and outside the Fed, for his tasteless appearance at a private Wall Street function for big investors one week after leaving the central bank.
A year later, I defended his right to earn a living after 18 years as a public servant. My point was that Greenspan can talk all he wants. You can choose not to listen. It's a woman's prerogative to change her mind. So here goes. There is something unseemly about Greenspan's conduct. Former presidents don't criticize U.S. foreign policy during times of war, Jimmy Carter notwithstanding. The same unspoken rule should apply to economic policy.
Unlike his predecessor, Paul Volcker, Greenspan cannot leave the global stage or the media spotlight. Ben Bernanke may be the new Fed quarterback, but Greenspan is still calling in plays (or commenting on them) from the sidelines. The juxtaposition of Greenspan's frequent TV and print appearances with the economic and financial fallout from his policies isn't helping his reputation.
There's enough blame to go around for what started as the subprime crisis, but surely Greenspan, the country's chief economic policy maker for 18 years, must shoulder the lion's share. So here's my advice, Mr. Greenspan. Give speeches for $150,000 a pop and share your wisdom with your key clients, who must pay you handsomely.
When the press calls, just say "no comment." This is an acquired skill, but I'm sure you'll catch on. As an economist, surely you appreciate scarcity value. "I'm reminded of the song by Dan Hicks & the Hot Licks," Kasriel said. "How Can I Miss You If You Won't Go Away?"
Ilargi: If you have faith in what the Street mob says, good luck with that. For the rest of us, it’s time to clean those pitchforks. The justice system does nothing; they can make preposterous claims every single day.
Financial advisers see S&P 500 rising
U.S. financial advisers are more optimistic about U.S. stocks than they were six months ago, with the majority expecting the benchmark S&P 500 index to rise by the end of the year as energy prices back off their record highs, according to a survey released Monday.
The Schwab Institutional survey of more than 1,000 independent registered investment advisers found that 58 per cent expect the S&P 500 to rise, compared with 46 per cent in January. Nineteen per cent think the index will rise more than 10 per cent in the next six months.
Among the reasons for that optimism: 57 per cent see energy prices falling in the year's second half, up from 42 per cent who said that in January. And the number of advisers who believe the housing market will weaken further has slipped to 71 per cent from 81 per cent in January.
Yet 77 per cent of the advisers call the current market environment tough, and nearly half said their clients have asked for more conservative investments this year. “No one thinks today's market conditions are easy,” said Bernie Clark, senior vice president of Schwab Institutional. But advisers “see a light at the end of the tunnel,” he said.
Obstacles include higher unemployment and rising inflation, according to 79 per cent of advisers surveyed. More than half of the advisers believe the Fed will raise rates again in the next six months – a big shift from the 6 per cent who held this view in January. Given the uncertain market environment, advisers said they were playing a more pro-active role and more than half have increased the frequency of client phone calls.
Eighty-five per cent of advisers said they won new clients during the past six months from full-service brokerage firms for two main reasons – some were looking for more personal advice while others had lost faith in their previous firm. Investors are changing their habits in other ways, too – one in four advisers said their clients have bought more fuel-efficient vehicles or delayed selling a home.
The semi-annual survey also highlighted shifts in investment strategies. In a bullish sign for stocks, the percentage of advisers who plan to invest more in cash fell to 22 per cent from 28 per cent six months ago. And just one in five plan to invest more in fixed-income assets over the next six months, down from a high of 27 per cent six months ago.
Advisers also consider U.S. small-cap stocks a more attractive option now than they did six months ago, the study found. Twenty-two per cent of advisers plan to invest more in small-caps over the next six months, a significant change from 9 per cent in January. The most popular investment vehicles through the end of the year are ETFs, REITs and mutual funds that use hedging strategies, the survey found.
Energy is expected to be the top-performing sector in the next six months, followed by technology and health care. Financials are also gradually regaining their footing, the study found. Hong Kong remains advisers' top pick for the top-performing developed international market over the next six months, with Canada second and Japan third. Among emerging markets, advisers expect the top three to be Brazil, China and India.
Lehman May Report $4 Billion Writedown, JPMorgan Says
Lehman Brothers Holdings Inc. may write down about $4 billion in credit-related investments and other assets when it reports fiscal third-quarter earnings, JPMorgan Chase & Co. analysts said. "The credit environment continues to be difficult," New York-based analysts led by Kenneth Worthington wrote in a report yesterday. "It will be another difficult quarter for Lehman."
Lehman may mark down some of its $61 billion of mortgage and other asset-backed securities after benchmark residential and commercial mortgage-related indexes declined by as much as 20 percent, the analysts wrote. The company may have already been selling some commercial mortgage assets, they added.
Lehman, the largest underwriter of mortgage bonds before the subprime market collapsed, has slumped 77 percent in New York trading as it struggles to pare its debt holdings. The bank has reported writedowns and credit losses of $8.2 billion in the past 12 months, according to data compiled by Bloomberg.
The analysts cut their per-share estimate for the third quarter to a loss of $3.30 from a 35-cent profit. They expect Lehman to report a loss of $6.77 a share for the full year, compared with their earlier forecast of a $2.35 loss. They maintained a "neutral" recommendation on the stock.
Lehman fell 63 cents, or 4.2 percent, to $14.40 at 10:02 a.m. in New York Stock Exchange composite trading. The stock is the worst performer this year in the 11-company Amex Securities Broker/Dealer Index.
"Lehman continues to have significant exposure to mortgages and asset backed securities," JPMorgan's Worthington said in the report. "We believe management wants to leave its mortgage troubles behind and restore confidence." Securities firms are cutting their holdings of riskier loans and selling assets to shore up capital.
Lehman wants to sell 20 percent of its more than $60 billion of "distressed" assets in the third quarter, Merrill Lynch & Co. analyst Guy Moszkowski, said in a July 28 note to clients. He expects the firm to post a $2.5 billion writedown on home loans in the quarter. The securities firm will probably retain its Neuberger Berman LLC asset-management unit, the JPMorgan analysts said. "We don't think the ratings agencies would welcome this divestiture," they added.
The bank is in talks to sell parts of its investment management unit to potential bidders including private equity firms Carlyle Group, Hellman & Friedman LLC and General Atlantic LLC, the Wall Street Journal reported today. Lehman has sent them detailed financial information about its hedge funds, private clients, private equity and Neuberger Berman units, the newspaper said, citing people familiar with the matter that it didn't identify.
The investment management unit is valued at $8 billion to $10 billion, the newspaper cited analysts as saying.
Lehman May Put a Prized Unit on the Block
Lehman Brothers, the troubled investment bank, is considering the sale of all or part of its prized money management division to private equity firms to raise billions of dollars of capital and ease the pressure caused by losses related to real estate.
The move would be the latest by a Wall Street firm forced to sell off high-end assets, following the recent sale by Merrill Lynch of its stake in Bloomberg L.P. and the sale by Citigroup last month of its large German consumer banking franchise.
Lehman sent letters last week to a number of financial companies, including private equity firms like Kohlberg, Kravis & Roberts, J. C. Flowers, the Blackstone Group, the Carlyle Group and Apollo Management, to test interest in its money management division, according to several people briefed on its contents.
The letter, a so-called memorandum of understanding, did not put a value on the division. It said that interested parties could bid for all or some of the pieces but encouraged bidders to make an offer for the whole business.
The investment management division includes Neuberger Berman, which Lehman Brothers acquired in 2003 for $2.6 billion, Lehman Brothers Asset Management and its private client brokers.
There has been widespread speculation that Lehman was contemplating a sale of Neuberger Berman, whose value is estimated by analysts to vary from less than $7 billion to as high as $13 billion (Lehman’s entire market capitalization is about $10.5 billion).
Lehman’s current talks with private equity are an attempt to put price tags on Neuberger and other pieces of its asset management unit, which should provide flexibility for Lehman executives when they sit down to review third-quarter earnings and calculate if they need to raise capital. A spokesman from Lehman declined to comment.
Lehman now faces the capital-raising problem that haunted Merrill Lynch last month. As the third quarter draws to a close, it is looking more likely that Lehman will have to write down the value of its mortgage and other investments to a degree that could wipe out all of the investment bank’s earnings.
In the last 12 months, the stock is down 74 percent, compared with a 33 percent decline in the Amex XBD broker dealer index. Earlier this summer, analysts expected Lehman Brothers to earn a small third-quarter profit, but now some expect a loss of $1.8 billion.
Through the mortgage boom, Lehman was a major player in the selling and packaging of residential and commercial mortgages. That has come back to haunt the firm, whose top management has extolled the virtues of conservative risk management.
In the second quarter, Lehman lost $2.8 billion, mostly caused by write-downs from residential real estate investments, and was forced to raise $6 billion. Investors who bought into that deal have been burned as Lehman’s stock has continued to fall.
Like Merrill, Lehman has run out of easy options to raise money. That forces Lehman to consider selling some of its more valuable assets. Aside from the potential sale of its investment management unit, Lehman is looking to offload assets, including a portfolio of up to $40 billion worth of troubled commercial real estate assets, according to investors involved in that sale.
Asset management — the business of managing money for wealthy individuals and institutions and creating instruments for them to invest in, such as mutual funds and hedge funds — provides among the steadiest form of earnings for banks, and analysts are split on whether it makes sense for Lehman to sell the unit.
Capital markets and investment banking businesses, on the other hand, have unpredictable profits in good markets and potentially deadly results in down markets. Some analysts favor spinning a stake in Neuberger Berman off to the public, a move that would allow the investment bank to continue to benefit from its earnings.
“The best would be to sell 20 percent to the public,” Richard X. Bove, an analyst at Ladenburg Thalman, said after he published a research note on Aug. 6. But selling all or part of Lehman’s investment management unit reverses years of trying to diversify its business.
After turbulent markets rocked Lehman Brothers in 1998, Richard S. Fuld Jr., the chief executive, focused on building asset management to provide investors a more stable stream of earnings.
In late 2002, Lehman bought the fixed-income division of Lincoln Capital Management. The following year, it bought Neuberger Berman, the asset management company, for $2.6 billion, along with Crossroads Group, a private equity fund manager based in Dallas.
In recent years, Lehman’s investment management division bought minority stakes in hedge funds, including D. E. Shaw and Ospraie, though those stakes are not thought to be for sale. As of May 31, Lehman’s investment management unit had $277 billion under management, making it a relatively small operation on Wall Street.
Lehman has 27 mutual funds in the asset management division, including 21 sold under the Neuberger brand name. Neuberger also manages private client money. In total, the mutual funds manage $22 billion, according to Morningstar, a tiny fraction of the total mutual fund industry.
“They’ve generally done pretty well,” said David Kathman, a mutual fund analyst for Morningstar. “The one thing that sets them apart is they tend to make pretty bold moves.” While that makes the funds attractive, one of the complications to any potential sale of Lehman’s investment management business is that ratings agencies could determine that the division or its parts are too important to Lehman’s business to sell.
At the same time, many bidders are not interested in buying the whole business because it does not fit with their own model. Currently, Lehman has brokers who sell products like investments in the D. E. Shaw hedge fund, or investments in Neuberger funds.
If a private equity firm were to buy Neuberger, but not these brokers, it would not have anyone to sell the products. On the other hand, Wall Street banks like Merrill Lynch are potentially interested in the brokers to add to their own huge sales force — but not in Neuberger Berman, said one person briefed on the negotiations.
For example, Blackstone is not interested in buying the whole asset management unit, said one person briefed on the firm’s plans. But the publicly traded private equity firm (not Blackstone’s private equity funds) is potentially interested in some of the pieces of Lehman’s asset management group, this person said.
UBS Has A Multibillion-Dollar Dream
UBS has a dream. After recently posting its fourth, consecutive quarterly loss, due mainly to write-downs on bad debt investments, it wants to be profitable again next year.
"We will be profitable again in 2009," UBS Chairman Peter Kurer said in a newspaper interview on Monday. Kurer told the Swiss weekly Neue Zuercher am Sonntag that the bank was focusing on returning to profitability, reducing risky investments, improving its balance sheet and dealing with several ongoing legal issues.
Are investors in agreement? "The market already expected UBS to make some profit next year," said Andreas Venditti, an analyst with Zurcher National Bank. "But the question is how profitable it will be. This is something that I don't think even Mr. Kurer knows."
Last Tuesday, the Zurich, Switzerland-based bank posted a fresh $5.0 billion loss, following more than $42.0 billion in mortgage-related write-downs. "Once UBS reduces the write-downs substantially, it will be profitable again," said Venditti, adding his estimate for UBS net profit next year was $7.3 billion.
A pool of seven analysts consulted by Forbes.com estimated net profit of $7.7 billion. "The estimate is a moving number; it was above $8.8 billion some weeks ago and it is still falling," Dirk Becking, an analyst with Sanford Bernstein, told Forbes.com.
Analysts told Forbes.com the key to returning to profitability is not to have any more write-downs. "Even if it looks like it will never end, it will," said Guido Hoymann, with Bankhaus Metzler.
Over the last year, European banks have seen a reduction in the value of their on-balance-sheet assets, as a result of their investments in securities backed by U.S. subprime mortgages. These losses and a recent American tax probe directed at UBS, have been particularly damaging for the Swiss bank's wealth management division in the U.S. and Switzerland.
Last Wednesday, Kurer admitted potential problems over "whistleblower complaints relating to working practices in the U.S. cross border business" in 2006.
'Liar loans' threaten to prolong mortgage crisis
In the mortgage industry, they are called "liar loans" -- mortgages approved without requiring proof of the borrower's income or assets. The worst of them earn the nickname "ninja loans," short for "no income, no job, and (no) assets."
The nation's struggling housing market, already awash in subprime foreclosures, is now getting hit with a second wave of losses as homeowners with liar loans default in record numbers. In some parts of the country, the loans are threatening to drag out the mortgage crisis for another two years.
"Those loans are going to perform very badly," said Thomas Lawler, a Virginia housing economist. "They're heavily concentrated in states where home prices are plummeting" such as California, Florida, Nevada and Arizona. Many homeowners with liar loans are stuck. They can't refinance because housing prices in those markets have nose-dived, and lenders are now demanding full documentation of income and assets.
Losses on liar loans could total $100 billion, according to Moody's Economy.com. That's on top of the $400 billion in expected losses from subprime loans. Fannie Mae and Freddie Mac, the nation's largest buyers and backers of mortgages, lost a combined $3.1 billion between April and June. Half of their credit losses came from sour liar loans, which are officially called Alternative-A loans (Alt-A for short) because they are seen as a step below A-credit, or prime, borrowers.
Many of the lenders that specialized in such loans are now defunct -- banks such as American Home Mortgage, Bear Stearns and IndyMac Bank. More lenders may follow. The mortgage bankers and brokers who survived were more cautious, but acknowledge they too were swept up in the housing hysteria to some extent.
"Everybody drank the Kool-Aid" said David Zugheri, co-founder of Texas-based lender First Houston Mortgage. They knew if they didn't give the borrower the loan they wanted, the borrower "could go down the street and get that loan somewhere else." The loans were also immensely profitable for the mortgage industry because they carried higher fees and higher interest rates.
A broker who signed up a borrower for a liar loan could reap as much as $15,000 in fees for a $300,000 loan. Traditional lending is far less lucrative, netting brokers around $2,000 to $4,000 in fees for a fixed-rate loan. During the housing boom, liar loans were especially popular among investors seeking to flip properties quickly. They were also commonly paired with "interest only" features that allowed borrowers to pay just the interest on the debt and none of the principal for the first several years.
Even riskier were "pick-a-payment" or option ARM loans -- adjustable-rate mortgages that gave borrowers the choice to defer some of their interest payments and add them to the principal. While some borrowers were aware of their risky features and used them to gamble on their home's value or pull out money for vacations, others like Salvatore Fucile insist they were victims of predatory lending.
Fucile, who is 82, and his wife, Clara, wound up in an option ARM from IndyMac after consolidating two mortgages on their suburban Philadelphia home. Fucile was attracted by the low monthly payments, but says the mortgage broker who signed him up for the loan didn't tell him the principal balance could increase. It has risen about $24,000 to $276,000.
"He put me in a bad position," said Fucile, who fears he will be forced into foreclosure. "He misled me." IndyMac was taken over by the Federal Deposit Insurance Corp. last month. FDIC spokesman David Barr declined to discuss the Fuciles' case, but said the agency has temporarily frozen all IndyMac foreclosures and is working on a broad plan to modify mortgages held by the Pasadena, Calif-based bank.
The low monthly payments of liar loans helped many home buyers afford to purchase in areas of the country where prices were skyrocketing. But they also helped drive up prices by allowing people to buy more than they could truly afford. Case in point: about 40 percent of loans made in California and Nevada in 2005 and 2006 were either interest-only or option ARMs, according to First American CoreLogic.
"It was pretty evident that the only thing that was supporting these loans was higher home prices" said Tom LaMalfa, managing director at Wholesale Access, a Columbia, Md.-based mortgage research firm. Now that prices have fallen, almost 13 percent of borrowers with liar loans were at least two months behind on their payments in May, nearly four times higher than a year earlier, according to First American CoreLogic.
Countrywide Financial Corp., now part of Bank of America Corp., was one of the top providers of liar loans. The company is now is paying the price. More than 12 percent of Countrywide's $25.4 billion in pick-a-payment loans are in default, and 83 percent had little or no documentation, according to a Securities and Exchange Commission filing last week.
Critics say Fannie Mae and Freddie Mac, which bought or guaranteed liar loans from lenders including Countrywide and IndyMac, should have stuck with traditional 30-year, fixed-rate mortgages. "I personally think that they ventured beyond their mission," said Richard Smith, a mortgage broker in Chattanooga, Tenn. Because of their decision to back shakier loans, he said, "the home-buying public is going to have to pay."
Fannie and Freddie entered the market for risky loans just as they emerged from accounting scandals. At the time, Wall Street giants such as Bear Stearns and Lehman Brothers Holdings Inc. were backing a growing share of ever-riskier loans, and both government-sponsored companies felt pressure to compete.
Freddie Mac wanted "to stay competitive in the market and take steps to preserve market share," spokesman Michael Cosgrove said. Fannie Mae increased its purchases of liar mortgages "at the requests of many of our customers," according to spokesman Brian Faith.
Both companies also were able to use subprime and liar-loan investments to meet government-set affordable housing goals. Now Fannie, Freddie and other mortgage investors are reviewing defaulted loans to see if lenders committed fraud. If they find enough evidence, they could force lenders to assume responsibility for losses.
But it's unclear how much money they might recover, especially from lenders that have gone under or been seized by the government.
Housing Starts in U.S. Probably Dropped to 17-Year Low in July
U.S. builders probably broke ground in July on the fewest houses in 17 years, signaling the residential-construction slump will continue to hurt growth, economists said before a government report today.
Housing starts plunged 9.9 percent to an annual rate of 960,000 after a 1.066 million pace the prior month, according to the median forecast of 77 economists in a Bloomberg News survey. A separate report may show wholesale prices probably rose at a slower pace in July as fuel expenses peaked.
Stricter lending rules, rising borrowing costs, falling property values and record foreclosures will further depress home sales and cause builders to keep retrenching. Inflation pressures are likely to ease as the downturn in housing, loss of jobs and credit crisis weaken the economy this year and into 2009.
"The supply of housing continues to be cut in response to the still relatively high inventories of unsold homes," said Brian Bethune, an economist at Global Insight Inc. in Lexington, Massachusetts. "This will continue to generate a large negative drag on overall growth in the second half of 2008."
The Commerce Department will release starts figures at 8:30 a.m. in Washington. Estimates in the Bloomberg survey ranged from 875,000 to 1.09 million. Also at 8:30 a.m., the Labor Department may report the producer price index climbed 0.6 percent in July after jumping 1.8 percent in June, according to the survey median. Prices excluding food and fuel probably rose 0.2 percent for a third month.
Commerce's housing figures may also show building permits, a sign of future construction, fell 15 percent to a 970,000 annual pace, economists forecast. A change in New York City's building code that took effect July 1 caused housing starts and permits to unexpectedly surge in June as builders hurried to break ground ahead of the new regulations. The magnitude of the July drop may reflect, in part, a payback.
Underneath the gyrations, demand is weakening. Sales of existing homes fell to a 10-year low in the second quarter, according to the National Association of Realtors. A third of all sales were foreclosures or "short sales," in which lenders take a loss on a property.
Financing has also become scarce, a quarterly survey of banks by the Federal Reserve showed. Three-fourths of the loan officers polled reported they tightened standards on prime mortgage loans, up from the April survey. Lending rules on non- traditional loans were also toughened.
The five largest U.S. homebuilders reported a combined $1.08 billion in losses in their most recent quarters. Builders are pessimistic as losses mount. The National Association of Home Builders/Wells Fargo's sentiment index yesterday showed optimism held at a record low in August for a second month.
Still, construction companies are making some headway in reducing the supply glut. The number of new homes for sale dropped in June by the most in four decades. Some housing-related firms are faring better. Lowe's Cos., the world's second-largest home-improvement retailer, yesterday said full-year profit may fall less than it had anticipated.
"The macro economic factors pressuring consumers and the ongoing challenges and uncertainty of the financial markets suggest a cautious sales forecast for the balance of fiscal 2008 is prudent," Chief Executive Officer Robert Niblock said in a statement.
Bank of Japan Says Economy Is 'Sluggish,' Keeps Rate at 0.5%
The Bank of Japan said it became more pessimistic about the outlook for the economy and kept interest rates at the lowest level among industrial nations.
"Economic growth has been sluggish against the backdrop of high energy and materials prices and weaker growth in exports," Governor Masaaki Shirakawa and his six colleagues said in a statement today after leaving the key rate at 0.5 percent.
The world's second-largest economy shrank at an annual 2.4 percent pace in the second quarter, as decade-high inflation deterred spending and a global slowdown dented exports. In April, the central bank shelved a policy of raising rates, and with Japan on the verge of a recession, economists say borrowing costs are unlikely to increase until next year at the earliest.
"Now the focus is on how long the downturn will last," said Hiroaki Muto, a senior economist at Sumitomo Mitsui Asset Management Co. in Tokyo. "The economy isn't likely to recover until 2010, and rates won't rise before then." The yen traded at 110.04 per dollar at 5:12 p.m. in Tokyo from 109.80 before the announcement.
The yield on Japan's 10-year bond fell half a basis point to 1.435 percent. The rate decision was unanimous, and expected by all 32 economists surveyed. World financial-market instability, the U.S. and global slowdown, and rising commodity prices all pose risks for Japan, the central bank said in the statement. The bank's downgrade of the economic assessment was the second in a row, after it said in July that the expansion was "slowing further."
"We think that the chances of a major deterioration are small," Shirakawa said at a press conference. Still, he added, "the timing of a recovery may be slightly delayed." Costlier materials and slumping overseas sales are crimping profits at companies from Toyota Motor Corp. to Canon Inc. Exports dropped the most since the 2001-2002 recession, last week's gross domestic product report showed, robbing Japan of the engine that drove its longest postwar expansion.
"While growth will likely remain sluggish for the time being, it is expected to return gradually onto a moderate growth path" as commodity prices ease and the global economy recovers, the bank said. Analysts don't anticipate the bank will reduce borrowing costs because Shirakawa is wary that keeping them low could stimulate the economy too much once it recovers.
"If the downside risks to the economy turn out to decrease, there will be an increased risk that prolonging the period of accommodative financial conditions will lead to swings in economic activity and prices," the bank said.
Of 26 economists who gave predictions through June, 21 said there will be no move by then. Four estimated higher rates and one forecast a cut. The bank's economic view hasn't changed dramatically from last month and the board will continue to examine both upside and downside risks when determining policy, Shirakawa said.
"The Bank of Japan will resume seeking normalization of interest rates once the economy shows signs of a recovery," said Teizo Taya, a former central bank policy maker and now adviser to the Daiwa Research Institute in Tokyo. "Still, it's hard to anticipate a hike this year or even early next year."
U.K. House Prices Decline Most Since at Least 2002
U.K. house prices posted the biggest annual decline since at least 2002 as banks choked off mortgage lending, deepening London's property slump, Rightmove Plc said.
The average asking price for a home fell 4.8 percent in August from a year earlier to 229,816 pounds ($426,929), the biggest yearly drop since Rightmove began measuring home values six years ago. Britain's most-used property Web site also said today that prices dropped 2.3 percent on the month, the most since December, led by London.
"The lack of mortgage finance is central to the problem," Miles Shipside, commercial director of Rightmove, said in the statement. "London, in particular, appears to be having its own special summer sale, with over 21,000 pounds off in a month."
Bank of England Governor Mervyn King said last week that the housing market faces "a significant adjustment" as banks ration loans for homebuyers. Falling prices may exacerbate the economic slowdown as the threat of a recession looms and unemployment rises the most in 16 years. The pound traded at $1.8671 against the dollar at 10:05 a.m. in London, from 1.8623 yesterday, the currency's first gain in 12 days. Against the euro, it was at 78.90 pence.
Prices in London fell 5.3 percent on the month and 3.8 percent from a year earlier. Each of the 32 districts in the capital showed a decline, and the biggest drop was in the southwest area of Wandsworth, where values fell 7.9 percent. Hackney, in east London, was the best performer, with a 0.6 percent decline.
The stock of unsold property per real estate agent rose for a seventh month to 78, from 77 in July. The number of transactions may reach the lowest since 1959, Rightmove said. Banks have starved the market of loans after more than $500 billion in losses and writedowns worldwide from the U.S. mortgage market collapse.
U.K. mortgage approvals fell to the lowest since at least 1999 in June, the Bank of England said July 29. The Royal Institution of Chartered Surveyors said last week that the housing market is at a "virtual standstill." King said on Aug. 13 that "there is a feeling of chill in the economic air" and that "the British economy is going through a difficult and painful adjustment" that "cannot be avoided."
Weakness in the housing market may "amplify" the impact of the lending squeeze on household spending, the central bank said last week. Retail sales probably fell for a second month in July, dropping 0.2 percent, according to the median forecast of 32 economists in a Bloomberg News survey. The government's statistics office will release that data on Aug. 21.
Britain's gross domestic product will either stagnate or contract in the next two or three quarters, meaning the economy may fall into a recession, the British Chambers of Commerce said in forecasts released today. Confidence on business prospects fell to the lowest level in at least 6 years, according to a survey of more than 200 companies released by Lloyds TSB Group Plc today.
The index of sentiment on the next 12 months fell to 22 in July, the lowest since the survey began in 2002, from 32 in June. The economy probably grew 0.1 percent in the second quarter, less than previously estimated and matching the slowest pace since the aftermath of the last recession in 1992, the median forecast of 34 economists surveyed by Bloomberg News shows. The statistics office will publish the figures on Aug. 22.
The central bank kept its benchmark interest rate at 5 percent on Aug. 7 for a fourth month, as policy makers weighed the risk of accelerating inflation against the threat of a recession. Minutes of their meeting, showing how the panel voted, will be released on Aug. 20.
The ongoing fall in house prices "is set to become increasingly painful for consumers over the next year," Lena Komileva, an economist at Tullett Prebon in London, said in an e- mailed note to clients today.
Germany acts to halt the 'giant locusts'
Germany's cabinet is expected to approve a far-reaching new law this week to stop "giant locust funds" from Russia, China and the Middle East from launching takeover raids on the country's prized industries.
The controversial measure will enable Germany to stop foreign investors from outside the European Union buying more than 25pc of any company when "public order and security" are at stake. The wording creates an elastic definition that goes far beyond the current law, which is restricted to the defence industry.
The proposals have set off a storm of controversy and raised fears that the country is drifting towards protectionism. The German Chamber of Trade and Industry (DIHK) has been highly critical of the draft law, warning that it risks provoking retaliation and is starkly at odds with the country's interests as the world's top exporting nation.
"This will damage Germany's economic standing. The controls should be restricted to questions of national security. In the face of such regulations, any financier is going to think twice about whether he should be investing here at all," said the group's chief, Axel Nitschke.
Michael Glos, the economy minister, said foreign investors had nothing to fear from the law, which is to be discussed by Chancellor Angela Merkel's Left-Right cabinet tomorrow. "The new rules are very modest and only allow government interference in foreign investment projects in very few cases," he said.
Chancellor Merkel has been wary of moves by Russia's state-controlled banks and companies trying to buy shares in strategic industries. She issued a blunt warning to premier Vladimir Putin (then president) that Berlin would not tolerate moves by VTB Bank to acquire a large stake in the Airbus mother-company EADS. She also stopped Russia's Mishkonzerns Sistema from taking a slice of Deutsche Telekom in 2006. Her suspicions have been validated by the hard-nosed behaviour of the Kremlin, which has repeatedly used its economic tentacles to pursue its Great Power strategic ambitions.
Russian billionaire Alexander Lebedev said Berlin was well advised to shut the door on secretive wealth funds and state banks, warning that they cannot be trusted if they come from corrupt regimes that refuse to play by established rules. "In Germany's place I wouldn't sell anything to a Russian or a Chinese state fund," he told Welt am Sonntag.
It is unclear whether any solo effort by Germany to stop investors would work under EU single-market laws.
Funds could easily use a stalking horse based in London or Dublin, perhaps working through a private equity group. Ownership would inevitably be blurred. Such a situation would create strong pressure for an EU-wide law restricting foreign investors. Britain would not necessarily have the votes to block such a measure.
Stephen Jen, currency chief at Morgan Stanley, said Britain's open-door policy means that the City would be the chief beneficiary of the German plan. "The funds can use operations listed in London," he said. Sovereign wealth funds already control $3 trillion in assets worldwide, led by Abu Dhabi's ADIA fund, now worth almost $1 trillion.
Mr Jen said the figure was likely to reach a staggering $12 trillion over the next seven years, making it the great transforming force of the global financial system. However, analysts doubt whether Russia's wealth fund will be a major issue in the long run, since Moscow needs the money for a $1 trillion rebuilding blitz on its own archaic infrastructure of roads and railways.
The Russian fund is already operating like a central bank rather than a strategic investor. The wealth is being held in liquid assets such as government bonds because the managers suspect that Moscow might recall funds at any time.
Ilargi: I think it’s getting to be time for all Canadians to read Garth Turner’s Greater Fool religiously.
The politics of collapse
Imagine you bought a house two years ago for $330,000, need to sell, and yet the real estate agent tells you to list at $275,000 if you hope to find a buyer. Finally, one comes along, but offers just $170,000. You agonize over accepting it, then learn the potential buyer’s bank balked at financing the deal, saying the price was too high.
This is a true story, from Riverside, California. Here’s another, from Cape Coral, Florida, where a guy who paid $147,000 for a home in 2003, then renovated it, received an appraisal of $279,000 two years ago. Recently, as he came to sell, he received another appraisal, for $140,000. It’s listed now for $129,900, and he can’t unload it.
This is one reason the Canadian prime minister is desperate to have an election. He’s got smart people around him. They know what’s coming.
In the last 12 months, for the first time ever, 25% of all the people in the US who sold their houses got less than they paid for them. Not less than they were worth during the bubble - not a loss of inflated paper, greedy profits – but an actual sucking off of their net worth. In some communities, more than 60% of all sellers are taking an absolute loss.
In fact in one town, a suburb of San Francisco, of those people who bought a home two years ago, the average unsupported mortgage debt is $171,00 – that’s $171,000 more than their houses are worth. Can’t happen here, you say?
Well, I’ve heard that before. When I published my cautionary book on the subject five months ago I was told it was impossible for housing sales in Canada to crash in 2008. They have. And when that happened, the experts and economists said, okay, but prices will hold. But they haven’t.
This week’s numbers show that for the first time in a decade, home prices are going down – first in Calgary and Edmonton, then in Vancouver and by this time next month, in Toronto. Coming later this year will be Winnipeg, Saskatoon and Regina.
In fact, prices on average in every community will be falling between 5% and 20%, according to several bank economists. The trouble is, those same guys said six months ago price declines were not in the cards. Period.
This leads me and a couple of others brave enough to say it (like David Wolf, of Merrill Lynch Canada), that home values will be lower next year by between 15% and 50%, depending on the community. Thousands of buyers who got into real estate since about 2005 will be under water.
Those young couples who took forty-year mortgages and made zero downpayments will be financially screwed, unable to sell their houses without a loss of tens of thousands of dollars and at the mercy of a rapidly slowing economy, higher energy costs and dwindling job prospects.
This is the nightmare government scenario. Just look south to see the damage this can do to a country, and an administration. A real estate meltdown and industrial desertification of Ontario (especially) and Quebec, where all the votes are.
Citizens pissed that Ottawa told them last year the economy was “solid as the Canadian Shield,” refusing to lower their income taxes, spending all the budget surplus, doing nothing effective to help the auto sector, and encouraging consumer debt with a 2% GST cut and those damned 40-year mortgages which walked so many young kids into so much debt on houses which are now fast deflating.
You may think I am an alarmist to say once again: Look south and see the future. But I’m not the only one who knows that a version of this will be unfolding in Canada next year. The Canadian middle class largely believes the myth its leaders have woven. But the odds grow daily the next election could be the first one hijacked by a house.
Ilargi: Maybe it’s time to start sueing people for making misleading crap statements such as these: "The mortgage market will likely come “back to reality” soon, with growth expected to be just 5 or 6 per cent in the coming year....". The numbers are very clear: Canada is fast becoming a nation built on debt, but banks have parallel universes available. Please don’t listen to these debt sharks.
Slow economy takes toll on Canadian household finances
The slowing economy is taking its toll on household finances, driving up debt at a faster pace than incomes and assets, new analysis from CIBC World Markets shows. “This is a fact because the economy is underperforming,” CIBC economist Benjamin Tal said in an interview about his analysis of household credit.
In the first quarter of 2008, household debt in Canada rose almost 3 per cent but personal disposable income rose just 2 per cent, pushing the debt-to-income ratio up to 130 per cent from 122 per cent a year earlier. At the same time, the level of assets hardly changed during the first quarter of 2008, since the stock market was correcting and house prices were levelling off.
So the debt-to-asset ratio rose to almost 18 per cent, a full percentage point higher than in early 2007 and the highest level since early 2003, the report shows. Canadians' net worth as a share of disposable income is on the decline, reversing the solid rising trend noted between 2002 and 2007. It's now back at the level seen in mid-2006.
“Canadians are seeing their net wealth position shrinking,” Mr. Tal writes. Rising net worth has been an important driver of consumer activity in the past few years, Mr. Tal said, and so its decline will likely take a big bite out of consumption in the coming months.
“This wealth position has been a mental driver of consumer strength over the past couple of years,” Mr. Tal said.
Consumers spent without fear as they saw their stock portfolios and housing prices rise healthily, he said, but that is changing quickly. “The wealth effect should not be underestimated.”
The overall household credit market has grown “impressively” over the past year, but in recent months has shown signs of backing off, Mr. Tal said. But since credit growth in this cycle has not been as strong as in previous cycles (after adjusting for inflation), the pace of softening probably won't be dramatic, he added.
“This is normal cyclical behaviour,” Mr. Tal said, and not the American-style bursting of a bubble. The mortgage market is still on fire, expanding 13.4 per cent from a year ago, but that's not sustainable, Mr. Tal said. Housing prices are falling in western Canada and levelling off elsewhere. Plus, Ottawa has clamped down on 40-year mortgages. So the mortgage market will likely slow “notably” in the coming year, CIBC predicts.
That's a healthy development, Mr. Tal added. Right now, the economy has stagnated, but the mortgage market is behaving as if the economy were booming. That kind of divergence, were it to persist, is a recipe for the formation of a bubble. “Mortgages rising at 13 per cent a year are is totally inconsistent with what we're seeing in the economy,” he said.
“When the economy is slowing and credit is accelerating, something is wrong here. Something is not good.” The mortgage market will likely come “back to reality” soon, with growth expected to be just 5 or 6 per cent in the coming year, Mr. Tal added.
Ilargi: No matter what the media and the banks are trying to make you believe, Canada is sinking fast. The CIBC can call a 13.4% rise in mortgages, and a 10% increase in consumer credit "impressive", but in the real world it only means that Canadians are rapidly dropping deeper into debt.
Home-mortgage surge about to abate: CIBC
CIBC World Market says "we are at the early stages of a softening trend" in the rate of growth in overall household credit in Canada – although the investment firm notes there has been double-digit growth in both mortgage and non-mortgage credit.
The Canadian mortgage market is still up by an "impressive" 13.4 per cent compared with last year but adds "this pace of growth is unsustainable," it says.
"There are also early signs that the pace of growth in non-mortgage consumer credit is slowing. Overall consumer credit is now expanding by just over 10 per cent on a year-over-year basis. Look for this figure to trend lower in the coming six months."
The report adds that the cumulative number of consumer bankruptcies rose by 3.8 per cent during the year ending June 2008, with Ontario and Quebec leading the pack, and says a further increase is likely.
Court strikes down ABCP challenge
The committee that's trying to fix Canada's frozen $32-billion commercial paper market will now push forward with its plan at full throttle, while pressuring financial institutions to strike side deals with some corporate investors so they don't take their fight against the plan to the Supreme Court.
Yesterday, a three-judge panel of the Ontario Court of Appeal unanimously ruled that the plan to restructure the market is fair and legal. The court rejected an appeal by a group of about a dozen ABCP holders of more than $1-billion of paper, who were angry about legal releases that will be granted under the plan to most of the market's major players - from banks to credit rating agency DBRS.
The releases protect the players from almost all lawsuits related to ABCP, with the exception of some very specific potential fraud allegations, prompting some investors to argue that they are unfairly being forced to give up their right to sue for things such as negligence and misrepresentation.
Following the court's decision, the committee that crafted the restructuring plan, headed by Toronto lawyer Purdy Crawford, said the plan "can now move forward to completion." "Absent any further appeals, we expect the restructuring to close by Sept. 30, 2008," Mr. Crawford stated. Some lawyers said their clients will now consider whether to take their cases to the Supreme Court.
Allan Sternberg, one of the lawyers who appealed to the Ontario court, said his client, Montreal businessman Hy Bloom, whose two holding companies own ABCP, has not yet decided whether to appeal to the Supreme Court. "There are cost consequences," he said, noting that an appeal would likely cost his client more than $50,000.
Howard Shapray, a lawyer for Ivanhoe Mines Ltd., said yesterday he hadn't yet spoken to his client about an appeal.
But "it is a fair expectation that somebody is going to apply for leave to appeal," he said. "It's an issue of national importance, which is the primary ground the Supreme Court of Canada looks to, and they also look to the issue of whether there's a conflict at the appellate level, which we clearly have in this case," he said, suggesting that the Ontario Court of Appeal ruling conflicts with an earlier decision in another case from the Quebec Court of Appeal.
In an interview, Mr. Crawford said that "all we're doing is getting ready as soon as we reasonably can to close this transaction. We don't know whether there will be an appeal or not. If there is an appeal, we will deal with it." Mr. Crawford declined to comment on whether the committee could complete the restructuring if there were an outstanding application to appeal.
"We don't want to play games with anybody," he said. "On the other hand, we have a lot of clients that need their money, so we'll do the best we can to move this forward as fast as possible." When individual retail investors threatened to block the plan earlier in the restructuring, brokerages and banks that sold them the paper agreed to deals that would see most of them receive 100 per cent of their money back.
Mr. Crawford said the committee can continue to encourage "people who sold the paper to the potential appellants to do whatever they can to arrive at a reasonable settlement with them." "The reality is that some of them [the upset investors] are damn lucky they didn't win the appeal here, because they begin to realize they'd be a hell of a lot better off with the restructured paper," he said.
Mr. Crawford noted that the majority of the corporate investors voted for the restructuring. Benjamin Zarnett, a lawyer for the committee, noted that investors would have to get leave to appeal from the Supreme Court before an appeal could go ahead, and that is granted "in a very, very small minority of cases in which it's asked for. In this case you have two decisions of the Ontario court approving the plan, and a very strong decision from the Court of Appeal today."
Toronto Mortgage Fraud Scheme Manipulated 'Puppet' Purchasers
Norman Ave. is a two-block long street near St. Clair Ave. W., and Lansdowne Ave. Number 16A is a small row house that recently became the subject of an apparent mortgage fraud case in Ontario Superior Court.
A title search of the property shows that it was sold to Winchester Financial Corporation in November 2004, for $153,500. Just four months later it was "flipped" to Danny Meneses at the inflated price of $299,000, almost double the original cost. National Bank provided Meneses with high ratio financing of $293,230. The mortgage was guaranteed by Oldemiro Demeneses.
Default occurred under the mortgage, and in July 2007, National Bank sold the property under the power of sale in its mortgage for $212,000. After deducting expenses, real estate commission, property management fees, legal fees and realty taxes, the net proceeds of the sale were just under $192,000. The bank was left with a shortfall of $98,642.67, and sued the borrower and guarantor to recover its loss.
After receiving statements of defence from the defendants, the bank applied to the court for what is known as a summary judgment – in effect, a final decision in the bank's favour based on its assertion that there was no genuine issue for trial.
At the hearing before Master Andrew Graham in Superior Court in March, the defendants Meneses and Demeneses claimed that they were innocent victims of a fraud, and that the bank had a duty to exercise "due diligence" to prevent the fraud. (A master is a court official who makes judge-like decisions on procedural matters.)
The defendants claimed that they had been approached by a family friend who was interested in buying a property to renovate, lease and then resell, and that in return for signing the paperwork, Meneses would be paid $5,000. Meneses was told that mortgage payments would be made by a third party, and that he would have no personal liability.
Meneses admitted receiving payment of $5,000 for signing "the paperwork," but claimed that if the bank had taken more care and appraised or inspected the property, it would not have made the loan. In effect, he argued that the bank was the author of its own misfortune.
Meneses and Demeneses also argued that they were innocent victims of a fraud involving a property flip at an inflated price, and that their lawyer never explained to them the consequences of the documents they were signing. It turns out that the facts in the case of National Bank v. Meneses are not unique.
Twice in 2007 alone, the Ontario Superior Court heard cases involving the use of "puppet" purchasers in circumstances similar to the Norman Ave. case. Both cases were sent on for a full trial based on allegations of fraud against the lawyer involved in one case, and the lawyer's misrepresentations in the other case.
Analyzing these two cases, Master Graham noted that there was no allegation that the lawyer in the Meneses case made any fraudulent representations which could cancel the bank's right to recovery on the loan. The borrower and guarantor were not induced to sign anything by misrepresentations of the lawyer – even though the allegations against him, if proven, might amount to negligence.
The court concluded that the alleged negligence of the lawyer did not raise a genuine issue for trial, and it awarded judgment against the borrower and guarantor for $98,642.67. Offering puppet purchasers a tempting sum of money to sign "some papers" is the latest development in the techniques of fraudsters in mortgage scams.
If anyone offers you or anyone you know to sign "some mortgage papers," consult an independent lawyer or call the police. If it sounds too good to be true, it probably is.
Asian Stocks Decline to Two-Year Low on Credit-Loss Concern
Asian stocks fell, driving the region's benchmark index to a two-year low, on renewed concern credit-market turmoil will hurt profits at financial companies and curtail economic growth.
Banks dropped, led by a 2.7 percent decline in Commonwealth Bank of Australia, on speculation the U.S. government will bail out Freddie Mac and Fannie Mae. T&D Holdings Inc., Japan's largest publicly traded life insurer, led the Nikkei 225 Stock Average to its biggest drop in six weeks. Virgin Blue Holdings Ltd. plunged by a record 28 percent in Sydney after earnings tumbled on fuel costs.
"Investors are so scared," said Masaru Hamasaki, a senior strategist in Tokyo at Toyota Asset Management Co., which manages $3.3 billion. "What lies underneath today's decline is investors' concerns about the prospects for the global economy. Anything related to financial companies is taken negatively."
The MSCI Asia Pacific Index lost 1.9 percent to 122.74 as of 7:37 p.m. in Tokyo, set for the lowest close since July 26, 2006. Financial companies were the biggest drag, accounting for 31 percent of the benchmark index's retreat.
The measure has slumped 22 percent in 2008 as soaring inflation hurt global economies and the world's largest financial companies posted writedowns and credit losses of more than $500 billion.
The Bank of Japan today said it became more pessimistic about the outlook for the economy and kept interest rates at the lowest level among industrial nations. Japan's Nikkei 225 Stock Average slipped 2.3 percent to 12,865.05, its largest drop since July 8.
Benchmarks retreated in most other Asian markets. China's CSI 300 Index climbed 1.5 percent, its biggest gain since July 24. Hong Kong's Hang Seng Index dropped 2.1 percent after Standard & Poor's Equity Research cut its end-2008 estimates for the gauge by 3.3 percent.
Don Quijote Inc., a Japanese discount-store operator, tumbled after forecasting earnings that missed analyst estimates. OneSteel Ltd. jumped in Sydney trading after the company posted higher profit. The U.S. S&P 500 Index yesterday had its largest drop in more than a week. Barron's reported that the U.S. government expects Freddie Mac and Fannie Mae, the country's biggest home- loan financiers, will fail to raise enough equity to offset credit losses. S&P 500 futures fell 0.3 percent today.
A bailout "adds to the speculation that no one really knows the extent of assets that were infected by the subprime contagion," said Olan Caperina, who helps manage about $6.7 billion at BPI Asset Management Inc. in Manila. A measure of financial companies on MSCI's Asian index lost 2.3 percent today, taking its 2008 slump to 27 percent, the largest decline among 10 industry groups.
Commonwealth Bank, Australia's biggest mortgage lender, lost A$1.14 to A$41, the lowest since Aug. 4. T&D slumped 3.4 percent to 5,480 yen. Sumitomo Mitsui Financial Group Inc., Japan's second-largest publicly traded bank, fell 2.7 percent to 682,000 yen.
National Australia Bank Ltd., the country's largest bank by assets, dropped 3 percent to A$24.10, its lowest close since Sept. 19, 2000. The stock was cut to "underperform" from "neutral" by analysts at Credit Suisse Group, who lowered their 2009 and 2010 earnings estimates to factor in the prospect of additional provisions.
Mitsubishi UFJ Financial Group Inc., Japan's No. 1 bank, lost 1.9 percent to 829 yen after raising its bid for UnionBanCal Corp., a Californian lender that managed to dodge the subprime lending crisis, by 17 percent. The shares also declined as the Japanese Bankers Association said the nation's banks halted transactions with 12 percent more companies in July than a year earlier as the firms issued checks that bounced.
Amid Olympics, China's stock market becomes a blood sport
It's not receiving much attention amid all the glare of China's Olympic gold medals, but the real story in China right now - to the extent that it affects the lives of ordinary citizens - is the country's crumbling stock market.
The losses have been nothing short of staggering. From its peak last October, China's main stock index has plunged 62 per cent, including a 5.2-per-cent skid yesterday. If you believe the stock market is a sign of what lies ahead for the economy, this can't be good news. As Zhang Qi, analyst at Haiton Securities, told Reuters: "There is no confidence at all, and no money entering the market to clean up this mess, so no one can call a floor now."
You'd be a fool to even try. Underlining the overwhelmingly bearish sentiment that's swept the formerly high-flying market, the number of declining stocks in Shanghai yesterday swamped advancers by a margin of 904 to 31, with more than 200 stocks tumbling by their 10-per-cent daily limit.
What a switch from last fall, when cab drivers, cleaning ladies and college students were opening millions of brokerage accounts each month. Not even warnings from the likes of former Fed chairman Alan Greenspan and Asian billionaire Li Ka-shing could prick the bubble. So what did?
The main culprit is a growing fear that China's sizzling economy will cool after the Olympic circus leaves town. In a research note, Lehman Brothers predicted growth in China's real domestic product will slow to 8 per cent next year from 9.5 per cent this year and 11.9 per cent in 2007.
Inflation is another concern. In July, producer prices jumped 10 per cent year over year, the sharpest increase since the mid-1990s. Through the first seven months of 2008, consumer price inflation averaged 7.5 per cent - well above the government's target of 4.8 per cent.
Rising prices are hitting Chinese especially hard in the stomach, as food costs soar. For now, the excitement of the Olympics is keeping these issues under the surface. But when the last medals have been handed out and the TV crews have gone home, the Chinese government might have to perform some gymnastics of its own to guide the economy through a period when inflation is rising, growth is slowing and the stock market is flat on its back.
Are U.S. financial stocks bottoming yet? It sure doesn't look like it, given how Wall Street is still chopping earnings estimates for the sector. Since the start of the third quarter, analysts have slashed their estimates for S&P 500 financials by 43 per cent, according to Thomson Reuters. That's bigger than the reductions at the same point in the second quarter (13 per cent), first quarter (13 per cent) and fourth quarter of last year (24 per cent).
Merrill Lynch & Co., which announced a pretax writedown of $5.7-billion (U.S.) in late July, accounts for about 40 per cent of the total estimate reduction in the third quarter. But even if you strip out Merrill, analysts still cut their estimates by 26 per cent. That hardly sounds like a bottom to us.
China May Spend $58 Billion to Aid Growth, Gong Says
China's government is considering spending as much as 400 billion yuan ($58 billion) to stimulate the economy and may ease monetary policy this year, said Frank Gong, head of China research at JPMorgan Chase & Co. Measures would include tax cuts, stabilizing capital markets and supporting the housing market, Hong Kong-based Gong said in a research note today.
Since July, Chinese policy makers have put extra emphasis on sustaining growth rather than cooling inflation in the world's fourth-biggest economy as the outlook for exports dims. Economic growth has cooled for four quarters and industrial output grew last month at the slowest pace since February 2007.
"The top leadership is carefully considering an economic stimulus package," Gong said. He didn't cite a source and wouldn't comment when telephoned. Gong correctly predicted in 2005 that China would scrap the yuan's peg to the dollar. The measures would cost 200 billion yuan to 400 billion yuan, or 1 percent to 1.5 percent of gross domestic product, the economist said.
"This is in addition to the cost of rebuilding Sichuan earthquake zone, with the budget of 500 billion yuan to 600 billion yuan," he said. The central bank will ease monetary policy "later in the year" as inflation eases and growth in China's foreign-exchange reserves begins to slow, Gong said. It will cut the portion of deposits banks are required to hold as reserves from a record 17.5 percent, he said.
China's currency reserves, the world's largest, rose 36 percent to $1.81 trillion at the end of June from a year earlier. Inflation cooled to 6.3 percent in July from a 12-year high of 8.7 percent in February. China will raise electricity prices and "reform" gasoline and diesel prices after the Olympic Games, Gong said without elaborating. The prices are controlled by the state.
Government statements last month dropped references to a "tight" monetary policy. The central bank has kept interest rates unchanged this year after six increases in 2007, trying to avoid attracting more money from abroad to an economy already flooded with cash.
In July, it eased lending quotas for national banks by 5 percent and regional lenders by 10 percent, according to reports by Goldman Sachs Group Inc., BNP Paribas SA, China Merchants Bank Co., and Industrial Bank Co. China's economy grew 10.1 percent in the second quarter, still the fastest pace of the world's 20 biggest economies. Gross domestic product expanded 11.9 percent last year.
Export and investment growth accelerated last month and retail sales increased by the most since at least 1999. While consumer price-gains eased, producer prices rose at the fastest pace since 1996. Weaker production growth may foreshadow softening demand for Chinese goods as the U.S., Japanese and European economies falter.
The central bank said Aug. 15 that it would "fine-tune" monetary policy as cooling overseas demand for the nation's goods poses risks to the economy.
Ilargi: Good to see people read me, but curious to see my words copied.
The mantra many others and I have been repeating is that home prices will fall until they are in line with income.
But I realized that is, perhaps, a gross miscalculation which I must address. I have new hypothesis: Prices will fall below the level of median income support; they will overshoot to the downside and bottom at "market clearing" prices. (emphasis added: CHS) The reasons are high inventory, high unemployment, scarcity of credit, scarcity of qualified buyers and poor sentiment.
Alt-A and Interest Only mortgages are going to be the next big wave of RRE defaults, which will dump more inventory on the market. The number of homes on the market in the US will take several years to clear in a normal environment but bubbles are obviously not normal. High inventories will demand lower prices.
In other words, if builders flooded a normal market with inventory, prices would have to lower in order to sell those homes regardless of incomes. This factor alone is the most important. Regardless of wages, prices will overshoot downward because there is too much supply.
One may argue that population growth will create a greater demand and I would reply that that population must have employment and wages and be creditworthy in order to qualify. Which brings us to the employment factor.
Don't look to BLS numbers for any realistic view of employment. By the time the numbers are high enough that even the BLS numbers look bad, that means the problem is already very deep. Unemployment is at a historical low, and we like to think we can exist as a service economy but as this illusion unravels, as it is presently, unemployment will increase.
The trend will be like any other, it will persist longer than and further than anyone thinks. High unemployment will create a shortage of qualified buyers. This will be another factor pressuring prices. I do concede that this implies an income factor, that factor being zero.
It is no secret that banks are in need of cash and RRE losses are nowhere near over let alone the coming CRE debacle. Currently they have been raising money just for losses, their ability to lend is greatly reduced. Securitized products may not be dead forever but they are dead for now. Banks that have to keep loans on their books are going to be discerning along more traditional lines than they were during the bubble.
It will be difficult to get a loan under normal lending standards. This will play a role in decreasing the pool qualified buyers, which in turn, will keep inventories high, which will pressure prices lower. Market forces will propel long-term lending rates (risk premiums) higher regardless of the Fed.
Home prices must fall to offset the difference, as this once again will impact the number of qualified buyers at any particular price point. The low saving rate in the US says that most don't have a 10-20% down payment. Saving up an adequate down payment will be harder with high unemployment and low wages.
The current wave of foreclosures will create a pool of ineligible buyers for at least 4-7 years after the event. Even if they are considered, interests rates will be such that prices must be lower in order for them to qualify.
Finally, poor sentiment will take hold. At some point, people will not want to have anything to do with real estate. The losses will have been so great and gone on for so long that the widespread idea of RE as easy road to riches will fade. This is good, as it will mark the beginning of the bottom.
When magazine covers highlight the permanent death of the housing market it will be one of many signs that the sector trend is about to reverse. But don't expect this anytime soon. Japan was in much better shape to weather their bubble and though the bubble has deflated, in reality, they still haven't recovered.
In summary, prices will fall to market clearing levels and that level is not singularly tied to incomes. Even in normal markets prices oscillate around the mean. After such a great distortion (bubble) it is somewhat unrealistic to think that prices will fall right back to the mean. The deflation of home prices is nothing more than a trend, and it will persist.
Affordability is a factor in the clearing of inventory but it is not the only factor. It is the other factors that I have mentioned here which form a positive feedback loop which increases inventory, a combination of factors that I believe will cause RE prices to slip below median income support.
From US Home-Loan Defaults To Global Economic Debacle
The financial market turmoil that emerged last August as the American housing bubble burst has collided with a surge in energy and food prices along with a toxic combination in the United States and Europe of tepid growth and rising inflation.
The crisis erupted on August 9, 2007 when the French bank BNP suspended three of its funds, causing short-term credit markets to freeze up and prompting the European Central Bank to inject 95 billion euros into money markets.
Today, with consumer and business confidence crumbling, governments and central bankers are scrambling to confect measures -- official bailouts, tax rebates, lower interest rates, credit injections -- to snuff out a perplexing array of economic brush fires that include a threat of recession.
“This crisis is different -- a once or twice a century event deeply routed in fears of insolvency of major financial institutions”, wrote former US Federal Reserve Chairman Alan Greenspan in a column for The Financial Times.
While many economists maintain that the broader economy can -- with difficulty -- weather the storm on the markets, there is a strong fear that the global financial architecture remains vulnerable to more upheaval. Initial suggestions that emerging markets would be unscathed are giving way to evidence of global slowdown.
“One year later it’s getting worse and worse”, commented Kenneth Rogoff, a Harvard University professor and former chief economist at the International Monetary Fund. “There’s a lot more restructuring ahead in the financial sector and the global economy has a lot of adjustments to make to the commodities shock”.
In the past year fabled financial titans like the banks Merrill Lynch, JP Morgan Chase, Bear Stearns, UBS and Deutsche Bank, as well as the two US mortgage financing behemoths Fannie Mae and Freddie Mac, have all been stung. Some emergency recapitalizations have opened opportunities for investors from emerging markets.
The US housing meltdown was brought on by years of a cheap mortgage credit that left many homeowners facing enormous debt they were unable to refinance when real estate prices began to fall. A subsequent flood of foreclosures undermined the value of billions of dollars in mortgage-backed assets held by the banks, triggering staggering losses and writedowns on the their balance sheets.
The IMF has estimated that banks and financial institutions have written off more than 400 billion dollars on mortgage-related investments and have sustained losses of 945 billion dollars. In such a climate, the banks in turn have grown markedly less willing to make loans among themselves and to businesses, prompting a worldwide squeeze on credit.
All this in a context of long-standing global imbalances and dollar weakness arising largely from US deficits that economists had long warned would unwind, possibly with vicious corrections. In an assessment of financial stability last month, the IMF found that “global financial markets continue to be fragile and indicators of systemic risk remain elevated”.
A crisis that began with a wave of mortgage foreclosures by subprime -- or high-risk -- US borrowers has spread to other forms of credit, it said. Jaime Caruana, head of the IMF’s financial markets department, said recently that with a continuing fall in prices “a bottom for the US housing market is not yet visible”.
And in an ominous report, The New York Times recently warned that another “far larger” wave of defaults could be on the way, this time by people with “prime” or good credit histories. The paper quoted JP Morgan Chase chairman James Dimon as telling analysts he expected losses on JP Morgan prime loans to triple in the coming months and described the outlook as “terrible”.
US policymakers, in particular Federal Reserve Chairman Ben Bernanke and Treasury Secretary Henry Paulson, have so far responded with “pump priming” measures, offering consumers 168 billion dollars in tax rebates, slashing interest rates and making Federal Reserve loans available to investment firms and banks.
The measures took concrete shape in an elaborate housing rescue plan signed at the end of July by President George W. Bush, described as the most sweeping housing legislation in decades. The act provides 300 billion dollars in federal guarantees to help refinance troubled mortgages.
It calls for government credit and equity injections in Fannie Mae and Freddie Mac, the two mortgage lenders that underpin much of the housing market, as well as 3.9 billion dollars to help local governments buy and rehabilitate foreclosed homes.
The Federal Reserve, the US central bank, has done its part by lowering its benchmark lending rate by 3.25 points between September and late April.
But for some economists the era of easy credit from 2003 onwards was the root of the problem. “The subprime crisis is a result of massive US borrowing that kept interest rates artificially low in the United States”, Rogoff said, “And that lulled people into thinking that there was no risk because credit was so freely available”.
Added Bank of America economist Holger Schmieding: “If the aftermath of September 11 in the United States and the stock market problems worldwide, central banks were inclined to be accommodative.” The Bank for International Settlements in Basel, the policy forum for central banking, concluded in its annual report that the main cause of the crisis was “imprudent and excessive credit growth”.
The main lesson for central banks, it suggested, was that they should raise interest rates quickly when asset prices gave early warning of inflation to come. Washington’s response to the crisis, namely its willingness to rescue troubled financial institutions, has therefore unsettled economists who fear that bad habits could be perpetuated.
Subprime pain sweeps the world
More than 100 local councils, charities, churches, hospitals and nursing homes across Australia are sitting on a $2 billion black hole after buying subprime investments structured by Wall Street banks during the bull market but which are now potentially worthless.
Melbourne's Metropolitan Ambulance Service and local councils are among those facing losses of hundreds of millions of dollars in the subprime meltdown because of bad debt they bought through a global investment bank. A document leaked to BusinessDay revealed that Lehman Brothers is managing tens of millions of dollars in funds for Victoria's community, education and health sectors, much of it invested in high-risk financial instruments now potentially worthless.
Other Victorian entities with millions in subprime exposure are not-for-profit defence personnel insurer Defence Health, which has $39 million managed by Lehman Brothers, and $17 million for the Victoria Teachers Credit Union. BusinessDay has identified more than 150 government, private and charitable institutions that bought complex financial instruments such as collateralised debt obligations (CDOs).
There have been few buyers for CDOs and similar structured finance products since the subprime meltdown this time last year that sent global financial markets into a tailspin. These toxic investments will wreck the finances of many local government and charitable organisations for years.
Twenty-three local councils are preparing a class action lawsuit against Wall Street bank Lehman Brothers to recover their losses. Among those that bought the products are four universities, dozens of super funds, ambulance services, the St Vincent de Paul Society, the Starlight Children's Foundation, the Boystown charity for underprivileged children, and the Anglican, Baptist, Uniting and Catholic churches.
While not revealing the councils' latest subprime exposure, the document showed East Gippsland Shire Council had $9 million managed by Lehman Brothers after the meltdown in banking markets and $6.5 million for Greater Shepparton. Gosford Council, on the NSW mid-north coast, is sitting on a $74 million portfolio of CDOs and similar "structured finance" products, Newcastle Council $39 million, Coffs Harbour $39 million and Sutherland $55 million.
NSW and Western Australia are the states most affected, followed by Victoria, South Australia and, to a lesser extent, Queensland, whose investment rules require local councils to invest via Queensland Treasury. National Australia Bank announced last month it was writing down the value of its CDO portfolio by $1 billion, or 90%, having deemed there was a high probability of a loss on the investments.
Most of the charities and councils that hold CDOs are yet to make write-downs, and thereby concede that they will incur losses. Their problem is that the market for CDOs no longer exists. There are no buyers, although many councils claim their CDOs are still producing income and therefore remain a viable investment.
While the exposure of NSW councils has been the subject of an inquiry earlier this year by Platinum Asset Management chairman Michael Cole, the extent of the exposure held by other state and local governments, and charities, super funds, churches and other organisations has until now been unknown.
The list is long and includes co-operatives, teachers' unions, credit unions, nursing homes, retirement villages, hospitals, listed public companies and state agencies. Documents seen by BusinessDay confirm the exposure to CDOs is nationwide. The organisations in the table show Charles Sturt and Griffiths universities, Australian National University, Open University and the University of Western Australia are all exposed.
The CDOs were created by investment banks, which bundled thousands of US subprime home mortgages and sometimes even car and credit card debts into a complicated "derivative" security. They were marketed as a safe investment, akin to a bond. The mix of the underlying home mortgage assets - "bricks and mortar" - was designed to minimise risk to the investor.
In most cases the banks that structured them acquired AA and AAA credit ratings from Standard & Poor's or rival credit ratings agency Moody's Investor Services by paying a fee. When the US credit markets iced over last year and property prices plunged, investors were no longer willing to buy CDOs. The instruments' very diversity worked against investors as no one could disentangle the product and its component parts: thousands of underlying mortgages packaged together.
The $2 billion in investments identified by BusinessDay pertains only to funds under Lehman Brothers management. Lehman acquired boutique local bank Grange Securities two years ago and Grange had been the biggest player in the CDO market, having undertaken a strategy of selling the product to local government, charity and semi-government agencies.
As Lehman was acting as "agent" to most of its council and charitable clients, it not only sold the products, it also managed them for clients, and in some cases "churned" the CDO portfolios by 200%, 300% and 500%. In other words, the bank bought and sold the products between its clients and earned commissions on the sales, according to sources close to the councils.
It was able to charge higher fees as the CDOs were considered high-risk products although the councils claim they were not properly advised of the risk involved in the investments, nor of the prospect that there would be no "liquidity" or "secondary market" to sell them. The CDOs were marketed with traditional Australian names such as Federation, Tasman, Parkes, Flinders, Kokoda, Kiama and Torquay.
Some councils even took out loans to buy the CDOs, or sought "leverage" to magnify their returns. In these cases the losses would be deeper. These Lehman portfolios, or "funds under management", contained not only CDOs but other structured finance products such as capital protected notes and floating rate notes (FRNs) whose value is also difficult to establish.
Gosford Council, for instance, has $135.5 million in investments, most of which Lehman managed, but the face value of the CDOs and notes is $74 million. The CDO and note exposure of Hastings Council is $45 million from total investments of $82 million, Wingecarribee $32 million of $59 million and Sutherland $55 million from $123 million. These figures are from late last year. They are not believed to have changed substantially.
Although Lehman Brothers is the biggest player in this CDO market, other banks also had a significant presence (our accompanying table represents only the Lehman funds under management post-credit meltdown - the figures may have changed in recent months).
While the collective exposure to Lehman may be less than $2 billion, there are hundreds of millions of dollars in CDOs and other structured finance products sold by other investment banks and promoters.
Even if 50% of the face value of these derivative investments could be recovered - and remember NAB recently wrote down the value of its CDO holdings by 90% - losses across the country from structured finance products may reach $2 billion. Most of the holders can hardly afford any losses, particularly in the present economic climate where their income is coming under pressure.
The Cole report into local government exposure to CDOs and related instruments in NSW found that the book value of highly structured credit products in NSW alone was $590 million and the exposure to "capital guaranteed" products (also considered to be riskier than they sound) was $450 million from $5.64 billion in investments among 152 councils in NSW.
Further to the Cole findings, the Federation CDO series sold by Lehman/Grange had already fallen 85% in face value as of January this year. The report found that NSW councils were down collectively $320 million on book value. Many held more than 45% of their assets in CDOs and FRNs.
That was January and globally investment product write-downs have more than doubled since then. Moreover, the valuations are considered conservative as they were in many cases guided by the product promoters. Nor did the inquiry examine the exposure of other states and other bodies such as semi-government agencies and charities.
The first NSW council to take legal action has been Wingecarribee in the Southern Highlands. Piper Alderman, the law company acting in the matter, has now signed up 20 councils including Armidale, Blaney, Deniliquin, Gilgandra, Kiama, Narrabri, Parkes, Walcha, Wingecarribee, Port Macquarie and Carbonne.
Lehman Brothers declined to answer specific questions, but said it did not know about the class action and was defending a single action from Wingecarribee Council. "Lehman Brothers will vigorously defend any legal proceedings commenced where we do not feel there is merit," Lehman said. "Lehman Brothers denies the claims Wingecarribee Council has made in its statement of claim filed with the Federal Court."
Ilargi: The level of disconnect with reality stuns at times. ”It would be a relief to see either combination emerge as a clear trend: a global slowdown pulling inflation down with it and an easing of the credit crunch, or a continued credit crunch and emerging market-led inflation pushing up prices for real assets. Either one would mean an end to the stagflationary rut we’re in that is eroding the value of all assets together.”
There is too much nonsense in there to even try to address.
Markets cheer a global slowdown as preferable to stagflation
Again, the impending decimation of global demand in the face of weak US spending is being interpreted as good news by market commentators with their noses pressed to currency rates. It is doubtless good news that inflation appears to be easing. If it does so in the Gulf, it could alleviate the uglier aspects of the boom, and if it does so among the biggest consumers of the Gulf’s oil, it could underpin the boom.
The problem remains, however, that the global economy now appears to be slowing in line with the US economy. So the sharp rally in the dollar is more about a retreat from risk than it is a reappraisal of growth prospects. It certainly does not mean that the financial crisis has no more woe to inflict. Commodity prices, while they have fallen sharply, remain historically high, imposing a significant drag on growth. And a rising dollar certainly doesn’t do much to maintain the one thing helping the US economy right now – rising exports.
Yet there are some analysts, mainly in the West, who perceive a bottom in the financial crisis having come with the bailouts of Fannie Mae and Freddie Mac, and who say that the growing likelihood of a global slowdown will result in sharply lower global commodities demand and slower inflation. This would seem an argument to return to bonds, which have been battered in recent weeks by inflation concerns.
But analysts in Asia and the Middle East say they still see little sign that inflation is abating. Keep in mind that folks in these parts have so far been behind the curve in the Great Decoupling Debate – Asia does not after all appear to be immune to the West’s slowdown, nor is it helping to cushion the global economy from the blow. No one is wrong or right here, really: the US slowdown has proved more severe than most people predicted, an outcome that even ardent decouplers warned would overwhelm the intraregional dynamism of emerging Asia.
Still, if commodities demand in emerging markets does offset “demand destruction” in the West, decoupling may yet manifest itself as persistently high commodity prices and continued inflation. This would be an argument for buying emerging market stocks and other real assets, including real estate and commodities.
It would be a relief to see either combination emerge as a clear trend: a global slowdown pulling inflation down with it and an easing of the credit crunch, or a continued credit crunch and emerging market-led inflation pushing up prices for real assets. Either one would mean an end to the stagflationary rut we’re in that is eroding the value of all assets together.
But I suspect that the shift has yet to come and that it is too early to look for either an end to inflation or a bottom in credit risk – even if credit default swaps have apparently declined. Like other financial crises, this one has yet to burn itself out. We have not seen the distressed assets being written off start to sell again. Once the US mortgage market starts to clear, once UK housing stops declining, or real estate in Australia improves, then it could be a sign the worst of the credit crunch has passed.
Then, it will take some new engine of growth to pull the global economy forward. And usually, we only find out what that is after it’s already underway. And just as often, it seems, these new engines become the next bubble. It was thus with tech, and again with the post 9/11 liquidity bubble. Some suggest that the so-called emerging markets, led by Chinaand India but including Russia, Brazil, Southeast Asia and the Gulf will emerge from the slowdown as the new engines of growth. This jibes with what I’ve been writing since the beginning of this blog: that what we are witnessing is the shuddering decline of the American-dominated global economic order and a shift of the balance towards the emerging world. This financial crisis is a paroxysm, not a death rattle.
In the meantime, the retreat from risk means zero tolerance for financial legerdemain. So while assurances from regulators are appropriate, allegations of fraud among local property developers and lenders are likely to be punished with even more redemptions by foreign investors.
It is important during this period not to equate falling stock prices with evidence of wrongdoing. Falling stock prices tend to lend urgency to allegations, but in this environment they prove absolutely nothing.
That isn’t to say the allegations are false, but a more meaningful indicator of whether smart money believes them to be true might be to track what happens with property prices and lending rates locally.
Concerns about the creditworthiness of borrowers and the veracity of financial statements should raise risk premia, pushing up further interbank rates, bond yields and mortgage rates.
Appraisal oversight 'broken'
As soaring home prices set the stage for America's great housing meltdown, a critical step in making sure those home sales were a fair deal -- the real estate appraisal -- was undermined from within.
After the nation's last major banking disaster, Congress set up a system to catch rogue appraisers. Their game: inflating the value of homes at the direction of equally unscrupulous real estate agents and mortgage brokers, whose commissions are determined by the size of the deals.
But a six-month Associated Press investigation found that the system is crippled by both the bumbling of its policemen and their inability to effectively punish those caught committing fraud. And despite ample evidence appraisers are pressured into inflating home values -- sometimes to prices in support of loans that are more than buyers can afford -- the federal regulators charged with protecting consumers have thus far made a conscious choice not to act.
"The system is completely broken," Marc Weinberg, the former acting director at the federal agency charged with monitoring the appraisal industry, told the AP before he retired earlier this year. "It's amazing that the system ever worked at all." The AP conducted dozens of interviews and reviewed thousands of state and federal documents, and found:
Since 2005, at the height of the housing boom, more than two dozen states and U.S. territories have violated federal rules by failing to investigate and resolve complaints about appraisers within a year. Some complaints sat uninvestigated for as long as four years. As a result, hundreds of appraisers accused of wrongdoing remained in business.
The only tool federal regulators have to force states into compliance is so draconian -- it would effectively halt all mortgage lending in a state -- that it has never been used. Both state appraisal boards and the federal agency changed with overseeing them are chronically understaffed, many with only one full-time investigator to handle the hundreds of complaints that arrive each year. Some don't even have an investigator.
"The appraisal reforms of the late 1980s were good reforms," said Susan Wachter, a real estate professor at the University of Pennsylvania's Wharton School of Business. "But they were not sufficient to prevent what we have seen . . . because regulation without teeth is not regulation."
To be sure, there are many causes of the housing crisis -- lenders who allowed people with spotty credit to buy homes with little or no money down, mortgage brokers who focused on selling loans without regard to the borrowers' ability to repay, investment bankers who bought and sold risky mortgage-backed securities.
A few of the worst offenders -- appraisers included -- have been put behind bars. But experts and industry insiders, including appraisers who feel betrayed by colleagues who don't follow the rules, believe the failure to effectively monitor the real estate appraisal industry contributed to housing's collapse.
There is no doubt, Wachter said, "that fraud has increased and appraisal fraud has increased in a way to exacerbate the problems."
This is the way the system is supposed to work: Typically, an appraiser receives an order from a real estate agent, lender or mortgage broker to inspect a property. Based on a physical inspection of the home and comparable sales in the area, they develop an estimated value for the property. That figure is used by banks to set the home's value as collateral for the mortgage loan.
Appraisers are supposed to come up with a value free of any outside pressure. But more than three dozen appraisers nationwide interviewed by the AP said they often felt pushed by a real estate agent or mortgage broker to fraudulently inflate a property's value. They supplied the AP with documents from lenders asking them to "hit a number."
"The higher the loan amount, the more money brokers and lenders make in the deal," said Ray Haynes, an appraiser from Cherryville, N.C. "And they threaten you. They say, "If you don't play ball with us, we'll go somewhere else.' And they do. I've seen my business shrink. They're all doing it. It's hard to stay honest." Documents obtained by the AP also show that hundreds of appraisers complained to federal and state agencies about such fraudulent inflation of property values.
The appraisal system has broken down before. In 1989, Congress concluded that "faulty and fraudulent appraisals were an important contributor to the losses that the federal government suffered during the saving and loan crisis." And it passed the Financial Institutions Reform, Recovery and Enforcement Act.
Under the law's reforms, a private group known as the Appraisal Foundation wrote the rules governing appraisers. The law also recommended that states begin licensing appraisers and disciplining those who break the rules. A federal agency called the Appraisal Subcommittee, an independent federal agency that answers to Congress, would conduct field reviews and audits, and maintain a national registry of appraisers -- including dossiers on those who break the rules.
But problems plagued the system from the start. It took years for some states to set up the independent review boards to supervise appraisers or hire personnel to investigate complaints. Even today, eight states still do not require appraisers to obtain a license or certification.
"We got to this point by a lack of enforcement. . . . The public has the right to expect the appraisal boards are taking care of that problem," said Bob Ipock, an appraiser from Gastonia, N.C., who is a critic of the current system. "And they are not. They're looking the other way."
The Appraisal Subcommittee is supposed to help states remove from the system those appraisers who agree to "hit a number." But it has only four employees to conduct field reviews and audits of 50 states and four U.S. territories, and hasn't even had a permanent director since the agency's former chief retired at the end of last year.
Following Weinberg's subsequent departure in February as acting director, none of the agency's current employees -- including interim director Vicki Ledbetter -- returned more than a dozen messages left by the AP over a period of several months seeking comment. When the agency does find a state failing to follow the law, the only tool available to force compliance is a death sentence known as "nonrecognition" -- a penalty that would ban all appraisers in that state from handling deals involving a federal agency.
"Do you know what that would have meant? The net effect is it would have effectively shut down mortgage lending in that state," former subcommittee director Ben Henson, who retired in December, told the AP. "To take that action would have been an unbelievable disruption to the economy. I wasn't going to do that."
When field reviews began in the 1990s, states were repeatedly warned they were failing to comply with the law -- warnings that continue to this day. But without the ability to issue fines or impose a less destructive punishment, the Appraisal Subcommittee is powerless. It has never taken any action against a state for not obeying the law.
"Either you shut it off completely in a state, or you just send letters," said Gary Taylor, an appraiser from New York who sits on the Appraisal Foundation board that writes qualification guidelines. "The threat of the atomic bomb is the only thing." And so, the violations stack up year after year, largely without consequence.
In the last three years alone, as the nation's housing market went from boom to bust, 27 states or territories failed to investigate and resolve complaints within a year. In Washington, D.C., the agency found last August that 32 of the district's 35 pending cases were older than two years. In Florida, almost 50 percent of 169 cases older than a year concerned appraisers involved in "fraud and flipping."
Faced with such backlogs, some states just give up. In New Hampshire, the state appraisal board decided in July 2006 to close all outstanding files dating to 2002 -- some of which included allegation of fraud -- because they "were too old to investigate." The flaws in the system also allow appraisers to stay in business while complaints against them are under investigation.
North Carolina appraiser Jerry Gooden had eight complaints filed against him between 2001 and 2003, all related to a trainee who performed dozens of appraisals under his supervision and later pleaded guilty to mortgage fraud. All the while, Gooden remained listed in good standing on the Appraisal Subcommittee's Web registry of appraisers.
His license was suspended in 2005 for nine months because of the complaints. But even today, his entry shows he's never been disciplined. When contacted recently by telephone, Gooden said he was busy and didn't have time to talk.
"I think the design of the system is excellent," said Philip Humphries, the current director of the North Carolina Appraisal Board. "But states don't have the money to hire personnel to carry out what the system was designed to do."
The key to happiness is freedom not income
In recent years, a small army of happiness gurus has lined up to proclaim the ills of modern society, and its failure to make us feel better. We have more money, say some, but family life has eroded. We live longer, but crime has risen. Some have even blamed affluence itself, arguing that the dizzying range of lifestyle options that we now confront frustrates the pursuit of happiness.
Yet contrary to the assertions of pessimists, newly released data, recently published in an article with colleagues from Jacobs University Bremen and the University of Michigan, shows that today’s world is a happier one. From 1981 to the present, more than 350,000 people from 90 countries were asked about their happiness and their satisfaction with life as a whole.
Among the 52 countries for which at least a decade of data is available, reported well-being rose in 40 cases, and fell in only 12. The average percentage of people who said they were “very happy” increased by almost seven points. How is it that the world is getting happier? In the words of Thucydides, the secret of happiness is freedom.
In each survey respondents were also asked to rate their sense of free choice in life. In all but three countries where perceived freedom rose, subjective well-being rose also. A chart, produced by the authors, shows how these increases in free choice and subjective well-being are strikingly related.
The world in which we live today is unquestionably a free one. For the first time in history, most of the world is governed democratically, the rights of women and minorities are widely acknowledged, and people, ideas and investment can cross borders.
Since the study began in 1981, dozens of middle-income countries have democratised, relieving many from fear of repression: every country making a transition from authoritarian rule to democracy shows a rising sense of free choice. In addition, there has been a sharp rise in the acceptance of gender equality and alternative lifestyles. Countries where this revolution has been most pronounced, such as Canada and Sweden, continue to show rising well-being.
Arguably, no region has experienced this transformation as rapidly as eastern Europe. In the space of two decades, several countries that were members of the Soviet bloc have become members of the European Union, with new freedoms to travel, work and live as never before imaginable. Not only has the proportion claiming to be “very happy” risen in every country except Serbia and Belarus, but this trend has been wholly driven by the younger generation.
Among eastern Europeans aged 15-24, the proportion saying they were “very happy” was 9 per cent at the start of the 1990s, roughly the same as in other age groups. By 2006, this proportion had more than doubled, and steady rises were also evident among those in their 30s and 40s.
Country after country in the study – Albania, Bulgaria, Bosnia, Croatia, the Czech Republic, Lithuania, Moldova, Romania, Russia, Slovakia, Slovenia and Ukraine – exhibits this trend. Belarus stands out as an exception in changes in happiness by age (the young are still as miserable as in 1990, and the elderly only a little better off).
So if the world is becoming happier, what are the implications? First, that the expansion of political and social freedoms over the past quarter of a century is vindicated. The open world in which we live is a fundamentally happier one. This may not surprise those who have argued in favour of a liberal global order. It will undoubtedly cause puzzlement and consternation among those who yearn for the false certainties of an earlier era.
Second, the results may engender caution towards attempts to engineer happiness through public policy. The happy countries include social democracies such as Sweden and Denmark, and more laisser faire economies such as Australia and the US. What they have in common are not their policies but institutions: democracy, rule of law and social tolerance. People are largely capable of engineering their own happiness when given the means to do so.
Third, the link from free choice to rising happiness suggests that the appropriate benchmark of development is not income per capita, but individual freedoms and capabilities. This is the human development perspective associated with Amartya Sen, the Nobel laureate. While income and well-being are closely correlated at early stages of development, once the threat of starvation recedes, social and political freedom appears to be as important.
Though the past 25 years have brought a happier world, there is no certainty that the next 25 will continue to do so. Many low and middle-income countries have experienced exceptionally high rates of growth, ranging from 4 to 11 per cent, while richer countries have undergone falling work hours and social liberation. There is no guarantee that either will persist indefinitely.
Meanwhile democratisation is a one-shot occurrence, and the collapse of communism is in the past. Today, there are as many countries that appear to be sliding into soft authoritarianism and state failure as there are countries that are becoming consolidated democratic cultures, while the future of the global economic order is itself in jeopardy.
It would be a huge irony if the benefits of liberal institutions for human happiness were to become evident precisely at the moment when those gains are most at risk.
Debt-Free: An Unrealistic Expectation
A Vice-President at Dickinson College complained about the move by wealthier schools to eliminate student loans as part of the aid package, arguing that such a move creates the "unrealistic expectation that students should graduate debt-free."
He points out that people borrow for cars and homes, and that education is just like any other big-ticket purchase. In effect, rich people can buy it for cash and those with less money should finance it over time. If education is like a Hummer--cash or credit--then why stop with college? Why not shut down the public schools K-12, and let those whose parents want them to learn to read and write pay cash or take on loans? (Maybe we're heading that way with failing schools in some cities.)
We support public schools with tax dollars because we believe we'll all be better off if more people learn to read and write--even for those of us who don't have children in the public schools. Why isn't the same true for college?
The GI Bill helped 2.2 million returning soldiers become engineers, scientists, entrepreneurs, and business leaders, fueling the economy and raising the standard of living. It cost $7 billion (about $240 billion in today’s dollars), but for every dollar invested, nearly five dollars were returned over thirty-five years in higher productivity and tax revenues. We all benefit when a smart person gets a good education.
Undergraduate borrowers leave school with an average of $20,000 in debt, and average graduate borrowers owe $45,000. Defaulted student loans now top five million. Debt now affects career choices, purchasing decisions (can you afford health insurance, a car or a home?) and even the decision to marry.
My coauthor Ganesh Sitaramen and I have worked on a proposal called Service Pays. We think the federal government should make money available to pay the equivalent of four years of college at a state school (money could be used at a state or private school). For every year after graduation that a student spends in public service (military, Peace Corp, Teach for America, etc.), a year of debts would be erased. Four years of service would pay off four years of college--a sort of reverse GI bill.
This isn't a gift--it's there only for those who want to work in public service. But for anyone who wants to work, regardless of family income, the option to pay for college through service is available.
But our proposal starts from the premise that education is not like a Hummer. It presupposes that we're all better off if young people have access to education. And it assumes that starting adult life deep in a hole of debt is not a good idea. I realize those are pretty controversial ideas in some circles.
The colleges that are moving away from debt believe that those who need aid should get outright gifts, not big debt loads. Of course, many of the schools moving in this direction have big endowments (Harvard, Yale, Princeton). But some schools of more modest means have moved in this direction too (Swarthmore, Bowdoin, Colby). Other schools might like to make their aid packages debt-free, but they are simply too constrained financially. Ganesh and I want to develop a way for students to help pay for their educations without taking on debt.
But the Dickinson VP advances a contrary thought: It isn't right to make college available at lower or no cost to students with less money. Instead, they should expect to take on debt. For some, paying for an education is like buying a fancy car.