Friday, August 29, 2008

Debt Rattle, August 29 2008: Swine Wear Pearls, Pigs Wear Lipstick

Walker Evans Fancy Gro. December 1935
Coca-Cola shack in Alabama.

Ilargi: Anyone with half a working neuron left knows by now that the vast majority of US goverment statistics are embellished hedonistic bogus.

Still, when GDP numbers yesterday seemed positive, all sorts of stocks soared, the Dow in tow, and the first not neuron-hindered analysts oinked and bleated about the bottom and end of the credit crunch. One day later, the picture has made a U-turn.

The useless GDP stats have found a fresh competitor in the little used GDI, or Gross Domestic Income. US personal income in July plunged 0.7%, or more than 8% on an annual basis, with disposable personal income -pay after taxes- down about twice as much.

For a good hard knock-on-the-head stat, eat this one: in June. with a whoop-ti-doodling $149.9 billion boost from stimulus checks, disposable income was down $1.9%. Yes, that’s over 20% annually.

Consumer spending managed to gain an anemic (and disputable) 0.2%, undoubtedly because not everyone had managed to spent their entire $800 stimulus checks received in June. There’s only so much cheap Belgian beer one American can drink in a day.

And this nation of empty pockets, a land today for three quarters inhabited by have-less and have-nots, is now called upon to step up to the plate and face the fastball of the on-going, fast expanding and prohibitively expensive tragedy of corporate bail-outs.

It’s important to realize that we’re not talking about financial issues when it comes to the bail-outs, these are political decisions. Who can be sacrificed, and who will be saved? The answer depends on two things: potential losses in votes, and potential losses in campaign contributions.

And the problem goes beyond tomorrow morning, there are long-term questions to address. If a corporation that is bailed out today, nevertheless folds in two years time, what will be the consequences? A new president doesn’t want to start off in January by killing off the US car industry, but what then is the alternative?

Ford and GM are no longer viable going concerns, and giving them $50 billion now will not change that. Hybrid cars will never gain enough market to bring them back to profits, and their ads about future hydrogen cars are nothing but ridiculous.

For one thing: who will buy those vehicles? Nobody has any money, and no bank has anything to lend them.

I have said before that the interval between presidencies (November '08- January '09) looks to be the only time to 'dump Detroit'. It would allow both the outgoing and incoming president to wash their hands clean, and say it didn’t happen on their watch.

To keep the US car industry going for another 4 years would certainly cost $100’s of billions, and it would still be pearls before swine. And what if they fold anyway in two years? Who wants the blame for that?

The same of course goes for Freddie and Fannie. For those still wearing party-hats after Freddie Mac sold $2 billion in short-term debt this week, here’s a number for you: Fannie and Freddie need to find re-financing for $250 billion (out of a total $1.5 trillion) in existing debt. And that's just the tally for September.

On top of that, they’ll have to find new and additional capital. Much of the existing debt resides abroad, and appetite for it in Japan and China is gone; both stopped buying; instead, they are selling off the debt.

The third large bail-out matter at hand is the FDIC, its member banks, and the customer deposits they hold. There is no question that the FDIC is dramatically underfunded, nor that hundreds of its member will go to that land in the sky where the dodo now lives.

If there were to be a decision to slosh yet more $100’s of billions past that receding event horizon, it would start to become a matter of taking people’s money out of their left pocket, and insert it back in the right (minus a fee, no doubt).

Of course there are people who genuinely believe that sales of houses and automobiles will return to former levels, and once again support vibrant car, building and lending industries. That is nothing but a long-shot though, certainly when we include the timing.

Who knows, perhaps something positive will lift the markets by 2025, though it’s highly doubtful, since there’s nothing in sight that could do it. What’s not in doubt is that until then, the economy will be on life-support, and most of the wealth that remains to date will vanish into anorexically thin air.

One day people will start asking why they must be hungry and cold and sick and dying too young while their money, and their labor, and that of their children, props up failed businesses. And that is when all this will turn out to be a political issue. It's a matter of time. Are today’s politicians willing to take a gamble on when that will be? And are you?

US Incomes Tumbled, Spending Slowed in July
Consumer spending slowed in July, suggesting the economy will weaken with the end of government stimulus payments, while a key inflation gauge crept higher. Personal consumption increased by 0.2% compared to the month before, the Commerce Department said Friday. June spending went up an unrevised 0.6%.

Personal income decreased at a seasonally adjusted rate of 0.7% compared to the month before. Income rose an unrevised 0.1% during June. The drop was the biggest since 2.3% in August 2005. For July, economists had forecast a 0.4% decrease in personal income and a 0.2% climb in consumer spending.

Consumer spending makes up about 70% of U.S. gross domestic product, reflecting a big part of the economy. Climbing prices helped elevate spending last month. In fact, when adjusted for inflation, spending in July fell 0.4%. Friday's data revealed a price index for personal consumption expenditures rose 0.6% in July compared to the prior month; it rose 0.7% in June.

Compared with a year earlier, the PCE price index climbed 4.5% in July. The year-over-year climb in June was 4.0%. The PCE price index excluding food and energy, or core PCE, rose 0.3% a second month in a row during July. Year over year, it climbed 2.4% in July, after increasing 2.3% in June.

The Federal Reserve watches the year-over-year PCE price index excluding food and energy closely for signs of problematic inflation. Fed officials define their statutory goal of price stability as inflation of 1.5% to 2%.

The income report showed private wage and salary disbursements increased $13.2 billion in July, compared with an increase of $7.9 billion in June. Government economic stimulus payments boosted the level of personal current transfer receipts by a mere $4.2 billion, at an annual rate, in July. The payments gave much larger boosts of $149.9 billion in June and $179.6 billion in May. The stimulus payments started going out in the end of April and lasted until about the middle of July.

The Commerce Department reported Thursday that gross domestic product surged 3.3% in the second quarter. Analysts, however, see growth fading in the second half of 2008, partly due to the end of the stimulus payments approved by Congress and the White House.

July disposable personal income -- income after taxes -- fell by 1.1%, after dropping 1.9% in June. Spending on durable goods, those designed to last three years or longer, tumbled 1.5% in July, after dropping in June by 1.3%. Non-durable goods spending increased 0.3% in July, after rising by 1.5% the month before. Spending on services went 0.5% higher in July.

The Commerce Department reported personal saving as a percentage of disposable personal income was 1.2% in July. It was 2.5% in June.

July incomes drop by largest amount in 3 years
Personal incomes plunged in July while consumer spending slowed significantly as the impact of billions of dollars in government rebate checks began to wane. The Commerce Department reported Friday that personal incomes fell by 0.7 percent in July, the biggest drop in nearly three years and a far larger decline than the 0.1 percent decrease analysts expected.

Consumer spending edged up a modest 0.2 percent, in line with expectations, but far below June's 0.6 percent rise. When the impact of rising prices was factored in, spending actually dropped by 0.4 percent in July, the weakest showing for inflation-adjusted spending in more than four years. The July performance for incomes and spending reinforced worries that the economy, which posted better-than-expected growth in the spring because of the rebate checks, could stumble in coming months as their impact fades.

Some economists worry that overall economic growth, which rose at a 3.3 percent annual rate from April-June, could come in at less than half that pace in the current quarter, and could actually dip into negative territory in the final three months of this year and the first quarter of 2009.

Back-to-back declines in the gross domestic product, which measures the value of all goods and services produced within the U.S. and is the best barometer of the country's economic health, would meet one rule of thumb for a recession. A gauge of inflation closely watched by the Federal Reserve remained elevated in July, rising by 0.6 percent. Over the past 12 months, this inflation gauge tied to consumer spending was up 4.5 percent, the biggest year-over-year increase in more than 17 years.

The surge reflected the big increases that have occurred this year in food and energy costs. Excluding food and energy, inflation by this measure was up 0.3 percent in July, and 2.4 percent over the past 12 months, still above the Fed's comfort zone. The central bank is caught in a bind between a sluggish economy and rising inflation pressures.

The 0.7 percent drop in personal incomes followed a 0.1 percent rise in June and a 1.8 percent surge in May. After-tax incomes dropped by an even bigger 1.1 percent in July, following a 1.9 percent decline in June and a 5.7 percent surge in May. All the income figures were heavily influenced by the rebate checks.

Democrats, including presidential nominee Barack Obama, are calling for the government to pass a second stimulus package to guard against the economy slumping into a deep recession. But President Bush, concerned about the impact the stimulus payments will have on the budget deficit, has resisted those calls, insisting that the rebate payments will continue to support the economy in coming months.

The administration is already forecasting that the federal budget deficit for the budget year that begins on Oct. 1 will soar to an all-time high in dollar terms of $482 billion. The report on consumer spending also showed that personal savings totaled 1.2 percent of after-tax incomes in July, down from a rate of 2.5 percent in June.

Lagging Incomes Signal U.S. Economy Weaker Than GDP Suggests
The meager gains in earnings over the last year signal the U.S. economy is in much deeper trouble than the growth estimates indicate, economists said.

Gross domestic income, or the money earned by the people, businesses and government agencies whose purchases go into calculating gross domestic product, rose 0.3 percent in the 12 months ended in June after adjusting for inflation, according to Bloomberg calculations based on today's Commerce Department growth report. GDP expanded 2.2 percent.

"The income side of the economy, with profits down for four straight quarters and employment falling, looks like a recession," said John Ryding, chief economist at RDQ Economics in New York. Incomes last quarter grew 1.9 percent at an annual rate after adjusting for inflation, a little more than half the 3.3 percent gain posted by GDP, according to Bloomberg calculations. The figures showed incomes dropped in each of the prior two quarters.

"What you are seeing is more legitimate economic weakness in the income numbers," said James O'Sullivan, a senior economist at UBS Securities LLC in Stamford, Connecticut. "The GDI numbers raise the potential that GDP is overstating growth." The 1.9 percentage-point difference between the GDI and GDP over the last 12 months is the biggest in the post World War II era.

Corporate profits were down 7 percent in the year to June, the biggest drop since the last economic contraction in 2001, according to the Commerce Department. The government also said wages and salaries increased by $52.5 billion in the first three months of the year, $20.2 billion less than previously estimated.

The income numbers are more in line with other figures that indicate the economy struggled from April through June. The jobless rate was 5.5 percent in June, up from 5.1 percent at the end of the first quarter, and employers cut 165,000 workers from payrolls, according to the Labor Department.

"I'm looking at the labor market, and the GDP income numbers make more sense," said Ryding. "It certainly did not feel like 3.3 percent growth." The earnings data may more accurately predict the start of economic contractions, according to researchers at the Federal Reserve.

Income adjusted for inflation "has done a better job recognizing the start of recessions than has the growth rate of real GDP," Jeremy J. Nalewaik, a Fed economist wrote in a December 2006 report. "Placing an increased focus on GDI may be useful in assessing the current state of the economy."

While the income and growth figures should theoretically match, the different methods used in calculating the numbers prevent them from converging fully. The disparity between income and growth may take a long time to be resolved, if ever. Once Commerce issues its final estimate for second quarter growth next month, the figures will not be updated again until the annual benchmark revisions are issued in July 2009.

Significant changes to income estimates take even longer, sometimes not appearing until more comprehensive revisions are issued every five years.

US banking sorrows come 'in battalions'
Every episode in the credit crunch has had its dramatic flourish. There were the defenestrations at Citigroup and Merrill Lynch late last year; then, in March, the Bear Stearns fiasco; the humbling of UBS; and now Fannie Mae and Freddie Mac, a tale of hubris that might impress Shakespeare himself. What next?

With the tragedy of the mortgage giants still unfolding, another dark drama is entering its second act, and it has rather a lot of players. It concerns America’s commercial banks. “Pretty dismal” was the frank description of their recent performance offered on August 26th by Sheila Bair, head of the Federal Deposit Insurance Corporation (FDIC). That was just after announcing a rise in the number of banks on its danger list, from 90 to 117.

Nine banks have failed so far this year, felled by shoddy lending to homeowners and developers—six more than in the previous three years combined. The trajectory is steep: Institutional Risk Analytics, which monitors the health of banks, expects more than 100 lenders—most, but by no means all, tiddlers—to fold over the next year alone. Alarmingly, the ratio of loan-loss provisions to duff credit is at its lowest level in 15 years.

The FDIC will soon have to replenish its deposit-insurance fund, which collects premiums from banks and stood at around $53 billion before the downturn. One of this year’s failures, IndyMac, has alone depleted the fund’s coffers by one-sixth—and it was no giant. This has pushed the fund’s holdings below a trigger point that requires the FDIC to craft a “restoration” plan within 90 days.

Ms Bair has indicated that banks with risky profiles—which already pay up to ten times more than the typical five cents per $100 insured—will be asked to “step up to the plate” with even higher premiums. This would ensure that safer banks are not unfairly burdened. But it will heap yet more financial pressure on strugglers. Bankers’ groups have already started to protest loudly.

How much will be needed? Possibly far more than the FDIC is letting on, reckons Joseph Mason of Louisiana State University. Extrapolating from the savings and loan crisis of the early 1990s, and allowing for the growth in bank assets, he puts the possible cost at $143 billion.

That would force the FDIC to go cap-in-hand to the Treasury. The need to do so could become even more pressing if nervous savers began to move even insured deposits (those under $100,000) away from banks they perceived to be at risk—which no longer looks fanciful given the squeeze on the fund.

Ms Bair’s admission, in an interview with the Wall Street Journal, that the FDIC might have to tap the public purse, albeit only for “short-term liquidity purposes”, will have done little to calm nerves. It is also sure to reinforce a growing sense that the financial-market crisis has a lot further to run.

Risk-aversion, measured by spreads on corporate debt, fell sharply after the sale of Bear Stearns in March but has leapt back in recent weeks as the spectre of systemic meltdown resurfaced. Sentiment towards spicier assets is astonishingly grim: prices of junk bonds and home-equity loans imply a default rate consistent with unemployment of around 20%, points out Torsten Slok, an economist at Deutsche Bank.

Banks continue to tighten credit, and their own belts—Citigroup has even restricted colour photocopying. What liquidity they have is being jealously hoarded, partly out of distrust of one another, but mostly in anticipation of refinancing requirements on bonds that they issued with abandon in the credit boom.

The spread over expected central-bank rates that they charge one another for short-term cash has risen to three times the level that it was in January. Worse, derivatives markets point to a further increase. Another measure of trust, or lack of it, the index of the “counterparty” risk that derivatives dealers pose, is creeping back towards its March peak.

Nor have investors grown any more confident about their ability to price the banks’ toxic mortgage-backed assets: Merrill Lynch’s cut-price sale of collateralised-debt obligations in July has had few imitators. Lehman Brothers has tried unsuccessfully to sell a pile of iffy securities backed by commercial mortgages all summer.

The woes of Fannie Mae and Freddie Mac weigh on these efforts. Bankers feel obliged to advise clients against snapping up distressed securitised assets until the mortgage giants are put on a firmer footing, says one. And banks themselves are exposed: paper issued by the mortgage agencies accounts for roughly half of their total securities portfolios, estimates CreditSights, a research firm.

American banks own much of the preferred stock (a hybrid of debt and equity) that the two firms issued. They were attracted by the preference shares’ combination of a low risk weighting and decent yield, says Ira Jersey of Credit Suisse, but have seen their prices tumble on fears that they will be wiped out if the government moves to prop the agencies up.

Although only a few regional lenders would be seriously hurt by this, it would add to the pain of many. JPMorgan Chase has just become the first bank to write down its holdings, saying it may lose $600m, or half the value it had put on them. That may start a trend.

Worse, banks have come to rely on issuing their own preference shares to raise capital, and will find that harder if holders of Fannie’s and Freddie’s paper suffer losses. Banks have raised a total of $265 billion of capital since last summer, says UBS. With much of that issuance underwater, investors are understandably wary of throwing good money after bad.

Contagion also spreads through the market for credit-default swaps. Banks have busily written such insurance contracts on Fannie’s and Freddie’s $20 billion of subordinated debt, which sits below senior debt in their capital structures. If the debt’s holders suffer losses in a bail-out, triggering a “credit event”, banks that had sold the swaps would face huge payouts.

The amounts involved are “impossible to calculate but far from trivial”, says one sombre analyst. As the bard wrote: “When sorrows come, they come not single spies, but in battalions.”

Banks borrow more from Fed; Wall Street takes pass
Banks borrowed more over the past week from the Federal Reserve's emergency lending program, while Wall Street firms passed for the fourth straight week. A Fed report released Thursday said commercial banks averaged $18.47 billion in daily borrowing over the past week. That compared with a daily average of $17.51 billion in the previous week.

For the week ending Aug. 27, Wall Street firms didn't take out any loans, the fourth straight period of no action. Their borrowing, however, averaged as high as $38.1 billion a day over the course of a week in early April. Investment houses in March were given similar loan privileges as commercial banks after a run on Bear Stearns pushed what was the nation's fifth-largest investment bank to the brink of bankruptcy. The situation raised fears that other Wall Street firms might be in jeopardy.

Bear Stearns was eventually taken over by JPMorgan Chase & Co. in a deal that involved the Fed's financial backing. The identities of commercial banks and investment houses that borrow are not released. Commercial banks and investment companies now pay 2.25 percent in interest for the loans.

In the broadest use of the central bank's lending power since the 1930s, the Fed in March scrambled to avert a market meltdown by giving investment houses a place to go for emergency overnight loans. The Fed has since extended those loan privileges into next year. Originally they were supposed to last through mid-September.

More recently, the Fed has said troubled mortgage giants Fannie Mae and Freddie Mac could draw emergency loans from the central bank if they needed. There was no indication in the weekly report that they had done so. Separately, as part of efforts to relieve credit strains, the Fed auctioned nearly $26.65 billion in Treasury securities to investment companies Thursday. The Fed was making $50 billion worth of the securities available.

In exchange for the 28-day loans of Treasury securities, bidding companies can put up as collateral more risky investments. These include certain mortgage-backed securities and bonds secured by federally guaranteed student loans. The auction program, which began March 27, is intended to make investment companies more inclined to lend to each other. A second goal is providing relief to the distressed market for mortgage-linked securities and for student loans.

A Nightmare on Wall Street
Like a Hollywood monster that is impervious to bullets, the credit crisis refuses to lie down and die.

The authorities have bombarded it with interest-rate reductions, tax cuts, special liquidity schemes and bank bail-outs, but still the creature lumbers forward, threatening new victims with every step. Global stockmarkets are suffering double-digit losses this year, and credit markets are once again gummed up.

For investors who cut their teeth in the 1980s and 1990s, the persistence of the crisis must be a surprise. Prompt action by central banks, after Black Monday in 1987 (when America’s stockmarket fell by almost 23%), or following the collapse of Long-Term Capital Management, a hedge fund, in 1998, suggested it was always worthwhile to “buy on the dips”.

One reason why things are different this time is that there has been a double shock. On top of the decline in house prices and the associated drop in the prices of asset-backed securities, the markets have also had to face a surge in commodity prices.

That has constrained central banks from easing monetary policy as much as they might have done, particularly in Britain and the euro zone. Even in America, rates might now perhaps be 1% (as they were in 2003) without the commodity boom.

In addition, the combination of the two shocks has created uncertainty about the direction of monetary and regulatory policy. Will the central banks be forced to “do a Turkey” and adjust their inflation targets upward (implicitly or explicitly) to reflect reality? Alternatively, will they crack down so hard on inflation that they force their economies into recession?

And will the price of investment-bank rescues be a harsh new regulatory regime that restricts the scope for future credit (and economic) growth? In the face of all this uncertainty, investors can hardly be blamed for being cautious.

The way that the crisis has centred on the banking industry also explains its duration. Stephen King, an economist at HSBC, points out that the financial crises of the 1990s were also prolonged, from the savings and loan collapses in America through the Swedish banking rescues to the extremes of Japan’s debt deflation. As Mr King says, “if banks are unable or unwilling to lend, monetary policy doesn’t work so well.”

Worse still, bank problems create a feedback loop with the rest of the economy. When banks get into difficulty, they restrict their lending. That in turn makes life more difficult for companies and consumers, causing them to cut their spending and making it harder for them to repay their debts. That forces further caution on the banks.

Recent economic data have highlighted how the gloom is spreading. Neither Germany nor Japan enjoyed a credit boom earlier this decade but both economies are suffering. Business confidence in Germany fell to its lowest level in three years, according to the latest Ifo survey, released on August 26th. “The credit crunch is morphing from an American-centred financial crisis into a global economic crisis,” says David Bowers of Absolute Strategy Research, a consultancy.

Another reason why the crisis is lasting so long stems from the nature of the previous boom. Everyone was borrowing money, from homeowners buying houses they could not afford in the hope of capital gains, to investors buying complex debt products with high yields because of the extra “carry”.

These investors were, directly or indirectly, beholden to the banks. Even when money was borrowed from “the market”, the lenders may well have been hedge funds, conduits or structured-investment vehicles, all of which had themselves borrowed money from banks in the first place. That former wellhead of finance has now run fairly dry.

In turn, that explains the absence of bargain hunters, particularly in the debt markets. Investment-grade debt might look attractive on a five-year view, if all you have to worry about is the risk of default. But most investors in that market have a three- or six-month view; they cannot afford for things to get worse before they get better, in case they are forced into a fire-sale of their assets.

So the markets (and the developed economies) are waiting for a catalyst for recovery. Lower commodity prices helped for a while, and may help further if they encourage central banks to cut rates. Evidence of a bottom in the American housing market may also do the trick. But the crisis seems certain to linger into 2009, and could even make it into the following year. Successful horror movies tend, after all, to have several sequels.

Bank of China flees Fannie-Freddie
Bank of China has cut its portfolio of securities issued or guaranteed by troubled US mortgage financiers Fannie Mae and Freddie Mac by a quarter since the end of June. The sale by China’s fourth largest commercial bank, which reduced its holdings of so-called agency debt by $4.6bn, is a sign of nervousness among foreign buyers of Fannie and Freddie’s bonds and guaranteed securities.

Foreign investors have been a mainstay of the market for such debt, but uncertainty over the mortgage financiers’ capital positions and the timing and structure of a potential government rescue has made some investors reassess their exposures. Asian investors in particular have become net sellers of agency debt, said analysts.

Federal Reserve custody data shows that for the year to July, foreign official and private investors bought an average of $20bn of agency debt a month, including debt issued by other government agencies such as Ginnie Mae and the Federal Home Loan Banks. Purchases of US Treasuries averaged $9.25bn.

From July 16 to August 20, foreign investors sold $14.7bn of agency debt, trimming their overall holdings to $972bn. They purchased $71.1bn of Treasuries in the same period. The US Treasury was granted powers last month to extend its credit lines to Fannie and Freddie and invest in their debt and equity.

The rescue plan came after a collapse in the companies’ shares heightened concerns about their ability to raise equity capital to cushion losses and whether they could maintain their access to the debt markets. By making a historically implicit government guarantee for the mortgage financiers’ debt increasingly explicit, the Treasury sought to reassure foreign and domestic investors by providing a safety net. Fannie and Freddie have a combined $1,500bn of debt outstanding.

This weekend, the Group of Twenty developed and advanced developing countries will be holding a preparatory meeting in Brazil. Although the crisis at Fannie Mae and Freddie Mac is not on the agenda, there is speculation that Treasury officials could informally encourage big holders of agency debt and mortgage-backed securities not to scale back their investments.

After a sharp drop in the market value of their stock last week, Fannie and Freddie have made a strong recovery after successful short-term debt sales. Fannie was 13.5 per cent higher on Thursday and Freddie was up 12 per cent. Bank of China’s disclosure on its holdings of Fannie and Freddie securities came as the bank reported a 15 per cent increase in second-quarter profit.

Worker Assets Vanish at Fannie and Freddie
Fannie Mae’s workers had $116 million in the employee stock ownership plan at the end of 2006. Today, it’s more like $17.5 million. Ouch.

The employees of Fannie Mae, and those of its counterpart Freddie Mac, are reeling from financial blows themselves as the mortgage finance companies lurch toward what could be a government bailout. Both firms ladled out hefty servings of stocks and options to reward and compensate employees — making them popular employers for years.

The top executive of Freddie Mac, Richard F. Syron, for instance, made about $18.3 million last year, two-thirds of that in stock and options that are worth a lot less today. His counterpart at Fannie Mae, Daniel H. Mudd, made $11.6 million, also much of it in stock.

But midlevel employees were paid in stock, too. Stock and options could account for a fifth of their total compensation, according to former employees and financial planners. Their ability to sell and diversify was often limited by restrictions on the grants, the terms of the specific plans and tighter rules on selling by employees while they addressed years-earlier accounting scandals.

For decades, both companies offered lush benefits, with traditional pension plans, 401(k)s, stock plans and other niceties, like child care plans. That means many employees still have a safety net, though their savings have declined, drastically in some cases.

“If it can happen to Fannie or Freddie, it can happen anywhere,” said Marjorie L. Fox, a certified financial planner in Reston, Va. “This is a cautionary tale you better pay attention to.”

For those people participating in the employee stock ownership plans, known as ESOPs, at Fannie Mae — Freddie Mac did not have one — they could do little but watch this year as the stock lost more than three-quarters of its value. In a lament echoing the fallen share prices at other firms like Bear Stearns, employees discovered their stock was essentially locked up.

The Fannie Mae plan, to which the company stopped making contributions last year, invests in company stock, allowing diversification to begin only at age 55. Still, former employees and financial planners say workers have probably been hurt more severely by their holdings of stock and options outside of retirement plans.

Richard K. Green, who was a principal economist and a director of financial strategy and policy analysis at Freddie Mac from late 2002 to early 2004, said that about 20 percent of his total compensation was in stock options. “It’s my understanding that for a fair number of people, it was an important part of their retirement planning,” he said. “If you joined in the ’80s, you did fairly well. But if you joined in the last 10 years or so, those options wouldn’t be worth a whole lot to you.”

Furthermore, both companies tightened restrictions on trading of company stock by employees while working to correct a series of accounting misstatements. Fannie Mae barred employees from selling shares — or buying them — from April 2005 to November of last year.

Freddie Mac limited employee trading of its stock beginning in June 2003, periodically allowing workers to sell shares during brief windows. Those restrictions were relaxed in March for most workers, but trading by many executives is monitored and more limited, a company spokeswoman said.

There are other financial disappointments for employees as well. Fannie Mae’s traditional retirement plan has been frozen, like its stock ownership plan, meaning no additional benefits will accrue. That leaves employees at Freddie Mac to wonder if such a cutback is in store for them. Freddie Mac says it has no plan to freeze the pension. Though it did not have an ESOP, Freddie Mac did have a stock purchase plan that allowed employees to buy company shares at a discount. Alas, some employees were buying all the way down.

The shares of both companies have rallied this week after they raised money in the credit markets at somewhat improved levels and after some analysts suggested they might be able to avoid a capital injection from the federal government. Shares of Freddie Mac have almost doubled so far this week, to $5.28, and shares of Fannie Mae have jumped nearly $3 so far this week, to $7.95. Still, the shares remain more than 80 percent below their closing price at the end of last year.

Many investors and policy makers remain concerned that the companies, which own or guarantee nearly half of the mortgages in this country, do not have enough capital to withstand rising losses from defaults by homeowners. Last month, Congress authorized the Treasury Department to pump billions of dollars into the companies, if needed.

Created by the government and operated as hybrid public-private entities, Fannie Mae and Freddie Mac were long viewed by prospective hires as both incredibly stable and tremendously profitable. Fannie Mae, for instance, has appeared on Fortune magazine’s list of best places to work. Each company has just under 6,000 employees. When Fannie Mae froze its pension plan to new employees and certain younger workers late last year, it increased its contributions to the 401(k), which has no company stock.

Along with its pension, Freddie Mac has a 401(k), which eliminated company stock as an investment option in late 2006. Workers were forced to sell any company stock in the plan by the end of last year, according to a company spokesman.
For a long time, Freddie Mac’s stock purchase plan was quite attractive, allowing employees to buy company shares at a 15 percent discount. At the end of 2007, that plan had $24 million in stock that if held today would be worth about $3.7 million.

Ms. Fox, the financial planner in Virginia whose office is near the headquarters of Fannie Mae in Washington and Freddie Mac in McLean, Va., said she recently fielded a call from a client who is a Freddie Mac employee. The client wanted to know if it was prudent to keep buying shares through the stock purchase program. “They had been doing this religiously over the years, adding between $500 to $1,000 a month, and they’ve seen the value of what they purchased slip to next to nothing,” Ms. Fox said. “It’s almost unfathomable.”

Luckily, the client had diversified much of the family’s Freddie Mac stock holdings, selling about 3,000 shares in 2006 for about $200,000 when the stock was trading in the mid-$60s. But the client held on to about 1,000 shares. Those have fallen from about $65,000 in 2006 to just $5,300 today.

The same client has unexercised stock options that are worthless because the strike price is well above the market price. There is also restricted stock and other equity worth much less than when granted. Still, the client’s family has a net worth of $2 million, putting it in better financial health than most Americans.

Compensation experts say employees and employers have learned from the painful stock losses by employees at technology firms and companies like Enron and WorldCom. But the problems at Fannie Mae and Freddie Mac show that many employees, and employers, have not fully appreciated the risks of having so much of their savings tied to a single employer.

“If you are going to invest in a single security, employer stock is a particularly stupid one to invest in because your human capital is tied up with your financial capital,” said Norman Stein, a professor at the University of Alabama Law School and a specialist in pension and employee benefits law. Employee stock ownership plans, which many companies have embraced for their tax benefits, can be particularly dangerous if workers do not have diversified investments elsewhere.

At Fannie Mae, the stock ownership plan, which has 7,900 participants, is merely a supplement to other retirement plans. According to a securities filing by Fannie Mae, employees can diversify once they are 55 years old and have participated in the plan for at least 10 years. Companies can let employees diversify earlier, but federal law doesn’t require it, according to Loren Rodgers, project director at the National Center for Employee Ownership.

Participants have previously challenged the company over this plan. In 2004, Fannie Mae was sued by former employees who claimed the company had violated its fiduciary duty to members of that plan under the Employee Retirement Income Security Act, citing corporate accounting misstatements. Fannie Mae rejects those allegations. That case is pending in United States District Court in Washington.

Is Freddie Mac next in GSE management shake-up?
Freddie Mac, the second-largest U.S. mortgage finance company, may soon follow its larger sibling Fannie Mae with a management shake-up that could boost investor confidence in the company.

Shares of both government-sponsored enterprises, or GSEs, jumped for a fourth straight session on Thursday, a day after Fannie Mae announced a shake-up of top executives including the exit of its chief financial officer.

Investors believe Fannie Mae's action was a move in the right direction. Now some say it is only a matter of time until Freddie Mac, which has a weaker capital position than Fannie Mae, follows suit with its own overhaul, and one that could include the removal of chief executive Richard Syron.

"Does Syron get the blame for not raising equity when (Freddie Mac's stock) was at $20? That seems to be the distinction between Freddie and Fannie," said James McGlynn, portfolio manager at Summit Investment Partners, who is based in Southlake, Texas. Freddie Mac shares were trading around $5.25 in mid-afternoon on Thursday.

"Someone was pigheaded and said, 'I don't need to raise equity until things improve,'" McGlynn said. Indeed, raising capital is one of the main distinctions between the two mortgage finance giants. Fannie Mae raised $7.4 billion in May and has said it may need to tap the market again, depending on how large losses are in coming quarters.

In contrast, Freddie Mac pledged in May to raise $5.5 billion of capital to bolster its balance sheet, but has yet to take any action. Still, McGlynn said Syron had built up goodwill at Freddie Mac for the role he played in ushering the company out of a multibillion dollar accounting scandal earlier this decade. "I don't know if there's a higher ranking person at Freddie Mac that has the trust of the people and the Street," he said.

In July, Congress gave the U.S. Treasury authority to lend money to or acquire equity in Fannie Mae and Freddie Mac if needed to prop them up. The shares of the two government-sponsored enterprises hit almost two-decade lows last week as fears grew that rising mortgage defaults and falling U.S. house prices could erode the capital of the two companies, leading to a rescue that would leave their common shares worthless.

That prospect, however, has appeared to fade this week as the companies enjoyed demand for debt sales and a multitude of Wall Street analysts said they had no immediate need for capital.

Fannie Mae and Freddie Mac, which own or guarantee nearly half of all outstanding U.S. mortgages, have reported a combined loss of about $14 billion for the past four quarters as the worst U.S. housing market downturn since the Great Depression brought on a wave of mortgage defaults.

"Are these problems that Freddie Mac is creating daily or are these problems because the housing market stinks?," said Gary Gordon, stock analyst at Portales Partners in New York.

"The loan portfolio they went into this year with is the loan portfolio they are going to have to deal with throughout this cycle, so whether Richard Syron or Michael Phelps is the head of Freddie Mac, it is the same issue," he said, referring to the American swimmer who won a record-breaking eight gold medals at the Beijing Olympics.

The housing market, however, has shown signs of bottoming out, which could portend smaller losses down the road. "It was not an internal issue that put Fannie Mae and Freddie Mac into the position they are in, so an internal management restructuring will not fix it," Gordon said. Fannie Mae's shake-up of top executives included the exit of its chief financial officer, but not its chief executive officer, Daniel Mudd.

James Post, a professor at Boston University's School of Management, said the leadership changes at Fannie Mae are probably just the beginning. "CEO Daniel Mudd has temporarily escaped the executioner," he said in a e-mail. And unless Fannie Mae returns to soundness, "Mudd's days may be numbered as well."

Post said the boards of directors at the two companies must be impatient given the intense pressure from shareholders, bondholders, regulators, Congress and the U.S. Treasury. "So, the story line leads in two directions: What happens at Fannie Mae, and how soon will the same fate befall Richard Syron at Freddie Mac," he said.

Fire the Fannie and Freddie bazooka
As Hank Paulson, America’s treasury secretary, is learning, the trouble with having a bazooka in your pocket is that you may have to use it.

He used the bazooka as an analogy to describe the massive firepower the Treasury could deploy, if necessary, in support of Fannie Mae and Freddie Mac, America’s beleaguered mortgage giants, thanks to a new law signed in July. Just putting the money at their disposal, he argued, could insure it would never be used.

Now his bluff is being called and the future of Fannie and Freddie is once again hanging like a thunder cloud over American finance. It is time for Mr Paulson to show what he, and his bazooka, are made of. None of his options is enviable—though choosing the right one could crown a long career in finance.

Fannie and Freddie have become indispensable to the housing market; they account for up to nine out of ten secondary mortgages in America, and owe or guarantee about $5.3 trillion. Meanwhile, hundreds of America’s banks rely on their shares to shore up their capital and foreign central banks are big holders of their bonds. Yet the two firms are woefully short of capital and in need of support. Whatever Mr Paulson does to address this, there will be collateral damage.

This week the shares of Fannie and Freddie rose slightly (they are still down 85% or so this year) on hopes that Mr Paulson would take the easy option and sit tight. It must be tempting. There has been a slight slowing in the pace of house-price declines. Fannie and Freddie found willing buyers in debt sales on August 27th.

Both firms are profiting handsomely from their new investments—though losing far more money on the old ones. Politically, laissez-faire is seductive. Congress, which has feasted on the lobbying largesse of Fannie and Freddie for decades, has a vested interest in the status quo.

Yet the one thing Mr Paulson must not do is sit on his hands. By allowing the Treasury to make loans to, or invest in, the companies, Congress made explicit what had always been tacitly understood: that it stood four-square behind the two agencies, even though they have private shareholders and managers paid like Wall Street barons.

That is capitalism at its worst: it means shareholders and executives reap the profits, but the taxpayer bears the losses. It is also risky. Between them, the firms have more than $200 billion of debt to roll over in the next month, and the markets are queasy. The collapse of just one bond auction could send shock waves around the world.

An alternative would be for the Treasury to throw Fannie and Freddie a lifeline, perhaps as much as $25 billion-30 billion in new capital. But under the new law, it is not clear that the government would have the right to oust the managers and punish the shareholders. That leaves the Treasury with the unpalatable option of rewarding the institutions for bad behaviour.

Not only would this throw good money after bad. It would encourage executives to “gamble for resurrection”—to take big mortgage risks in a desperate attempt to make profits. All of which argues in favour of the bazooka option, nationalisation, as the only one that is fair to the taxpayer.

Once the two firms’ capital sinks below a certain threshold (which could easily happen with a nudge from Mr Paulson), receivership—as a prelude to nationalisation—is allowed by law. In a stroke, that would lower the twins’ funding costs and, hence, mortgage rates, and show commitment to the stability of the mortgage market.

It would, of course, technically add huge liabilities to the government’s balance sheet; but these would be offset by mortgage assets that are almost as large. Nationalisation need not be the end of the story. The giants’ assets should be liquidated over time, or the entities broken up and privatised. The companies’ size and strange structure carry a big cost for American finance.

Backed by cheap government funding, their bosses have speculated with the gusto of hedge-fund managers—and lost, time and again. The two Leviathans have squeezed private firms into the riskiest ends of the mortgage market, such as subprime lending. They have not brought sharply lower mortgage rates to America. Europe, where mortgage markets are fully private, is no worse-off.

Politicians, especially the Democrats, will rush to their defence. After all, the two firms have big influence. That is the strongest reason to move quickly—especially now they are so nearly insolvent. Fannie and Freddie have outlived their usefulness and should be dismantled. Doing so would be a great legacy to leave to American finance. But as the November elections approach, Mr Paulson’s time is running out

Fannie Mae and Freddie Mac: A Damage Report
Talk of a government bailout of Fannie Mae and Freddie Mac has reached a crescendo recently, including market rumors of a surprise government recapitalization of the mortgage finance companies over the Labor Day weekend, which the Treasury Dept. has denied.

In view of a potential rescue of the troubled firms, it may be time for a damage report. Here is an assessment of how much wealth holders of the agencies' stocks and debt have lost since the housing crisis began to wreak havoc on the government-sponsored enterprises—and the potential financial damage that may lie ahead for investors.

Losses for holders of the GSEs' common stock are straightforward—roughly $100 billion in market cap has vanished since the start of 2008, with Fannie and Freddie shares down about 85% over the past eight months. Losses for investors in the mortgage giants' preferred shares, which continue to pay hefty dividends, are harder to calculate.

Fannie and Freddie each have multiple issues of preferred stock, which vary based on initial share price, number of shares issued, and dividend rates. For example, all of Freddie Mac's preferreds issued in 2007 were priced at $25, while those issued in prior years were priced at $50. The share counts vary, however, and the preferreds now trade at various prices.

Here too, the losses have been significant. Freddie Mac's most recent preferred shares, issued on Nov. 29, 2007, at $25, closed at $12.87 on Aug. 27, translating to a loss of $2.91 billion for those who bought them at the original price.

Ultimately, the losses to shareholders will be determined by how Treasury decides to treat the companies' equity if it intervenes to recapitalize the agencies. The market for preferreds is pricing in the risk of some form of government intervention, with some issues trading for as little as 50 cents on the dollar, compared with around 92 cents on the dollar at the end of June, says Sam Caldwell, an analyst who covers regional banks for Keefe, Bruyette & Woods.

It's mainly individual investors who have borne the brunt of the losses on the agencies' common stock, but regional banks, insurance companies, and other financial institutions have taken the hit on the devalued preferreds, and those with a substantial portion of their capital tied up in these securities can ill afford to have all their value wiped out under a government bailout.

Fannie and Freddie preferreds account for at least 32% of the tangible capital held by two regional banks—Gateway Financial Holdings and Midwest Banc Holdings—and 5% or more for a slew of others, according to an Aug. 25 report by Caldwell. While he believes large-cap banks have limited exposure to agency preferreds, Caldwell found 38 banks with aggregate exposure of $1.3 billion, and 81 other banks that said they didn't hold any preferreds.

A day of reckoning for losses on the agencies' preferreds could be Sept. 30, when firms will need to mark down the value of the assets on their balance sheets to fair market value. A few regional banks have already taken writedowns for other-than-temporary impairment on the preferreds they hold. Earlier this week, JPMorgan Chase said the value of its preferreds has been halved to $600 million this quarter and hinted it will take a charge on those assets when it reports third-quarter earnings.

"What's good for JPMorgan should be good for the rest of the industry," says one analyst who covers regional banks and asks not to be named.

The accounting firm KPMG has been more aggressive about directing clients to write down the value of impaired assets than some of its peers, so all financial institutions that use KMPG as their auditor would be expected to take writedowns at the end of September, says Caldwell. And certainly, if the preferreds continue to trade underwater and the government hasn't made any decision on a bailout, all firms that have invested in the agencies' preferreds would have to take a writedown by the end of this year, he adds.

At least the preferred holders are still getting the dividend they expected when they bought the shares. Earlier this month, Fannie's board slashed the quarterly dividend on its common stock to 5 cents from 35 cents a share to preserve $1.9 billion in capital through 2009. Freddie sliced its 50 cent quarterly dividend to 25 cents in late 2007. The implications for debt issued by the two agencies are harder to figure.

The housing bill that President Bush signed into law at the end of July made explicit the federal government's guarantee of $5.2 trillion in U.S. mortgages backed by Fannie and Freddie, so that debt is presumably free of risk. Although no one has any doubt that the debt Fannie and Freddie issue to finance their own operating costs, all of which seems to be actively traded, would be made whole, the securitized mortgages the agencies have packaged and sold to investors are a different story, says Bill Larkin, a portfolio manager for fixed income at Cabot Money Management, based in Salem, Mass.

"The fear here is that the market participants—most of the stuff was purchased by foreign central banks—will see the risk and stop purchasing it. If that happens, then [mortgage] rates would rise [substantially]," he says. If the government does intervene, bondholders' principal and accrued interest would be protected, but that doesn't mean they would be able to trade the debt easily, he says. Strategists agree that the Treasury wouldn't risk the sanctity of a global banking system by not guaranteeing that debt.

Fannie and Freddie need to refinance about $250 billion in debt in September, and the market will be watching to see how successful they are. Neither agency has had difficulty attracting subscribers to its monthly bond auctions, which makes Larkin think they won't have a problem rolling over the debt that matures next month.

Outside of a bailout, the agencies' subordinated debt would be at risk only if the credit ratings were downgraded to junk, which would force many financial institutions to sell their holdings at big losses, says Larkin. In an Aug. 18 story, Barrons estimated that there is a total of $19 billion of GSE subordinated debt that would be at risk under a government bailout.

The ratings on the subordinated debt are hovering just above investment grade. On Aug. 22, Moody's Investor Service (MCO) lowered its rating outlook on the agencies' AA2 subordinated debt to negative from stable but affirmed their senior debt ratings at AAA.

Moody's also downgraded Fannie's and Freddie's preferred stock ratings to BAA3 from A1, Standard & Poor's Ratings Services on Aug. 26 affirmed its AAA/A-1+ rating on Freddie's senior unsecured debt with a stable outlook but lowered the subordinated debt rating to BBB+, and the preferred stock rating to BBB- from A-, also placing those ratings on CreditWatch Negative.

Michael Wallace, global market strategist at Action Economics, says some of the subordinate debt holders still have reason for hope that Fannie and Freddie can successfully recapitalize on their own. If the government intervenes, though, "it's anybody's guess what anything will be worth."

Despite the increased chatter about an impending bailout, most analysts see no pressing need for one as long as the GSEs hold ample amounts of excess capital on their balance sheets. As of last week, Fannie's excess core capital—above the amount required by regulators—was $9.4 billion and Freddie's was $2.7 billion.

And with $10 billion in mortgage paydowns a month, each company would be able to free up $1 billion of core capital every quarter if they opted not to reinvest these paydowns, according to a Citigroup report published Aug. 21. A point of further irony: Despite mounting foreclosures, Fannie's and Freddie's profitability has been improving lately with margins between their assets and their borrowing costs the widest they've been in many years, Citigroup said. Larkin says it is highly unlikely the Bush Administration will do anything to damage the private-enterprise component of the GSEs.

"The last thing [they] want to do is create another giant division of the U.S. government. That's why things are quiet now. This is a political football," he says. In addition, if the government makes a move that ends up harming the agencies, the Administration wold be chastised for making home mortgages less affordable.

Wallace at Action Economics disagrees. He believes Republicans don't like the quasi-governmental structure of Fannie and Freddie, which doesn't jibe with their view of free markets, and says if the government does take them over, it could just as easily dispose of them, change their mandates, or sell off their assets.

All told, the damage to the agencies' equity and debt investors is hard to quantify, but it will certainly run in the hundreds of billions of dollars. Dan Seiver, a finance professor at San Diego State University, provides one final bit of perspective: However much stock and bond investors stand to lose in the end, it will probably be dwarfed by the total wealth that American homeowners have seen evaporate since the credit crisis started—an amount he estimates will be in the trillions.

GM says US Carmakers Deserve $50 Billion Bail-Out
A top General Motors executive said Thursday that automakers were “deserving” of as much as $50 billion in government-backed loans so that they can build more fuel-efficient cars.

G.M.’s vice chairman, Robert A. Lutz, said the car companies need money to retool their plants but probably cannot raise enough capital on their own because of the tight credit markets. He said the automakers have already made considerable progress in transforming themselves and that the government should help them proceed faster.

“The American auto industry is deserving of government loan guarantees,” Mr. Lutz told reporters at an event near Chicago where G.M. showed off its 2009 lineup. “We have done a whole bunch of things that people said, ‘Why aren’t you doing this?’ ”

The automakers, along with the United Automobile Workers union and Michigan lawmakers, are urging Congress to appropriate $3.75 billion to back the $25 billion in loans authorized last year. They also want more money — up to double the original amount, given the sudden jump in consumer demand for fuel efficiency — and they are urging Congress to act by the end of September so that the money can be available next year.

Critics have denounced the loans as a bailout. Detroit carmakers have announced plans to revamp numerous truck plants so that they can build the smaller cars and crossover vehicles that have become scarce at many dealers. The cost of each conversion is significant, ranging from $75 million at a Ford plant near Detroit that already had a recent major overhaul to several billion dollars at other facilities.

Sales of pickups and S.U.V.’s plummeted this year as gasoline prices climbed above $4 a gallon in much of the United States. In July, large S.U.V. sales were down 43 percent, and sales of full-size pickup trucks declined 28 percent. Automakers have been offering substantial discounts on some models and shutting down the plants that make them to keep inventories from growing larger.

But Mr. Lutz said that interest in trucks had begun to rebound and that big vehicles “still represent a great opportunity to register sales.” Since mid-July, the average price of regular gas nationwide has fallen 45 cents, or 11 percent, according to the AAA motor club.

“We’ve been hearing from some of our dealers that pickup sales have bottomed — same with S.U.V.’s,” Mr. Lutz said. “There has been some resurgence of demand for full-size pickups and sport utilities. Many people still simply need to buy a truck.”

Still, August is expected to be dismal for G.M. and most other automakers. on Thursday projected that total sales for the month would be 14.4 percent lower than a year ago and that G.M.’s sales would be down 27.5 percent. Sales would also be down at Chrysler, Ford and Toyota, Edmunds said.

G.M. said it was seeing a good response to its current promotion, which offers “employee pricing” to all buyers, but Edmunds said big discounts had been overshadowed by the high gas prices and sluggish economy. “Over all, the program has not been nearly as effective as its first implementation back in 2005,” the director of industry analysis at Edmunds, Jesse Toprak, said.

The falloff in truck sales has been devastating to the Detroit automakers because those vehicles historically have generated the most profit. Mr. Lutz said small cars would become considerably more expensive, filling some of the void created by the evaporation of big profits from trucks.

Toyota joins other automakers in warning of more troubles ahead
Even Toyota is not immune to the slowdown in the global economy. The Japanese company, which is battling General Motors for the title of the world's largest automaker, cut its sales forecasts Thursday, warning that higher fuel costs and the economic downturn in the United States and Europe are likely to hold back the auto business at least through 2009.

"We have been going at top speed up to now," Katsuaki Watanabe, the Toyota president, was quoted by The Associated Press as telling reporters in Tokyo. "It is time to set more cautious targets." The Japanese group, which includes Daihatsu Motor and Hino cars, now expects to sell 9.7 million cars and trucks in 2009, Watanabe said, 700,000 fewer than its previous forecast. That is still 2.1 percent higher than the 9.5 million Toyota expects to sell this year.

A big reason for Toyota's more bearish outlook is the 10 percent reduction, to 2.7 million vehicles, in the company's 2009 sales target for the United States, where Toyota has invested heavily in trucks and sport utility vehicles that have lately fallen out of favor. Toyota said it would also be cutting production in Britain and Poland to bring output in line with slipping demand in Europe.

Toyota is only the latest of the global automakers to admit to suffering as inflation and economic weakness in their major markets undermine consumers' buying power, and high gasoline prices drive a shift toward more fuel-efficient, and in many cases, less profitable, vehicles.

Auto sales are slumping in the world's two most important markets, North America and Western Europe. U.S. auto sales fell 10.6 percent from a year earlier in the January-July period, according to Ward's Automotive Group, as the rate of decline accelerated in the second quarter. Western European sales fell 2 percent in the first six months of the year, according to the European Automobile Manufacturers' Association.

The auto industry's pain has been particularly intense in the United States, where Ford posted an $8.7 billion second-quarter loss, and General Motors posted a $15.5 billion loss for the quarter. The Detroit automakers have idled truck plants across North America and laid off tens of thousands of workers. The U.S. automakers are trying to drum up political support for a government aid package.

European companies are also under pressure. The French automaker Renault warned in July that "the deterioration in the macroeconomic environment has far exceeded the worst-case scenarios envisaged," while the German company Daimler said it was assuming that the world economy "would continue to lose momentum as the year progresses." High prices for raw material, rising inflation and the credit crisis, Daimler added, would almost certainly prevent a significant near-term revival.

Toyota's outlook has been hampered by the 20 percent of its U.S. lineup that is made up of big sport utility vehicles and pickup trucks. The company said last month that it had misjudged the speed of the swing in consumer taste toward smaller cars. The announcement Thursday was an acknowledgement of what many analysts had expected.

"It's not surprising, given the market conditions, but I think their forecast might be a little conservative," Tatsuo Yoshida, an auto sector analyst at UBS in Tokyo, said. He predicted 2009 sales would come in closer to 10 million vehicles. "Sales are still growing," he said, "but the pace is a lot slower." And the company disappointed analysts Thursday by declining to provide a forecast for 2010, he said, suggesting that the business outlook remains extraordinarily cloudy.

Toyota and Nissan Motor are more exposed to the current problem than Honda Motor, whose trucks and sport utility vehicles are generally smaller and lighter than its competitors. With its nimbler fleet, Honda has benefited directly from the shift to more fuel-efficient vehicles.

Toyota is working quickly to get back its momentum. It is reconfiguring its U.S. operations, concentrating truck production in Texas, and retooling a Mississippi factory that had been meant for its Highlander crossover vehicle to make its Prius hybrid cars. On Monday, Toyota said it would raise prices on some vehicles in Japan to protect profits, the first time in decades that it has increased prices there on existing models.

The problem of the wrong product mix is weighing even more heavily on U.S. automakers. In July, General Motors dealers reported an average 174-day on-hand supply of the Yukon XL-Suburban, up from a 92-day supply a year earlier. Inventory of Chevrolet's C/K Suburban nearly doubled over the period, to 116 days from 63 days. The U.S. automakers are offering discounts of $10,000 or more on some sport utility vehicles just to get rid of them so that dealers have space to stock more of the fuel-efficient cars consumers are clamoring for.

Watanabe, the Toyota president, also said that Toyota would roll out its plug-in hybrid car in 2009, a year ahead of schedule, though it will be available initially only to corporate fleets. Toyota may be feeling added urgency to get the car on the road, because General Motors said this month that it had "essentially finished" designing its first plug-in hybrid car, the Chevrolet Volt, and said a production-ready prototype would be ready soon. Nissan Motor is planning a purely electric vehicle of its own, which it plans to begin selling by 2010.

And Toyota, which sold 4.8 million vehicles worldwide in the first half to GM's 4.5 million, is investing aggressively in its business, Yoshida said, and will be better positioned once the current problems ease. "When the business environment is tough, the stronger players become even stronger," he said.

Tight Credit Puts Squeeze On Big Three Auto Dealers
The credit crunch squeezing Detroit's Big Three auto makers is now spreading to some of their dealers, adding financial pressure to a group already strained by this year's big drop in auto sales.

The latest and most prominent example is Bill Heard Enterprises Inc., one of the largest Chevrolet dealers in the country, with 2007 sales of $2.1 billion. Earlier this month GMAC LLC, the financing company partly owned by General Motors Corp., stopped doing business with Bill Heard over concerns about financial losses related to the privately owned chain of 14 stores, Bill Heard confirmed through a spokesman.

The weakening credit profiles of GM, Ford Motor Co. and Chrysler LLC and their finance arms are adding a new challenge for dealers. In the past, GMAC, Chrysler Financial and Ford Motor Credit were key elements in how Detroit pumped up vehicle sales. They typically offered dealers easy credit to help them sell as many cars and trucks as possible, even if they gave away some of their margin to do so.

But now that the car makers and their once-lucrative financing units are racking up losses and struggling to raise funds themselves, they are getting tougher on dealers with weak finances. And since GMAC and Chrysler Financial are both controlled by private-equity group Cerberus Capital Management LP, each is now being run to maximize profits, not auto sales.

Tighter credit is "starting to hurt," said Mark Williams who sold a dealership near Cincinnati to Ford earlier this year but still owns two others. "You have less [financing] sources, and the sources you do have today are willing to advance less money," Mr. Williams said.

Other domestic-brand auto dealers around the country are also feeling the pinch. In Sacramento, Calif., Winter Volvo Lincoln Mercury is preparing to close its doors on Sept. 2, after 60 years in business. Also in the Sacramento area, Elk Grove Ford closed at the end of June and Great Valley Chrysler Jeep went out of business in May.

After suffering a big sales drop in the first few months of 2008, Longhorn Dodge, in Fort Worth, Texas, shut down in May. "GMAC has changed due to the economic environment, and it has put more strain on the individual dealership," said Duane Paddock, owner of a Chevy dealership near Buffalo, N.Y., and head of the GM dealer council.

GMAC typically provides dealers with subsidized financing for customers as well as low-interest-rate loans to buy the vehicles they hold in inventory on their lots. The loss of financing from GMAC is likely to make it even harder for Bill Heard and other dealers to improve their financial situation. The Chevy dealer has told GM it is now considering selling at least two or three of its stores.

Neither Chief Executive Bill Heard Jr. nor other executives were available to comment. In a statement, a company spokesman said it "is taking actions" to address GMAC's decision. It plans to "increase [its] efficiency and productivity, tap the emerging fuel-conscious market with an appropriate product mix, reduce our already competitive cost structure and restructure our business."

GMAC declined to comment on Bill Heard. But a spokeswoman acknowledged that "clearly this is a challenging market environment," adding that its actions "are not different than that of other financial-service companies."
In the long run, a dealer shakeout could help the Big Three by reducing competition and improving profits of the dealers who survive.

But turmoil in their retail networks could hurt Detroit's sales in the short term. The tightening of "floor plan" credit will encourage dealers to inventory fewer vehicles. In the past, the Big Three boosted sales by pushing dealers to order more vehicles than they could sell.

Bill Heard normally could help GM prop up its own declining sales. Started in 1919 from a lone Chevy dealer in Columbus, Ga., the company operates huge Chevy stores in Houston; Memphis, Tenn.; Tampa, Fla.; Scottsdale, Ariz.; and elsewhere. But it has had to borrow large sums to keep its megastores filled with inventory and is heavily dependent on GM's Chevy brand, whose sales have plunged this year as consumers have turned away from pickups and sport-utility vehicles

FGIC still faces risks despite MBIA deal
Troubled bond insurer FGIC Corp avoided possible regulatory intervention by reinsuring its municipal bond portfolio with MBIA Inc, but it may still face solvency issues over the long term, according to an analyst report.

MBIA agreed on Wednesday to reinsure FGIC's $184 billion of municipal bond risk and will receive $741 million of unearned premiums from the deal after paying FGIC a ceding fee of about $200 million. FGIC tumbled into junk territory earlier this year on concerns that it would breach minimum regulatory capital requirements and could be taken over by its regulator as losses mounted on complex mortgage-backed debt it insured.

"While the deal will boost capital supporting the remaining FGIC policy-holders, it does little to solve the company's longer-term solvency issues," CreditSights analyst Rob Haines said in a report issued on Thursday.
But the agreement is a positive credit development for MBIA, which lost its top ratings earlier this year due to exposure to troubled mortgage-backed debt, Haines said.

MBIA shares surged almost 35 percent on Thursday to $16.15 and debt protection costs on the holding company and the insurance arm fell. MBIA's credit default swaps declined 2.25 percentage points on an upfront basis to 20.75 percent, or $2.075 million to insure $10 million in debt for five years, plus annual payments of $500,000, according to CMA DataVision.

Terms of the deal, known as "cut-through" reinsurance, may also mean that credit default swaps written on the debt FGIC insures will now be backed by the debt underlying MBIA's policies. The "cut-through" reinsurance means that a policy-holder would seek payment directly from MBIA in the event of a default, rather than approaching FGIC first.

Credit default swaps typically insure against the risk of a company defaulting on its debt. In the case of bond insurers, however, the contracts are backed by the debt the companies have written policies on. When more than 75 percent of the debt underlying a default swap is transferred to a new company the swap also moves, or succeeds, to the new institution.

"The deal's novel feature is the cut-through which (legal opinions withstanding) may cause a succession event in FGIC's CDS to MBIA's CDS," Tim Backshall, chief strategist at Credit Derivatives Research, said on Thursday in a report. FGIC, whose owners include PMI Group, Blackstone Group, Cypress Group and CIVC Partners, guaranteed about $313.9 billion of debt as of the end of 2007.

The deal with MBIA boosts FGIC's capital levels by $1 billion. But it effectively leaves it with a massive structured portfolio and the worst of its municipal bond portfolio, including a $1.2 billion exposure to Alabama's Jefferson County, which is considering a bankruptcy filing.

If this happens, it would be the biggest municipal bankruptcy since California's Orange County filed in 1994.
"The deal will allow FGIC to remain technically solvent for several quarters, but we continue to expect significant deterioration of its structured book and would warn of the potential for significant losses in its public finance book as well," Haines said.

FGIC had statutory capital of $732 million at the end of the second quarter and its claims-paying resources totaled $5.2 billion, according to Haines.

For Lehman, More Cuts and Anxiety
On Wall Street, the ax keeps falling again and again. As the financial industry limps from one bleak quarter to the next, bankers and traders who dodged painful layoffs in the past year wonder if their luck is running out.

The issue gained new urgency on Thursday, as Lehman Brothers, Wall Street’s most troubled firm, prepared to lay off up to 1,500 people in its fourth round of cutbacks this year. Those layoffs, which would amount to about 6 percent of Lehman’s work force, are likely to come before the firm reports third-quarter results in mid-September, according to a person briefed on the plan.

The grim news at Lehman underscores not only the precarious state of that once-proud firm but also the pain afflicting the whole of Wall Street. Banks and securities firms have shed more than 101,000 jobs this year, according to Bloomberg News, as the mortgage crisis and struggling economy brought an abrupt end to years of prosperity for the financial industry. Few think the bloodletting will end there.

“We’re not done seeing headcount reductions on Wall Street in this cycle,” said Jeff Harte, a securities industry analyst at Sandler O’Neill. Lehman has already laid off more than 6,000 workers since June 2007. The expected round of cuts is a stark reminder of a basic truth on Wall Street: in good times, you get rich; in bad times, you get fired.

Like other Wall Street banks, Lehman focused its initial job cuts on its mortgage origination and securitization businesses. Now, as business remains lethargic, jobs in investment banking and trading are on the line.
Several major firms, including Lehman, close their books for the third quarter on Aug. 31, and analysts have been slashing profit estimates.

The continued deterioration of the mortgage market, especially the commercial real estate market and the residential market for borrowers with credit a rung above subprime, bodes ill for banks and brokerages. Other Wall Street business do not look much better. Over the past year, according to Goldman Sachs, merger advisory volumes fell 36 percent, initial public offerings tumbled 75 percent and debt underwriting sank 45 percent.

With Lehman, investors are anticipating poor results. Analysts say the firm could face write-downs of as much as $4 billion and an estimated loss for the quarter of $3.30 a share. Many analysts are shifting their focus to what steps Lehman will take — or announce it will take — to shed its extensive portfolio of troubled securities.

The bank, whose market capitalization has dwindled to about $11 billion, owns about $61 billion in mortgages and asset-backed securities.

“For the franchise (and shares) to turn the corner, we think management needs to announce a significant bulk asset sale or framework for investors to evaluate the structure/pricing of likely asset disposals (and incremental capital, should it be needed),” wrote Patrick Pinschmidt, an analyst at Morgan Stanley. He added that the weak third quarter made this “more urgent (and difficult).”

Lehman executives are examining many options. Among them is the sale of Lehman’s investment management division, which includes Neuberger Berman and could fetch $7 billion to $10 billion. Other options include the sale of about $40 billion of troubled commercial real estate, and the creation of a separate unit that would be owned by Lehman shareholders and house a substantial portion of Lehman’s commercial and residential mortgage assets, freeing the investment bank to try to move forward.

People briefed on Lehman’s plans say an ideal situation would be to put the toxic assets into a separate unit and then recapitalize the investment bank with the proceeds of a sale of part or all of Neuberger and perhaps a capital infusion from abroad.

Lehman’s stock has been rattled by persistent rumors about what the firm’s next move will be. Last week, the stock fell 13 percent and rose 16 percent on two separate days. The shares have lost 73 percent of their value this year, rankling employees and customers. On Thursday, they rose 7.4 percent to $15.87 amid a broad rally in financial shares. Even so, few think the firm is out of the woods.

Top Lehman executives have been knocking on doors all over the world seeking a capital infusion, courting sovereign wealth funds and investors like the Korean Investment Corporation, Korean Development Bank and Citic of China.

But a white knight has not emerged, and another bad quarter — Lehman lost $2.8 billion in the second quarter and was forced to raise $6 billion in equity — will be difficult to manage in the deteriorating environment.

Concerns for Spanish banks after downgrade on mortgage securities
Fitch Ratings has downgraded six sets of Spanish mortgage securities issued by Banco Santander, heightening concerns that the damage from Spain's property crash is spreading to the country's strongest lenders.

The loans were "sliced and diced" and packaged in an identical way to sub-prime mortgage bonds in the US, belying claims by the Spanish government that the country had avoided the sort of lending practices seen in Anglo-Saxon economies.

The cluster of residential property securities, worth €4.06bn (£3.27bn), were all based on mortgages that exceeded 80pc of the house value, and many were 95pc or even 100pc. They were all issued in 2007 at the height of the property boom. Fitch downgraded the lower tier A, BBB, and BB tranches of the securities. The upper levels remain stable.

Santander said it had kept an entire block of €1.23bn of loans - known as Hipotecario 4 - on its books after the security was issued in October. By then the market had frozen. The second block of €2.83bn issued earlier in 2007 was partially sold, mostly to investors in Northern Europe.

The pattern that emerges is eerily similar to the final stage of the US sub-prime debacle. The big difference is that the Bank of Spain prohibited the use of structured investment vehicles (SIVs).

Fitch said the loss provisions on the debt suggested a write-off of 35pc against book value. "What they are effectively saying is that property prices in Spain are going to fall by almost that much," said Andy Brewer, the agency's senior director for structured credit.

The arrears rate on the most recent vintages has reached 7pc to 8pc, with high levels of default among foreign residents. Fitch said it suspected that British and other North European owners of second homes in Spain were throwing in the towel.

This may create serious legal complications. British owners may assume that they can walk away from a Spanish property that has fallen into negative equity. In fact, they can be pursued for the assets and income in Britain until the outstanding debt is paid off.

A one-third fall in Spanish property prices goes far beyond the sort of correction expected by most economists in Spain, and would cause havoc to the banking system. Official data shows that prices have fallen 3.9pc over the past year, although property developers say the actual drop has been much sharper.

Santander itself is a well-capitalized lender with global operations and can almost certainly cope with any losses, but the smaller regional banks and "cajas" would face serious stress under such a scenario. Santander's overall arrears rate on its Spanish property loans is now 2.5pc. The bank's non-performing loans ratio is 1.34pc, which is low compared to other European banks.

Sources close to the bank say the writedowns on the securities are based on rising arrears caused by high interest rates and job losses.

UK unemployment to hit 2 million, house prices to fall more than 30%
In an unprecedented move, a member of the Bank of England's Monetary Policy Committee (MPC) has criticised the Bank for complacency and "wishful thinking", predicting that two million people will be out of work by Christmas and that house prices will fall by more than 30 per cent.

David Blanchflower, who has consistently warned of the perils facing the economy, attacked the Bank's current thinking. "To sit and worry about inflation expectations, rather than worry about the fact that the economy is going to go into a recession, seems to be misguided," he said.

"People have to start to respond to the fact that we are in a recession and the danger is we'll be in a very serious and long-lasting recession unless we do something. This is a call to action." He demanded a substantial cut in interest rates and said the Bank's latest forecast of "broadly flat" growth "certainly has a great deal of wishful thinking attached to it".

Mr Blanchflower's unemployment forecast would mean 330,000 more people losing their jobs by the end of the year – banks and construction firms being the first to lay staff off, he believes. The MPC – charged by the Government with the task of setting interest rates – meets next week to fix rates; few expect an immediate cut, despite the warning.

Mr Blanchflower is an external member of the MPC, which is chaired by the Governor of the Bank of England, Mervyn King. Intellectual tensions between the MPC's membership have become more apparent in recent months, with the emergence of a three-way split revealed in the MPC's minutes.

One "hawk", Tim Besley, also an external member, has recently been voting for a quarter-percentage-point increase in rates, with Mr Blanchflower, the so-called "arch-dove", habitually opting for a cut of the same size, or more.

A majority in the MPC has voted for no change since May, torn between fear of accelerating inflation and a slump that would see price rises way below the official target of 2 per cent a year. The Bank's rate stands at 5 per cent, having been cut by 0.25 per cent in April. The Bank of England maintains that all MPC members are supposed to put forward an independently formed view eloquently and vigorously, as equals.

However, Mr Blanchflower's passionate rebelliousness and criticism of fellow MPC members may not be welcomed in the Governor's parlour. "I feel a weight on my shoulders," Mr Blanchflower told Reuters. "I feel that things I have been fearful about have come to pass and I have actually been pretty accurate in what's coming and I have failed to convince the others of what is appropriate.

"People need to understand that sometimes you will have to focus on the timing of issues. I think people have become complacent and they have not understood what would happen if an economy starts to slow fast, if firms start to close. What we have now is a turning point in many ways – certainly you might think of it as a paradigm shift. We have a global financial crisis, an oil shock coming [and] people with little experience of what is really going on."

Sterling fell on reports of Mr Blanchflower's comments, as traders marked up the chances of the Bank reducing rates sooner rather than later. A quarter-point in November seems to be the most likely outcome, later than Mr Blanchflower urges but presentationally easier for the Bank, given that the "spike" in inflation at 5 per cent or more should by then be over.

On the day that the Nationwide Building Society reported that property prices had fallen by more than 10 per cent a year for the first time since the crash of the early 1990s, Mr Blanchflower warned that worse was to come.

"I thought 30 per cent was the potential fall we could see," he said. "I think that might even now be optimistic. I think 30 per cent does look a fairly optimistic number and markets are now coming around to that view." Such a house-price fall would plunge around two million owner-occupiers into negative equity.

British house prices falling fastest in 18 years
Prime properties in the heart of rural England have finally been drawn into Britain's sliding housing market, it emerged today, as Nationwide Building Society reported that prices are falling at their fastest annual rate in almost 18 years.

Savills, the UK property agency that specialises in the high end of the property market, said that deals involving country piles worth up to £5 million are declining, following a 45 per cent fall in transactions in Central London where prices fell by 7 per cent. The company said: "Prime country property was initially less affected than London but is now following suit."

The company confirmed that it will cut jobs as a result of the dire market conditions but declined to comment on how many staff will lose jobs. In the UK alone, Savills employs 3,000 people.

Nationwide, the UK's largest building society, said the decline in house prices was now reaching double digits and falling at a rate not seen since the fourth quarter of 1990. In its latest monthly assessment of the market, the society said the price of a typical house had fallen by 10.5 per cent over the last 12 months to £164,654.

The monthly drop in house prices accelerated to 1.9 per cent in August, Nationwide said. The society said that prices fell by 1.5 per cent the previous month. With house prices falling steadily since last October, according to the lender, it means that the housing market has been in steady decline for almost a year.

Fionnuala Earley, Nationwide's chief economist, said: "Recent activity levels in the housing market have been very subdued.
"Housebuilders, in particular, have been reporting significant reductions in site visits and reservations of new properties since this time last year in spite of a big increase in the use of sales incentives."

Yesterday, it emerged that Taylor Wimpey, the UK's biggest housebuilder, is selling less than half a house a week on each of its sites, despite offering substantial incentives to homebuyers. Uncertainty over house prices has prompted speculation that thousands of estate agents will be made redundant.

Foxtons, the private equity-owned estate agent, appears to be under increasing pressure over the terms of an attempted financial restructuring. Reports today suggested that lenders to Foxtons had called in Close Brothers as an adviser after failing to syndicate £270 million of the debt used to back the buyout of the estate agency by BC Partners, the UK private equity group.

The latest data from Nationwide come after figures from the British Bankers' Association earlier this week showed that mortgage approvals fell 65 per cent last month. The Council of Mortgage Lenders reported that lending to the embattled buy-to-let sector had dried up.

Today's figures from Nationwide, traditionally among the least conservative of house price monitors, comes after Halifax, a rival, said house prices fell 1.7 per cent in July and at an annual rate of 8.8 per cent.
Halifax reckons that the average house price was £177.351 in July.

The Treasury minister who thought the housing crash was a joking matter
Vince Cable held a press conference this morning to outline various ways to ease the pain in the housing market. I’m not sure any of his suggestions will make a massive difference (they include letting housing associations borrow more to buy up empty homes***).

But credit to the Lib Dem Treasury spokesman, who has long been alert on this issue. As he reminds us, Labour MPs were literally laughing at the idea of an imminent housing crash - as recently as the spring. Here, as a sorry reminder of government complacency, are extracts from the Hansard account of a debate in April on a Lib Dem-led motion on the housing bubble:

Angela Eagle, exchequer secretary to the Treasury: “The Liberal Democrat motion has been much commented on, possibly because it reads like the storyboard for “Apocalypse Now”, or perhaps even “Bleak House”. According to the motion, we are facing an “extreme bubble in the housing market” and the “risk of recession”, and we must “act to prevent mass home repossessions”.

Presumably that is why the hon. Member for Taunton (Mr. Browne) got through his entire speech without mentioning any of those things until the last minute—they obviously keep him up late at night.

Fortunately for all of us, however, that colourful and lurid fiction has no real bearing on the macro-economic reality. In difficult economic times—here I find myself in agreement with the hon. Member for Fareham (Mr. Hoban)— [ Interruption. ] —at least in part; I do not want to get him into trouble. In difficult economic times, it generally pays to remain calm and to apply a cool, analytical mind to the situation.

Hysterical over-reaction, as this motion demonstrates, might attract a few cheap headlines and some doom-laden Lib Dem press releases, and it might even frighten a few voters ahead of local elections, but it is not mature or responsible, as my hon. Friend the Member for Leeds, East (Mr. Mudie) took some time to point out. Now that we have had “Apocalypse Now” and “Bleak House”, I am going to talk about “An Inconvenient Truth”, which is that the economy is strong and stable.”

ater…. Siôn Simon (Birmingham, Erdington) (Lab): ”It is alarming me to discover that people as esteemed as the Liberals think that we are in the grip of an “extreme bubble”. If we are in an “extreme bubble” now, could she tell us what sort of bubble we were in during the early 1990s when people’s homes really were being repossessed by the hundreds of thousands?”

Angela Eagle: ”…Because our economic fundamentals are right, we can look forward with reasonable expectation to getting out of this situation. The housing situation will be unwound in a relatively calm and orderly way, which is what people need to know.”

Calm and orderly, you say?

*** This now seems to be the government’s big idea, according to The Times on Friday morning. Questions for the government: where will the money come for councils to buy up unwanted homes (occupied or otherwise)? Will central government give billions of pounds to local authorities (if so from where?). Or will it let them borrow more (if so from whom? Most banks are in retreat from anything property-related). This sounds more like a useful mopping-up exercise rather than a measure which will make much difference to the crash.

Expect an official announcement on Tuesday. It will also be interesting to see what’s changed since Caroline Flint spoke to the FT in June:

The housing minister is pressing ahead in the area where she believes she can make a difference - using the clout of public sector bodies to help housebuilders, not only by buying thousands of new-build homes from them, but perhaps by changing payment terms so registered social landlords pay more upfront.

Ilargi: England is asking Bulgaria for advice on how to work this......

Property crash opens door to the new government-owned (council) house
Gordon Brown is set to usher in a new era of council housing by helping local authorities to buy repossessed and unsold properties. Cash and powers will be made available so that town halls can intervene in the housing market, The Times has learnt.

The measures – which could be announced as soon as Tuesday – will encourage councils and housing associations to offer struggling borrowers financial help in return for a stake in their homes or outright ownership. The number of council homes has plummeted since 1981 from 6.1 million to 2.5 million. Hundreds of millions of pounds of extra cash earmarked for social housing could now be released early to buy up newly built properties.

It is understood that town halls will also be encouraged to emulate Liverpool’s local authority, which offers first-time buyers help with deposits in return for a small equity stake. Other options, including a stamp duty holiday, are being held back for further consideration. The news came as Mr Brown’s plan for eco-towns unravelled further when Tesco became the latest developer to withdraw its bid.

The scale of the housing crisis was underlined yesterday with the biggest drop in prices since 1990. The latest monthly fall – the tenth in a row – means that the average property has lost 10.5 per cent of its value in the past 12 months, according to the Nationwide building society.

Alistair Darling, the Chancellor, and Caroline Flint, the Housing Minister, have been working for three months on measures to invigorate the mortgage market, particularly for first-time buyers, and to cushion those affected by rising repossession rates. Up to 300,000 homeowners are already in negative equity. Vince Cable, the Liberal Democrats’ Treasury spokesman, said that this figure could quadruple.

David Orr, the chief executive of the National Housing Federation, said that the new mortgage rescues would be open to those on low incomes, particularly young families. Gideon Amos, of the Town and Country Planning Association, said that allowing councils to intervene would help the whole market.

It is estimated that 4,000 estate agents have lost their jobs and that this could rise to 10,000 by the end of the year. Savills said that country homes worth between £1 million and £2 million fell in value by 5.2 per cent in the three months to June.

Pakistan Sets Floor on Stock Prices to Stop Plunge
Pakistan set a floor for stock prices on the benchmark exchange, moving to halt a plunge that has wiped out $36.9 billion of market value since April.

Securities can trade within their daily limit of 5 percent "but not below the floor-price level" of yesterday's close, the exchange said on its Web site, without giving details. The Karachi Stock Exchange 100 index capped a six-day, 16 percent slump to 9,144.93. Trading starts at 9:45 a.m. local time.

The exchange is working to restore confidence after President Pervez Musharraf quit on Aug. 18 to avoid impeachment, and ruling alliance members nominated rivals for the presidency. Investors stoned the exchange last month after it removed a 1 percent daily limit on price declines. Today's decision follows a collapse in the index to the lowest in 26 months.

"This could cause liquidity to dry up because who wants to buy if they can only pay a higher price?" said Daphne Roth, Singapore-based head of equity research in Asia at ABN Amro Private Bank, with about $30 billion of Asian assets. "Risk appetite is low and investors are avoiding markets where there is political instability."

Pakistan's biggest political parties on Aug. 26 proposed rival candidates to replace Musharraf in a Sept. 6 parliamentary vote. Asif Ali Zardari, head of the Pakistan Peoples Party, will compete with nominees including former chief justice Saeed-uz- Zaman Siddiqui, put forward by Nawaz Sharif, leader of a faction of the Pakistan Muslim League.

Sharif quit the coalition on Aug. 25, accusing Zardari of reneging on a pledge to reinstate judges fired by Musharraf. Stocks have plunged on concern the political instability will blunt government efforts to tackle a rising Taliban insurgency, grapple with inflation at its highest in 30 years and revive the faltering economy.

"The market is definitely in a condition where it will need some extraordinary measures," said Nasim Beg, who manages the equivalent of $370 million in stocks and bonds as chief executive officer of Arif Habib Investments Ltd. in Karachi.
Pakistan's stock market value plunged to $38.8 billion on Aug. 26 from the peak of $75.7 billion on April 4.

Police and paramilitary forces ringed the exchange on July 17, a day after hundreds of investors stoned the building and shouted anti-government slogans. The Securities and Exchange Commission of Pakistan, which had imposed a 1 percent daily limit on price declines, was forced to remove the measure as trading volume plummeted. The commission sought to halt a slide that wiped out $30 billion of market value in three months, threatening to undo a 14-fold rally since 2001.

"Freezing the index would not be a good idea," said Habib- ur-Rehman, who manages the equivalent of $91.5 million of stocks and bonds at Karachi-based Atlas Asset Management Ltd. "Direct intervention in market movements would lead to further complications as we have seen in the recent past."

Japan Plans to Spend 2 Trillion Yen on Stimulus Plan
Japanese Prime Minister Yasuo Fukuda, facing elections within a year, plans to spend about 2 trillion yen ($18 billion) to revive the world's second-largest economy.

Included will be 400 billion yen earmarked for a small and midsize company credit-guarantee program that would back about 9 trillion yen of loans, bringing the size of the package to 11.7 trillion yen, the government said in a statement in Tokyo today.

"Most of this is just padding from lending-related measures," said Richard Jerram, chief Japan economist at Macquarie Securities Ltd. in Tokyo. "It looks as though the genuine spending-related components will be 1 trillion to 2 trillion yen spread over a year, which is insignificant."

Fukuda's popularity has fallen by half since he became leader of the ruling Liberal Democratic Party last September, amid disputes with the opposition-controlled Upper House and after he re-imposed a tax on gasoline in May. Economic and Fiscal Policy Minister Kaoru Yosano said the government won't issue new bonds to pay for the 2 trillion yen of spending, which also includes providing medical benefits for low- income elderly people and improving earthquake resistance of schools.

"The program earmarks 2 trillion yen in real spending, but probably barely half of it will contribute to boost GDP," said Kyohei Morita, chief economist at Barclays Capital in Tokyo. "The government needs to provide steps to encourage spending by companies and households, but no such steps are in the package."

"The emphasis of this plan is on helping out small and medium-sized companies, agriculture, the forestry and fishing industries and other enterprises affected by rising oil prices," Fukuda told reporters in Tokyo today. Japan already has 778 trillion yen of outstanding debt, which at 147 percent of gross domestic product is the largest among industrialized nations.

Yosano said the government is "still on track" to meet its goal of balancing the budget by 2011 to contain the debt. Yosano said the government was also considering tax cuts for low-income earners, without specifying their scale or how they would be funded. Debate over the package exposed divisions within the ruling coalition.

"The LDP had to compromise for a tax cut because they are afraid of losing New Komeito party support before an election within a year," said Takehiro Sato, chief Japan economist at Morgan Stanley in Tokyo. "These measures will probably push up the gross domestic product only by about 0.2 percent and that isn't much for the economy in a recession."

LDP Secretary General Taro Aso said the government should consider postponing its budget goal because the economy may be in a recession. The New Komeito Party, the junior coalition partner, advocated a bigger spending program. In contrast, Yosano and Finance Minister Bunmei Ibuki, both of whom were appointed in a Cabinet reshuffle this month, stressed the need to maintain fiscal discipline.

The economy shrank an annualized 2.4 percent last quarter, the most since 2001, and the fastest inflation in a decade is eroding the spending power of consumers amid sluggish wage growth. Last month Japan's 250,000 commercial fishermen staged the biggest strike of its kind demanding the government ease the cost of running their boats.

"Fukuda just wants to demonstrate to the public that he's trying to do something about the deteriorating economy," said Jiro Yamaguchi, political science professor at Hokkaido University in northern Japan. "The countdown for a general election has started."

Foreign spigot off for US consumers
As US public attention shifts from the Olympics to running mates and the celebrity "news" de jour, the infrastructure beneath your house is termite-infested. Just beneath the nicely painted exterior and behind all the new appliances, doubt is boring through the beams, gnawing at the studs.

Alongside falling prices, rising mortgage rates, stricter credit conditions and general malaise, the structure that supports American home ownership is being condemned by market valuation. Fannie Mae and Freddie Mac have nose dived and been downgraded toward a smaller future - and these are more important names for your future than Joe, Sam, Kathy, Mitt, Meg ...

Fannie Mae was created in the depths of the Great Depression to decrease foreclosure and increase home ownership. In 1968, it was re-chartered as a public company, removed from within official government agency status. Freddie Mac, since its inception in 1970, has financed 50 million homes.

Fannie and Freddie mission statements make clear, they exist to facilitate, ease and cheapen home ownership. They do this by acting as liaisons between international capital markets and mortgage seekers. They borrow at preferential rates - based on the implicit/explicit - assurance of the US government.

Borrowed funds are used to buy mortgages and bundles of mortgages. They provide credit guidelines and purchase mortgage issued by banks. This reduces banks' risk and provides banks with more cash, more quickly to make more loans at lower costs. These firms, then, exist to facilitate, ease and accelerate bank lending for home purchase.

Fannie and Freddie form a central hub between lenders and investors. After they buy American mortgages, they bundle sell and guarantee repayment. This transforms mortgages into investments for banks, corporations and governments all over the world. Your home mortgage, bundled with many other folks' mortgages, is sold, repackaged and assured by Fannie and Freddie.

This reduces risk and assures global savings flow in to support American purchases of homes. International investment is the foundation on which our home ownership was built. Well over US$1 trillion of our mortgages have been sold to foreign investors this way in the recent past.

As you sit down and read this, your mortgage may well be "owned" by a firm, individual or central bank thousands of miles away. This relationship is neither healthy nor sustainable in its present form. Rising defaults, falling dollars and the sheer size of past borrowing are turning people off to American mortgages. The foundation below our houses is shifting.

What we are witnessing is the breakdown of the link between middle-class America and the global financial markets it has over-tapped across the last several decades. Fannie and Freddie were the support infrastructure connecting houses to capital market access. They have been caught with weak financials, swollen balance sheets and escalating default, just like the home owners they assist. The size of their retained mortgage portfolios is truly gigantic.

The extent of the firms' guarantee commitments is global in scope. Sixty-six global central banks buy loans bundled and or backed with Freddie Mac and Fannie Mae involvement. As of June 30, 2007 foreign entities and individuals held over $1.4 trillion in securities of US agencies such as Freddie and Fannie.

Fannie Mae's June 2008 statement declares a gross mortgage portfolio of $750 billion and guarantees of mortgage backed securities and loans of $2.6 trillion. Freddie Mac's June statement details a retained portfolio balance of $792 billion and a total mortgage portfolio balance of $2.2 trillion. These two giants have retained interest in over $1.5 trillion and guaranteed over $4.5 trillion in mortgages, mortgage backed securities and loans. There are $11 trillion in outstanding mortgage liabilities in the US.

The US housing market continues to melt down with dire consequence. In the seven years from 2001 through late 2007, household real estate value increased by $8.873 trillion to $22.495 trillion. It has since fallen by $4,2 trillion. Many claim we are at or a near a bottom. These claims should be viewed with extreme weariness. The housing downturn is not over and it will take a while after it is over to judge the damage.

The search for parallels with today yields little. The closest one finds is the interesting decline in home ownership across the period 1905-1920 followed by a surging rise across the '20s and then collapse across the 1930s. Fannie was born of this collapse, the ideology of The New Deal and sense that government-driven market interventions could broaden home ownership in America. This was a success. Home ownership did grow spectacularly across the period from 1938-2007. It is falling now as Fannie and Freddie flounder.

In 1940, US home ownership stood just below 44%. At the start of 2008 68% of Americans owned their home. Over the decades, Fannie and Freddie changed, middle-class America changed and the global financial realm underwent several revolutions. The last and most transformative revolution involved the rise of securitization and integration of global financial markets.

Securitization involves transforming assets and promises of future payment into financial products for sale to investors. International financial integration tears down the walls between national banking systems and allows savings, loans and payments to be gathered and transferred across international boundaries.

A world of wealth poured into US real estate through securitization and deregulation. This flow was channeled and molded by the actions of Fannie Mae and Freddie Mac. The decline of these firms will have dramatic and long-lasting implications for home mortgage finance. This will impact the price of American homes, the cost and ease of borrowing for home ownership.

Housing prices have further to fall and global savings will likely never be lent to American consumers at recent percentage levels. Across the past few years America has been borrowing over 50% of the world's internationally available savings. The diminishing role of Fannie and Freddie will impact more people, for far longer than presidential running-mate selections. Policy makers and managements in Fannie and Freddie are stuck. Today's consumer strength, their missions and international financial realities no longer align.

We face a housing finance future different from the recent past. Fannie and Freddie will not be able to function in the same way, or to the same extent. The debates about and plans for these firms will touch millions of families through housing prices, finance terms and cost. Fannie and Freddie are much more important than Joe, Sam, Kathy, Mitt, Meg


Anonymous said...

If only Politicians had the courage to tell it like it is.
Obama was great last night, however no politician is willing to say NO to GM and other 'bailouts'.
The fear to call it what is it has brought us to this breaking point as a nation.
If only more folks knew that the ship was sinking they could have and would have done more to change the way they live in order to survive.
Thank you Ilargi

Anonymous said...

I've sent my family some articles about the financial crisis, about the number of banks failing, about foreclosures, about limits on credit cards being reduced.
One sister said to stop sending such pessimistic articles because she didn't have time to read them. Besides she had a vacation to plan.

If my family is still so clueless, most of America is too. Even if politicians had the courage to tell it like it is, majority of people would not believe it, until they are jobless and can no longer buy anything on any credit card.

I am grateful to have found Ilargi and Stoneleigh to read, to better prepare and survive.
Anonymous Reader

OuttaControl said...

@bicycle mechanic yesterday:

Thanks for the heads up on your various points. I'm not sure what constitutes an expensive bike tube where you live but MEC has 26 X 2 Shraeders for a little over US$2. That is, if they have any left after I put in my order today ;)

Michael said...

Who is really surprised that people don't want to hear the bad news? Most people think they OWN their house, even though they still make vast Mortgage payments or own their car even though they still pay down the credit on it.

As it was put here a while ago: People have confused Credit with Money. No wonder the reality hasn't hit home yet.

bicycle mechanic said...


I'll check them out. I was ordering bearings etc from United Bike Supply, and they were out of tubes. I'll have to check on that size for their cost. I was looking for 26 x 1.5-1.75. They weren't the cheapest tube by manufacture choices, but a decent tube. I'm back ordered on several items for a couple of weeks. The sales tech said that the tubes had gone up and supply was gone. He said they had been busy.

A local shop here I went into were out of tubes on common sizes, owner said supplier issues. And I saw some comments on a bike forum saying the same thing.

I suspect new/more demand.

OC are you on the west coast of Canada. Might have something to do with cost. Shipping from west to Midsouth US from Oregon is not cheap anymore.

Anonymous said...

I have given up on telling other people about the coming deluge. Of the many I have tried to tell, none, to my knowledge (including some that said they agree) have changed the way they live at all. It is just too painful to leave the party while the music is still playing and everyone is having a good time. It is the American Dream twist on Martin Luther, "If I knew the world would end tomorrow, I would still buy me a new SUV today". Anyone who wants to know what is going on can easily look on the internet and find out; Most just don't want to know.

OuttaControl said...


Why don't we take this private; I doubt others are interested.

outtacontrol at ymail dot com

Iowa Boy said...

I've whipped up a diary contrasting the economic effect of bailing out Ford/GM (putting off consequences) with putting that money into rail electrification(economic growth).

We will do the wrong thing, unless F+GM are permitted to unwind in the 11/4/08-1/20/09 timeframe.

brimstone said...

heads up

End of a huge world bubble

If that is true, then the theory I laid out above, that we are witnessing a peak in a parabolic finance/asset/stock bubble of world proportions, is going to pan out. I think the entire credit crisis can be looked at from that perspective. We are merely witnessing the relentless unwinding of the biggest financial bubble in history. And, ominously, this particular bubble has grown from the end of WW2 to the present. That is one HUGE economic bubble, and this one envelops the entire world. This is not just a bubble in one country’s economy.

The point of emphasizing it’s from the end of WW2 is that we are not talking merely about a banking crisis, or whatever. We are talking about the deleveraging of the greatest economic/finance bubble in history. Once the level of leverage reached 60 to 1, it becomes impossible to stay ahead of the deleveraging, even for central banks. The implications are staggering. Every major economy in the world is involved. The outcomes of deleveraging this monster bubble, represented by the green oval, will be what I term Credit Crisis II. At 60 to 1 leverage, a loss of 1 to 2% wipes out the capital.

Whether it’s the Chinese Central Bank (BOC), the Fed, the ECB, and then all the other world financial institutions of every type, insurance companies, gigantic retirement funds, other banks, you name it, the present losses of capital to the world financial system is pervasive worldwide.
Nobody will escape the wrath of this deleveraging, and that is why I call it Credit Crisis II. Credit Crisis I was only the preliminary round…Credit Crisis II is characterized by the realization that the gigantic losses of capital cannot be purged from the financial system, even with big public bailouts. And that this deleveraging cannot be stopped. There are too many interlinkages. And, without writing a book on this, the next victim when Credit Crisis II unfolds, will be massive world currency instability. This will make any of the banking and currency crises we have seen since WW2 look like child’s play. It is not clear when Credit Crisis II begins but it is threatening already.

Per the article linked in todays debt rattle, Spain is on the verge of collapse. It looks possible that Spain could be the trigger of the global melt down. It seems clear to me that Spain is the guilty party that is taxing the resources of the ECB. When the ECB pulls back Spain is toast and starts the global chain reaction of currency collapse. ALL of the FIAT currencies. Got shiny metal?

OuttaControl said...

Brimstone, you write ...starts the global chain reaction of currency collapse. ALL of the FIAT currencies. Got shiny metal?

Seems to me that financialsense views the solution to all financial problems as owning gold; hyperinflation or, as you just alluded to in your excerpt, the obvious deflation that has begun. Does it make sense that gold is the answer no matter what happens?

Anonymous said...

brimstone - thank you for Christopher Laird article. Another piece of the puzzle that shows how quickly this credit bubble could burst.
Anonymous Reader

Ilargi said...

The Chris Laird article is nice, but...

It doesn't say anything that I haven't been saying here for a long time, or Stoneleigh for that matter. So what's the added value? That someone agrees with me?

Taking the timeframe all the way back to WWII is a little extra spice, but then again, I would have no problem making a case for a bubble that started in 1913 or 1932, so it's not a particularly impressive detail.

It's an OK piece, but, seeing that Financial Sense is a highly ranked finance site, it's strange that it didn't appear there years ago. You'd shudder to think Laird figured this out yesterday morning.

What have they been advising their clients until now?

Anonymous said...

the hosts of financial sense talk radio have been talking about the issue of inflation/deflation lately. they are the strong believers of hyperinflation and have put the probability of deflation at 5% without explain how the number is derived at.

Stephen Leeb in his books about peak oil and economic collapse has predicted overall inflation trend with spells of deflation in between. Leeb, known for his capital management firm and news letter, also earned his Ph.D. in psychology.

someone has argued that TPTB needs to create the deflationary scare in order to justify their inflationary actions.

another argument is that gold is money (rather than just another commodity), so it is something good to have no matter inflation or deflation.

brimstone said...


you are 100% correct in that you have been making similar calls. I give you and Stone Leigh all the credit and thanks in the world for the knowledge i have pickup due to your hard work. I have only known of your blog for about 3 months so i am not an expert on what you have covered before.

What got me win that article was house it put the pieces together. Seeing the same think from different angles is very helpful for me and the linked article was an opportunity to see the situation from a different angle. I was only trying to share my "awe" for lack of a better term to awakening to the real mess.

I am the equivalent of a toddler who just learned to walk and doesnt know what direction to head in first.

Also ( and please do not be insulted) your thoughts and analysis here are extreme compared to the "mainstream". To see the same ideas you have discussed else where really reinforces them and forces me to accept what you have clearly pointed out.

Finally, while i am no expert, my personal conclusion is that holding physical gold an silver is the smart choice for me.

brimstone said...

Does it make sense that gold is the answer no matter what happens?

maybe, it depends on your reason for holding it. for me the answer is yes. i see precious metal as a store of wealth

OuttaControl said...


Last year when my parents said they were considering buying some property to flip in BC, I knew the real estate bubble had topped in Canada. Similarly - and Mish talked about this recently - gold is very probably exeriencing a similar price bubble itself. The 'common' wisdom that we are experiencing (hyper)inflation has gotten into the psyche of the retail investor; witness the physical shortage of American Eagles.

But when the populous realizes that Bernanke/Trichet can't/won't print currency as promised, I suspect that assets of all types - including gold - will be madly converted into the most tangible form of money there is; cash.

I suppose there's a certain amount of gold a person could have on hand (i.e. NOT in a bank) just to hedge bets but I wouldn't accumulate that much, personally, although it might be a good thing to buy in a few years when I think it will be much, much cheaper.

BTW, did you hear about that company in the states who paid his employees a nominal face amount ... but in gold, so his employees could reduce their income taxes? Smart. But I think he got busted just the same.

CrystalRadio said...

Micheal you said:

As it was put here a while ago: People have confused Credit with Money. No wonder the reality hasn't hit home yet.

Just to add to that, the step after that is to not confuse money with wealth.

Money is just the next step closer to true wealth, which could be just sitting in a tree eating bananas and saying things like "me Tarzan you Jane".

I think there could be one more step made of gold before true wealth though. (or for Canadians alone - Canadian Savings bonds:)

Anonymous said...

ilargi and stoneleigh - I appreciate all you both write here, I am deeply grateful I found your website which I only found in March. Until then, like most people even now, I never knew there was a crisis in the financials. When I find other writers who agree with you, it helps my slow small brain to better comprehend the the enormity of what is to befall the world. Thank you.
Anonymous Reader

Anonymous said...

I am confused. Is gold a commodity? Will deflation make gold worthless?

I hear some people say that they won't be able to eat gold or precious metals in the coming collapse. Gold has to be converted to currency or cash to be exchanged for goods, right?

Here is a food for thought question directed at any participant of this blog:

If at this time one cannot buy land and store food and other necessities, is it better to keep cash (currency) in a hidden safe place or buy gold and keep it in a hidden safe place?

Thank you.


Greenpa said...

I have a small reference to TAE and the psychology of herds here, which you might like-
Reality Free

Anonymous said...

Hi Ilargi
I wonder what you think about the rest of the world(particulary Europe).
Will we in EU suffer as bad as you believe in US.

brimstone said...

serious question:

per several recent articles posted by Ilargi and SL, the financial sense article i linked, and several itulip articles i have read, It looks like the trigger for the collapse could come from europe and the ECB.
My question is, if we are looking at not just an american financial collapse, but a global financial collapse (hooray for globalization), then what difference does it make if it takes the form of rapid deflation or rapid inflation?
I am not trying to be flippant, but it seems to me that if the global banking/finance system collapses paper currency of any form is worthless.
am i missing something here? because from what i see, if the US or Europe goes down, we all go down