Baltimore, Great Fire of 1904. Electric Railway Powerhouse
Ilargi: It is clear that after this weekend, as the state of Texas will be hit by a storm the size of ... the state of Texas, -possibly large- parts of it will never recover, nor ever again be the same.
There is a metaphor in there for the Wall Street banking system. After this weekend it will never be the same.
There are pretty desperate negotiations over Lehman going on into this morning, and it looks by no means sure that a deal will be done. For one thing, the Treasury and the Fed seem to want nothing to do with doling out more funds, on the heels of the $5.5 trillion taxpayer tab for Fannie and Freddie. There is an end even to that sort of largesse.
Then again, which private party will be willing to take the risk to buy into the -at least- $52 billion in debt Lehman is exposed to? The reason the talks are so frantic lies hidden in Lehman’s involvement in the global derivatives trade, an involvement that could cause a cascading storm surge throughout the global financial system to the tune of untold trillions of dollars, where one gamble covers the next bet covers the next gamble. Rinse and repeat.
Lehman’s market cap may be a mere $3 billion, its damage potential may be 1000 times bigger.
That leads us face first into the true state of affairs in the world of finance. The US banking system, as a whole, is insolvent. It doesn’t have the money to support its commitments. Plain and simple. And it’s not just the banks; the entire US financial system is insolvent.
On Monday, Lehman’s will be history, one way or another. And the next set of American orphans are lining up in front of our eyes: AIG, Merrill Lynch, Washington Mutual, Wachovia, Ambac and MBIA, none of them can survive unless there is divine intervention.
Really, the whole sytem is insolvent. Not every single part of it, but at least 85% of the parts. And if that many cogs in a machine fail, chances are that the whole apparatus will stop functioning.
But that’s still not the whole picture: the whole global financial system is insolvent too. Europe is sliding fast, Japan has the largest public debt on the planet, China’s production is sputtering for lack of clients, Russia puts large amounts of money into its economy.
The international banks, like their US counterparts, all have large amounts of paper in their vaults that has been creatively valuated using computer models programmed using generous prescriptions of Prozac and LSD.
Going back to the US for a moment: commercial-bank loans from Fed emergency windows rise to a record $19.8 billion, U.S. government debt balloons to $5.3 trillion, home foreclosures climb again in August, retail sales are slumping, the trade deficit is soaring. Is there anyone who believes that an orderly buy-out of Lehman will reverse all that mayhem?
No, we need to add another one to our list of insolvent systems: the US government.
Of course we can have lengthy debates over the very possibility of a federal government going bankrupt; while that can be interesting in theory, the reality remains that US deficits rise ever faster, that interest payments on the debt alone will rise over half a trillion dollars soon, and tax revenues at all levels of government are falling off a steep cliff.
On top of all the shortages and deficits, the situation is worsening fast. And even for a government, it has to stop somewhere. Print money? No, you can't do that, not in a global economy. The more you print the less it’s worth, like a hamster on a treadmill.
What would have to happen for all of this to heal and revert, is a return to prices of homes and other assets to their peak levels of a few years back. And that is simply not going to happen; it is not possible. Banks have no money to lend, or invest, and individuals have no collateral to use against mortgage or car loans. Game over.
That in turn means there is NO way to prevent the financial crisis we see approaching, no more than Galveston can wish or pray for the behemoth hurricane with the little name, Ike, to magically go away. We, like Galveston, will have to live through this. Or die trying.
All that’s left as collateral for the value of the US economy, and the US dollar, is the future capacity of the American worker to cough up taxes. And the US worker, bless her soul, makes her meagre livelihood flipping burgers for other US workers. Which is not even enough to make the payments for her trailer home.
No matter what happens with Lehman, or AIG or Merrill, or with any other bail-out attempt, this will not get better. It will get much worse. The system is broken, and we have spent our future.
JPMorgan Set To Take Over Washington Mutual
Washington Mutual’s new chief, Alan Fishman, could be looking at the briefest executive tenure in recent memory. The American Banker reported Friday that the struggling Seattle-based thrift is in “advanced discussions” to sell itself to JPMorgan Chase . The publication, citing sources, said the talks “are ongoing at the highest levels of both companies.”
The news comes just five days after WaMu hired Fishman, a longtime thrift industry executive, to replace Kerry Killinger. The decision was greeted with a torrent of selling in WaMu’s shares, which fell as low as $1.75 in trading Thursday - putting them down 95% over the past year - before they staged a recovery to end up on the day at $2.83.
WaMu said Thursday evening it remains well capitalized and has enough liquidity to survive as an independent firm, and took issue with Moody’s decision to downgrade the firm.
But JPMorgan chief Jamie Dimon has long been seen as a natural buyer of WaMu, having made a below-market bid for WaMu this past spring before Killinger, in his wisdom, opted instead to take a recapitalization deal from a group led by private equity firm TPG.
With WaMu shares now fetching around $3 apiece, down from the low double digits at the time of JPMorgan’s earlier $8-a-share bid, the sides may find it easier to agree on price this time around.
Lehman Still Looking for Suitor, Possible 3-Way Deal
Beleaguered investment bank Lehman Brothers is still actively working to find a buyer and the situation remains very fluid Friday, CNBC has learned.
Bankers were talking late Thursday night about a three-way deal selling the investment bank to one party, selling the investment business to another and the balance sheet of real-estate loans to another.
Officials from the Federal Reserve and the Treasury are involved in the negotiations, these people say, but as of right now, there are no plans for the government to provide financial assistance to facilitate a purchase of Lehman in the way that the Federal Reserve provided a so-called "back stop" to JPMorgan Chase when it agreed to purchase Bear Stearns in March after that bank imploded because of bad debt on its balance sheet.
However, there is some thought that regulators might relax capital ratios -- rules that require banks to keep a certain level of liquidity on hand in proportion to the level of risky assets in their portfolios -- for the acquirer.
Top Lehman executives are hoping that HSBC takes over the company -- as it will likely keep Lehman as more independent unit of the company and keep the name -- but if that does not happen, the preference is for Bank of America.
If Bank of America wins out, the company will probably drop the Lehman name, but maintain the Lehman corporate culture to some extent. Lehman executives fear a takeover by Barclays because they think the UK-based bank will kill off anything Lehman-related.
The price Lehman will fetch is a huge unknown. The per-share offer "could be $1, $5 or a penny," one person close to the deal said. No one knows really how to value the $40 billion of subprime and commercial real estate on Lehman's books.
Chief executive Richard Fuld, Jr. is taking the brunt of the criticism for Lehman's current situation. Once considered the best CEO on Wall Street, Fuld's reputation is now being hammered and will probably get worse. There are allegations that Fuld's statements earlier in the week, that the company was viable, with strong liquidity, conflict with the facts.
Bank of America May Lead Lehman Bid, MF Global Says
Bank of America Corp., the biggest U.S. consumer bank, may team up with Barclays Plc and private equity firms to make an offer for Lehman Brothers Holdings Inc., analysts at MF Global Securities Ltd. said.
"A consortium could work, and it's been done before," Mamoun Tazi, a London-based analyst at MF Global, said in a telephone interview today. "Only a domestic buyer could negotiate the right guarantees. Barclays could take the asset management unit which would make sense," he said.
Barclays would add actively managed mutual funds and hedge funds by bolting on Lehman's asset management unit to its own San Francisco-based Barclays Global Investors division, Tazi said. It would also expand in quantitative funds, he added. Lehman is seeking buyers for the investment bank amid signs that the U.S. government may balk at providing the funding that enabled Bear Stearns Cos. to sell itself and avoid bankruptcy.
Chief Executive Officer Richard Fuld, who built New York- based Lehman into the biggest U.S. underwriter of mortgage bonds during his four decades at the firm, was pushed toward a forced sale after talks about a cash infusion from Korea Development Bank ended, sparking a 70 percent drop in the firm's market value over the past four days.
Barclays Chief Executive Officer John Varley, 52, crafted a 63 billion-euro ($89 billion) bid for Dutch bank ABN Amro Holding NV last year with the help of Bank of America, which agreed to take ABN Amro's LaSalle unit for $21 billion in a adjunct transaction. Varley lost ABN Amro to a group comprising Royal Bank of Scotland Group Plc, Banco Santander SA and Fortis.
Lehman's asset management unit, which includes Neuberger Berman Inc., may be worth as much as 4.5 billion pounds ($8 billion), similar to the value of Barclays's fund management unit, Tazi said. A "distressed purchase" of all of Lehman by a group led by Bank of America may enable Barclays to buy the unit for less, Tazi said.
Goldman Sachs not buying Lehman: sources
Contrary to market speculation, Goldman Sachs Group Inc is not pursuing an acquisition of Lehman Brothers Holdings Inc, reflecting concerns that integrating two investment banks would be too disruptive, sources familiar with the situation said on Thursday.
As Lehman stock plunged 46.5 percent to a new low of $3.88 a share, there was speculation that Goldman, the largest and strongest securities firm on Wall Street, would step in and acquire its struggling rival.
While reporting a $3.9 billion third-quarter net loss and a series of restructuring plans, Lehman on Wednesday also said it was "examining all strategic alternatives to maximize shareholder value." Some analysts and investors interpreted the remark as meaning that Lehman was looking to sell the firm.
Taking over Lehman would be a risky and daunting task for Goldman, particularly in the depths of a global financial crunch, the sources told Reuters. Lehman had 25,935 employees at the end of August, not that many fewer than the 31,495 who worked at Goldman at the end of May. Goldman will report its third-quarter results next week.
The two firms are engaged in essentially all the same businesses, so that there would be considerable overlap. And while Goldman has largely avoided major damage from mortgage securities and buyout financing, it would still be a tall order to absorb a firm with a large amount of risky and illiquid assets.
Lehman on Wednesday said its books at the end of August included $33 billion of commercial mortgages and property; $13 billion of residential mortgages; $4.6 billion of "other asset-backed positions," such as CDOs; and $10.4 billion of acquisition financing.
In afternoon trading, Lehman shares had recovered slightly but were still down 36.9 percent or $2.67 to $4.58. Goldman Sachs shares were down 2 percent or $3.10 to $154.49.
Lehman Brothers Dead Bank Walking Seeking Rescue
Following the bust off Bear Stearns back in March 2008, the US investment bank that next topped the list of most likely to follow Bear Stearns into financial oblivion was Lehman Brothers. Lehman Brothers was America's 4th biggest bank that has seen its share price collapse by more than 70% in recent days, and more than 90% over the last 12 months.
The bank over the last few weeks has been desperately seeking to sell off many of its assets ahead of this weeks results so as to reinforce its balance sheet, however losses still came in at the worst end of expectations with a further write down of $8 billion of assets resulting in a loss of $4 billion.
The panicking Lehman board of directors has been speculated as buying the banks own stock as hedge funds fought to profit from its anticipated demise by shorting the stock much as transpired during the Bear Stearns collapse, i.e. hedge funds with accounts with Lehman's short the stock and then close accounts with Lehman's forcing the bank to repay funds which is does not have and hence the bank collapses and hedge funds profit from the decimated share price.
In March of this year hedge funds were suspected of a similar attempted run on Britain's biggest mortgage Bank HBOS. However, recognising this problem, the SEC restricted short-selling of a number of financial institutions in July which includes Lehman Brothers, so the ongoing situation is not clear.
Lehman as well as the regulators will be eager for the bank to be taken as soon as possible, to be rescued in some shape or form to prevent a cascade of failures from happening due to Lehman defaulting on its derivatives obligations. Therefore as the US Fed gave a $30 billion sweetener on the Bear Stearns deal to JP Morgan, the expectation is for a similar if not larger sweetener for the likes of potential buyers such as Bank of America, possibly this weekend.
The first phase of the credit crisis saw escalating losses, the current phase of the crisis is increasingly seeing the banks going bankrupt with only one of two options available, either nationalisation or takeover by another bank at virtually zero valuation coupled with tens of billions of loan guarantees.
The total world wide banking losses to date are estimated at $600 billion, which has left many of the big banks capital bases decimated. However we have yet to pass the half way mark as the eventual losses look set to pass $1 trillion on the way through $ 2 trillions, the impact of which will result in a huge deleveraging of the $500 trillion derivatives market as crippled banks are forced to liquidate positions and assets at huge losses to reinforce their balance sheets.
In such a crisis climate the worlds banks are least willing to take on new debt hence the credit crisis is and will continue to hit the wider economy for several more years that looks set to tip many of the western economies into recession by the end of this year.
WaMu 'May' Be Forced to Sell Deposits to Stay Afloat
Washington Mutual Inc., facing up to $19 billion in bad home loans and slammed by a 34 percent drop in its stock this week, may sell parts of a nationwide 2,300-branch network to raise capital.
"The only real asset they have that's worth anything to other banks is the deposit base, because of their branches," said L. William Seidman, chairman of the Federal Deposit Insurance Corp. from 1985 to 1991. Seattle-based WaMu can probably sell branches in New York and Chicago, said Bert Ely, president of Ely & Co. Inc., a bank consulting firm based in Alexandria, Virginia.
Alan Fishman, WaMu's new chief executive officer, may have to shed branches that hold $143 billion in deposits. The biggest U.S. savings and loan is headed for its fourth straight quarterly loss. Suitors have walked away because of potential damage to their earnings and WaMu's chief regulator, the Office of Thrift Supervision, has told it to boost risk management and compliance.
On top of those challenges, Fitch Ratings yesterday cut its rating on WaMu debt to BBB1 from BBB, citing a lack of "flexibility" to add capital. Moody's Investors Service cut its long-term deposit and issuer ratings to Baa3 from Baa2 because of WaMu's "reduced financial flexibility, deteriorating asset quality and expected franchise erosion." Moody's reduced the senior unsecured rating to below investment grade at Ba2.
WaMu lured Fishman, 62, with a $7.5 million cash bonus and $1 million salary after his ousted predecessor, Kerry Killinger, failed to halt losses on home loans that already total $6.3 billion. The lender has estimated the sum could climb as high as $19 billion in the next 2-1/2 years, raising concern WaMu may need to raise cash for a second time this year. The company says more capital isn't necessary.
Without most of its branches and deposits, WaMu would be limited to businesses that include credit cards and mortgages -- neither a guaranteed moneymaker in the current economic climate. WaMu's credit-card division had net revenue of $956 million in the quarter ended June 30, down from $1.2 billion the previous quarter. Commercial and home-loan units had a combined $351 million in revenue for the period, compared with $757 million.
"Who's going to take the assets? It's probably more valuable together than separated," said Gary Townsend, CEO at Hill-Townsend Capital in Chevy Chase, Maryland. "It's like going to the supermarket, and anyway, the whole chicken is probably more valuable than the pieces."
Other capital-raising options are limited because the market for preferred securities dried up since a government takeover of Fannie Mae and Freddie Mac. The thrift raised $7 billion in April from TPG Inc., the Fort Worth, Texas-based private-equity firm run by David Bonderman.
The TPG deal itself may thwart investors. If WaMu is sold for less than $8.75 a share or is forced to raise more than $500 million in equity within 18 months, it must compensate TPG for the difference, according to filings with the U.S. Securities and Exchange Commission. "TPG is probably at a loss-mitigation stage at this point," Ely said. "Given how much they have invested, it probably makes sense to double down and then figure out how to get out of this investment."
A call to Washington Mutual spokesman Brad Russell wasn't returned. TPG spokesman Owen Blicksilver declined to comment. After three days of silence as the stock slid, WaMu yesterday said in a statement that it is "well capitalized," with approximately $50 billion of liquidity from what it termed reliable funding sources. Net charge-offs may increase by less than 20 percent in the third quarter, compared with 60 percent in the previous period.
The company "continues to be confident that it has sufficient liquidity and capital to support its operations while it returns to profitability," according to the statement. WaMu said it expects a loan-loss provision of $4.5 billion in the third quarter, down from $5.9 billion in the second quarter, mostly from residential mortgages. The total loan-loss reserve is expected to rise to $10.3 billion at the end of the quarter from $8.5 billion in the previous period.
The OTS could place the bank under its control and sell off assets, but it has little incentive to do so because WaMu is the regulator's biggest customer, Ely said. The OTS is "fully aware of the situation, and we're monitoring it," spokesman Bill Ruberry said yesterday. Andrew Gray, a spokesman for the Federal Deposit Insurance Corp., declined to comment. WaMu's sliding stock price doesn't imply that the bank itself is suffering, said Robert Hartheimer, a former director at a division of the FDIC that resolves failing banks.
"The focus on the stock price should not necessarily cause people to talk about the failure of WaMu," Hartheimer said yesterday. "There are plenty of financial-services stocks that are under pressure. I don't believe there necessarily should be a connection between a low stock price and speculation of a failure."
Poole Says Fed Shouldn't Give Funding to Any Lehman Agreement
William Poole, former president of the Federal Reserve Bank of St. Louis, said the U.S. central bank and the government shouldn't provide funding for any purchase of Lehman Brothers Holdings Inc. by another bank.
"Absolutely, I would say we cannot provide assistance in this case," Poole said in an interview with Bloomberg Television today. The Fed should tell any bank asking for help to buy Lehman that "this case is different and we're not going to provide that assistance and you've got to make your own decision. We'll help you work through it but we're not going to give you any cash."
Chief Executive Officer Richard Fuld is seeking buyers for the investment bank. Unlike when JPMorgan Chase & Co. took over Bear Stearns Cos., the Fed and Treasury aren't likely to put up money for a purchase of Lehman, people briefed on the matter said yesterday.
Lehman "needs to resolve this situation quickly and the more quickly the better," said Poole.
"Lehman must have substantial value as an ongoing firm. It must be valuable to hold the thing together rather than split it up into pieces, which is what might happen if it ends up in bankruptcy court. "I'm assuming it's got some value to somebody and that value has got to be unlocked," said Poole.
As Lehman collapses, anti-bailout backlash grows louder
Reports Thursday that the government is helping to broker a sale of Lehman Brothers brought a flood of angry criticism from bloggers who believe the Bush administration is coddling Wall Street at taxpayer expense and plotting another huge bailout.
The Washington Post reported that the Treasury Department and the Federal Reserve "are helping Lehman Brothers put itself up for sale," but there was no clear indication the government would offer any debt guarantees or other backup to encourage a sale, as it did in the sale of Bear Stearns earlier this year.
Still, housing and economic blogs echoed with increasingly angry warnings to the government. "How the hell did we, as taxpayers, suddenly become the bottomless purse for irresponsibility?" commenter JDZ wrote on L.A. Land. On the economics blog Calculated Risk, commenter "Ella" wrote: "I am in the middle class. My government has seen fit to waste my money. One bailout after another. More of my taxpayer dollars misused. ... Who will bail me out?"
On the same blog, commenter "Dogbert" wrote: "Lehman paid out $9.5 billion in bonuses in 2007. ... Now, they're looking for a few billion to survive. Is this insane or what?" Another commenter, "km4," wrote, "Comrades Bush, Paulson and Bernanke Welcome You to the USSRA (United Socialist State Republic of America)."
The commenter was quoting "Dr. Doom" economist Nouriel Roubini, who has emerged as a leader in the anti-bailout crowd, writing this week of the Fannie-Freddie bailout, "This is the biggest and most socialist government intervention in economic affairs since the formation of the Soviet Union and Communist China ... the biggest government intervention and nationalizations in the recent history of humanity, all for the benefit of the rich and the well connected."
Anticipating yet another Sunday announcement from Treasury, another Calculated Risk commenter wrote, "Making a 'surprise' bailout announcement two weekends in a row is beyond Third World." On CNBC.com, 81% of respondents to a poll answered that the government should not take over Lehman Brothers. Nearly 5,900 people voted.
Merrill shares sink in sympathy with Lehman
Shares of Merrill Lynch & Co Inc dropped on Friday on concern that the bank could go the same way as Lehman Brothers, which saw its stock fall to multiyear lows on talk that it is being forced to sell.
Merrill shares were down more than 11 percent at $17.23 in early trading, while Lehman Brothers fell 14.2 percent to $3.62. Merrill is seen as having similar problems to Lehman Brothers, so it makes sense that its share price will fall in line with Lehman Brothers, investors said. Both banks have large holdings of toxic debt that they have been looking to sell, and both have struggled to raise capital.
Not everyone, however, believes Merrill shares will follow Lehman Brothers' low enough to spark takeover talk or involve the U.S. Treasury. "I think Merrill Lynch has obviously had some difficulties, but I think this is an overreaction on the street," said Matt McCormick, portfolio manager and banking analyst at Bahl & Gaynor Investment Counsel in Cincinnati.
"I am not as worried about the future of Merrill Lynch as I am about Lehman Brothers," he added. Merrill Lynch Chief Executive John Thain in July arranged to sell $30 billion of complex debt securities to a private equity firm. The deal came with a write-down of more than $5 billion, and Goldman Sachs' analyst William Tanona last week warned the bank may have to write down more assets in the third quarter.
The struggling U.S. firm has already written more than $40 billion since the credit crisis began over a year ago.
The bank's share price has fallen 68 percent this year.
WaMu cut to "junk," sees $4.5 billion loss reserve
Washington Mutual Inc. was downgraded to below investment-grade status by Moody's Investors Service, after the largest U.S. savings and loan projected a $4.5 billion third-quarter increase in reserves for bad loans but said it has more than enough capital.
Moody's cut the Seattle-based thrift's senior unsecured debt rating two notches to "Ba2," its second-highest "junk" grade, from "Baa3," with a "negative" outlook. It also lowered its rating for the banking unit to "Baa3" from "Baa2." "Washington Mutual's access to the debt and equity markets remains severely constrained," Craig Emrick, a Moody's senior credit officer, said in an interview.
He added, though, that "there are no significant ratings triggers from a downgrade like this, because Washington Mutual is not reliant on wholesale short-term funding." Shares of the thrift rose 20 cents to $3.03 after-hours but gave back some gains following Moody's downgrade. The shares rose 51 cents, or 22 percent, in regular trading on the New York Stock Exchange, after touching an 18-year low of $1.75.
Investors are worried that Chief Executive Alan Fishman, who replaced the ousted Kerry Killinger this week, might fail to raise sufficient capital to cover mortgage losses that the thrift has said could reach $19 billion through 2011. Washington Mutual said it expected the third-quarter increase in loss reserves to decline from $5.9 billion in the second quarter, when its overall net loss was $3.33 billion.
It also said it expects net charge-offs, or loans it does not expect to be paid back, to be roughly $2.7 billion in the third quarter, up from the second quarter's $2.17 billion. In a statement, the thrift called the Moody's downgrade "inconsistent" with its finances, but said it does not expect a "material" impact on borrowings, collateral or margin requirements, or to suspend dividends on its preferred stock.
It also said it has $50 billion of liquidity from "reliable funding sources," and expects capital to remain "significantly above" regulatory minimums for "well-capitalized" lenders. Fitch Ratings on Thursday cut its credit rating to "BBB-minus," the same level as Standard & Poor's, and those agencies' lowest investment grades. The thrift expects to report full results on October 22.
About $3.4 billion of the reserve increase is expected to come from residential mortgages. Credit card reserves would rise by $600 million from the second quarter as the thrift moves securitizations back onto its balance sheet, not because credit quality is deteriorating, a spokesman said.
Fishman is a former chief operating officer of Sovereign Bancorp Inc and chief executive of Brooklyn, New York's Independence Community Bank Corp. Washington Mutual said it will take a charge for losses on $282 million of Fannie Mae and Freddie Mac preferred stock it owns. It also may take a non-cash goodwill write-down to reflect the lower value of various assets.
Non-interest income is expected to be about $1 billion, up from $561 million in the second quarter, reflecting growth in deposit and retail banking fees. Investors remain worried about the thrift's capital even after Washington Mutual raised $7 billion this year from investors led by private equity firm TPG Inc TPG.UL. "Unfortunately, their options have narrowed significantly, even over the past two days," Sean Egan, manager of the ratings desk at Egan-Jones Ratings Co, said in an interview. He said the thrift may need to raise well over $10 billion.
Earlier this week, Washington Mutual said its main regulator, the Office of Thrift Supervision, had stepped up its oversight into how the thrift manages risk. OTS spokesman William Ruberry said the agency is monitoring the situation. Separately, in a regulatory filing, Washington Mutual said it awarded Fishman a $1 million annual salary, a $7.5 million signing bonus, stock options and restricted stock, as well as eligibility for performance-based bonuses and incentives.
Lehman Races to Find a Buyer
The investment bank Lehman Brothers Holdings Inc. spent Thursday energetically shopping itself to potential buyers -- among them Bank of America Corp. -- just a day after insisting it had found a way to patch up its massive real-estate-related losses.Given the firm's deep financial troubles, a deal of any sort is far from certain, according to people familiar with the situation.
In addition, prospective buyers, which also could include Barclays PLC, would likely want the U.S. government to help shield them from future losses from any such transaction, these people said, as happened in March, when Bear Stearns Cos. was forced into a deal to be acquired by J.P. Morgan Chase & Co. In that deal, the federal government agreed to absorb as much as $29 billion in potential losses.
The Federal Reserve and Treasury Department have been working with Lehman to help resolve the bank's troubles, including talking to potential buyers, according to people familiar with the matter. Federal officials currently aren't expected to structure a bailout along the lines of the Bear transaction or this past weekend's rescue of mortgage giants Fannie Mae and Freddie Mac.
Resolving the mess at Lehman could help stem a wave of pessimism that the U.S. financial system faces the prospect of much deeper turmoil because of bad loans and the weak economy. Late Thursday, Washington Mutual Inc. rushed out some details about its third-quarter results in hopes of ending a 34% slide in its stock price so far this week.
In better times, Lehman's chief executive officer, Richard Fuld Jr., routinely vowed he would never sell the company, which he has run for nearly 15 years and which ranks as the oldest major firm on Wall Street. Now, however, he is scrambling to find a way out before nervous clients pull back from trading with the firm or its lenders cut back on their credit lines.
In a matter of just days, Lehman's fate has spun out of the firm's control. On Wednesday, it announced a turnaround plan aimed at making it possible for the beleaguered firm to survive as a smaller organization freed from the toxic real-estate assets that led to $6.7 billion in losses in the past two fiscal quarters.
However, that strategy -- ranging from spinning off commercial real-estate to selling a stake in Lehman's lucrative investment-management division -- failed to halt a slide in Lehman's stock price.
After the close of trading on Wednesday, the rating agency Moody's Investors Service put Lehman's credit rating on review, saying it would be lowered from its current A2 level unless Lehman can negotiate "a strategic transaction with a stronger financial partner." A downgrade by Moody's or Standard & Poor's would drive up Lehman's borrowing costs, making it tougher to operate.
On Thursday, Lehman was squeezed even more by a morning report from Merrill Lynch & Co. analyst Guy Moszkowski, who said the firm could face a potential "take-under" offer, a scenario in which a company is sold for less than its per-share stock price. As a result, Lehman shares fell by as much as 48% by midday Thursday, touching their lowest point since 1995. The price bounced back a bit. In 4 p.m. New York Stock Exchange composite trading, Lehman was down 42% to $4.22.
Bank of America, which is holding preliminary discussions about a transaction, appeared to be Lehman's best hope as of late Thursday. Still, people involved in the deal talks said it was too early to say what shape a sale might take, or if it would happen at all. According to several people familiar with the matter, one goal among negotiators is to unveil any deal to shore up Lehman before Asian financial markets reopen for trading on Monday.
Any prospective buyer is almost certain to look to the U.S. government to help protect against future losses. However, it would be politically challenging for the government to formulate another Bear Stearns-like rescue for Lehman, particularly coming so soon after it agreed to take over mortgage giants Fannie Mae and Freddie Mac. The Fed has grown increasingly uncomfortable with the growing perception that it will craft bailouts for the U.S. economy.
The sense of urgency has narrowed the list of potential buyers, already wary about exposing themselves to potential losses that may be lurking in Lehman's balance sheet. For instance, Nomura Holdings Inc., the big Japanese investment bank, is a potential buyer but given time-zone differences and regulatory approvals needed at home, it is unlikely it could do a quick deal.
There's only a relative handful of suitors large and strong enough to absorb Lehman. Goldman Sachs Group Inc. was mentioned Thursday as a possible white knight, but people close to the firm say it wasn't approached and isn't interested. Other possible buyers, including France's BNP Paribas SA, the U.K.'s HSBC Holdings PLC, Germany's Deutsche Bank AG, Spain's Banco Santander SA, aren't expected to participate, according to people familiar with those banks' intentions.
One outside potential remains Barclays, the U.K.'s third-largest bank. Barclays has been eager to expand its investment-banking franchise around the globe. Another potential scenario is a consortium of bidders that divide up the pieces of Lehman among themselves. A number of prospective buyers would likely "come out of the woodwork," if the U.S. government were to offer some form of protection against future losses, said one person monitoring the process.
House Speaker Nancy Pelosi (D., Calif.) said Thursday that Lehman's impact on the credit markets would have to be evaluated before the federal government moved to pull together a rescue package for the troubled investment bank.
Outside Lehman's headquarters in midtown Manhattan, employees taking lunch breaks or a few minutes for a smoke early on Thursday afternoon discussed the firm's future. Many sounded dazed. "It's over, man...unless we get bought out in the next 24 hours, it's over," said a young man, in conversation with someone on his cellphone. He said he was a Lehman employee and declined to answer further questions.
At a fast-food vendor across the street, people waiting to order food discussed the dive in Lehman's share price this week, and the latest headlines from CNBC. Outside, a group of three men, wearing Lehman badges and walking back into headquarters, discussed the fallout for other firms on Wall Street. "At some point, where does it stop?" one said, as he headed back to the office.
Lehman for sale in rush to salvage struggling firm
Lehman Brothers is for sale as Wall Street and financial regulators rush to salvage a once-thriving brokerage firm that's threatened by a potential exodus of clients and trading partners.
Lehman has put itself up for sale and has been calling rival banks, brokerage firms and other potential acquirers, according to three people familiar with the situation. Suitors include Bank of America , The Wall Street Journal reported, citing unidentified people familiar with the matter. The Treasury Department and the Federal Reserve are helping with the sale, the Washington Post reported, citing sources familiar with the matter.
Nothing is finalized and there are several potential outcomes, but a deal is expected to be unveiled this weekend before Asian markets open Monday morning, the newspaper added. Potential buyers remain wary about troubled assets on Lehman's balance sheet and are increasingly looking to the U.S. government to help backstop any future losses, the Journal said.
Lehman shares slumped 42% to $4.22 on concern any sale of the firm will be at a knock-down price similar to the Bear Stearns bailout, which was brokered by the Treasury and the Fed in March. Lehman stock slumped another 18% to $3.45 in after-hours action. "They're groping for solutions," said Sean Egan, president of Egan-Jones Ratings, a ratings agency that's paid by investors rather than issuers. "They need a large, sophisticated investor who can provide confidence to shareholders, bondholders, trading partners and regulators."
"There are a number of firms that have the ability and gravitas to save Lehman," he said. "But the question is whether they're willing to step up." Egan predicted the bailout of Fannie Mae and Freddie Mac in early August, a month before the Treasury Department, headed by Henry Paulson, seized the mortgage giants on Sunday. "Paulson has had difficulty getting back home on weekends lately and the next few may be work weekends again," Egan said.
The Treasury Department, Securities and Exchange Commission Chairman Christopher Cox and senior SEC staff are monitoring markets and are in contact regularly with market participants, a spokeswoman and spokesman said. They declined to comment specifically on Lehman. A Federal Reserve Bank of New York spokesman declined to comment.
Lehman reported a fiscal third-quarter net loss of almost $4 billion on Wednesday after more than $5 billion of new write-downs, mostly on soured mortgage exposures. The firm is hoping to sell 55% of its investment management business soon and spin off $25 billion to $30 billion of commercial mortgage holdings into a new company by early next year. However, Lehman also said it's "examining all strategic alternatives to maximize shareholder value."
Influential ratings agency Moody's Investors Service warned late Wednesday that if Lehman doesn't strike a deal with a stronger financial institution, the firm would be downgraded from A2 to Baa, one level above junk status. "The change in rating agency posture is an unexpected negative that may create a distressed sale situation," Mike Mayo, an analyst at Deutsche Bank, wrote in a note to clients on Thursday. A credit rating of less than A for Lehman "seems unacceptable," he added.
Such a downgrade would reduce future profitability by making it more expensive for the brokerage firm to borrow money. It would also limit Lehman's ability to trade with some partners, analysts said. "They would have to post more collateral because they would be less creditworthy," Elisa Parisi-Capone, RGE Monitor's lead analyst for finance and banking, said in an interview. "Clients often have minimum rating requirements with entities they deal with, so many would be driven away from Lehman by this."
AIG Stock Slides, Bond Risk Jumps on Capital Concern
American International Group Inc. plunged 22 percent in New York trading and the cost of insuring its debt rose to a record on concern that the company may be the next big U.S. financial firm to run short of capital.
AIG, the largest U.S. insurer by assets, dropped $3.79 to $13.76 a share at 10 a.m. in New York Stock Exchange composite trading. The price of credit-default swaps, used as hedges against losses on bad debt, approached distressed levels and traded higher than those for Lehman Brothers Holdings Inc., the securities firm that's fighting for survival.
"It's a carbon-copy story for a lot of these guys that need capital," said Robert Bolton, managing director for trading at Mendon Capital Advisors Corp. in Rochester, New York. "It's unprecedented that two storied franchises, Bear Stearns and Lehman, have taken on the type of water they have, and now there are fears about another titan, AIG." Chief Executive Officer Robert Willumstad has promised to deliver a turnaround plan on Sept. 25 after the New York-based firm posted three quarterly losses totaling $18.5 billion.
AIG's market value shrunk by more than one-third this week on concern the company's credit ratings will be cut and trigger more than $13 billion in collateral calls that would drain cash. The insurer raised $20.3 billion in May by selling debt and equity, diluting the holdings of long-time investors. It's "very hard to predict" if AIG will need more capital, Willumstad said Aug. 7.
"As distressed as they are, raising new capital could be extremely hard," said Tim Backshall, chief strategist at Credit Derivatives Research LLC in Walnut Creek, California, today in an e-mail. The insurer disclosed in an Aug. 6 filing that a ratings cut may have "a material adverse effect on AIG's liquidity." The company was forced to put up $16.5 billion in collateral through July 31 for investors who bought protection from AIG through credit-default swaps.
AIG's problems stem from a business that sold credit-default swaps to protect fixed-income investors against losses. The firm reported about $25 billion in writedowns in three previous quarters on the swaps. The contracts backed $441 billion of assets as of June 30, including $57.8 billion in securities tied to subprime mortgages. Most of the valuation declines on the swaps will reverse and AIG may have to pay $8.5 billion on the contracts in a worst-case scenario, the company said Aug. 7.
The company has "plenty" of options left to raise capital, Citigroup analyst Joshua Shanker said in a Sept. 10 note, including selling units and scaling back insurance underwriting. He said the company is "not similar" to Lehman Brothers. "AIG has plenty of less-drastic options in its arsenal before the impact of a controlling partner is even under consideration," said Shanker, who rates AIG "buy."
The company's consumer lender, reinsurer and aircraft lessor are among the units that could be sold to raise cash, analysts have said. Credit-default swap sellers demanded 12.5 percentage points upfront and 5 percentage points a year to protect AIG bonds from default for five years, according to broker Phoenix Partners Group.
That means it would cost $1.25 million initially and $500,000 a year to protect $10 million in AIG bonds for five years. Yesterday, it cost $688,000 a year with no upfront payment, according to CMA Datavision. It now costs more to protect against an AIG default than it does to protect bonds of junk-rated casino operators MGM Mirage and Las Vegas Sands Corp. It costs $720,000 a year for protection on $10 million of MGM bonds and $675,000 for Sands.
Even before today, AIG's credit-default swaps traded as if the company was rated B1, four levels below investment grade on the Moody's Investors Service ratings scale and 10 levels under its actual rating of Aa3, according to data from Moody's capital markets research group. Todd Bault of Sanford C. Bernstein & Co. has said AIG may need to raise $20 billion to cushion coming losses, while Morgan Stanley analyst Nigel Dally said the firm may need $15 billion.
Lehman: The Next Bailout?
Has the US entered a new era of government bailouts for business?
First, Uncle Sam intervened to rescue investment bank Bear Stearns. Then last week the government took over failing mortgage giants Fannie Mae and Freddie Mac. Now Lehman Brothers is tottering – raising the prospect of another US salvage operation. And the Big Three automakers are in Washington this week with hats in hand, asking for loans to finance development of more fuel-efficient vehicles.
To some economists, actions taken so far have redefined the criteria for the type of firm the government considers "too big to fail." That's particularly true, they say, because the bailouts have occurred under a supposedly pro-free-market Republican administration. But others say the bailouts are isolated actions. After all, Washington's 1979 provision of loan guarantees to Chrysler wasn't followed by a spike of US intervention in the marketplace.
"This is not the age of bailouts," says Peter Morici, a professor of business at the University of Maryland and former chief economist at the US International Trade Commission. "We get into these situations and then we sober up."
In the case of Bear Stearns, Fannie Mae, and Freddie Mac, company size was just one factor in the government's calculations about whether to throw them a taxpayer-funded lifeline. The nature of their connections with the rest of the economy was far more important. If Bear Stearns went under, it could have dragged down a web of firms with which it did financial business. Fannie and Freddie together own or guarantee half the nation's mortgages. Their failure could have caused the flow of mortgage money in the US to freeze up.
But if these firms qualify for help, so might Lehman, as well as other financial institutions battered by the housing crisis, such as Washington Mutual, the nation's largest savings and loan. Lehman is currently bigger than Bear Stearns was before its government-arranged takeover by JP Morgan Chase, after all.
Lehman chief Richard Fuld has announced plans to spin off the bank's prized investment management division and split the remainder into two banking entities, one with good loans and one saddled with bad housing-backed assets. If he has time to accomplish this paring, he might reduce the institution's size enough so that US officials might decide it's OK to let it fail, if the situation comes to that.
Lehman does have one advantage that Bear Stearns lacked – access to overnight loans from the Federal Reserve. The Fed initiated this program after the Bear Stearns debacle, so that hard-pressed institutions might be able to stay afloat while they look for cash from other sources. But Lehman got itself into trouble by making bad bets in the market, say critics of government intervention. And Washington shouldn't be helping it out.
"I don't buy the 'too big to fail' argument," says Chris Edwards, director of tax policy at the Cato Institute. "Failure is a normal happening in the marketplace. About 10 percent of all US businesses fail every year."
Meanwhile, the situation of the auto firms is somewhat different from that of financial institutions battered by bad housing loans. Their argument is that they need millions of dollars to develop products that meet new fuel-economy standards imposed by Congress, and that normal debt markets aren't operating normally as the credit crisis continues to rage.
Up to $25 billion in government-supported loans for automakers were a part of the 2007 energy bill, which passed Congress and was signed into law by President Bush. But auto firms want to raise government help to $50 billion. Top Detroit officials will push for the increase in funding on Sept. 12 at an energy summit in Washington, D.C.
They have the support of many congressional Democrats. "It's very important to our country," said House Speaker Nancy Pelosi. But backing from the Bush administration is far from assured, despite its recent moves to rescue financial institutions. US officials know that their interventions in the market could well have negative consequences.
One is pressure for help from more firms and other industries. If the airlines industry got aid following Sept. 11, why not the automakers now? And if Detroit gets help, what about other struggling old-line industries? Lines will have to be drawn, according to officials. Otherwise, firms might actually start to engage in riskier behavior, knowing that Washington will come to the rescue.
"Mitigating that problem is one of the design challenges that we face as we consider the future evolution of our [financial aid ] system," said Fed Chairman Benjamin Bernanke in an Aug. 22 speech. To some critics, such mitigation might be too little, too late. The financial bailouts have already expanded the notion of what firms might qualify for US help – not so much because of the firms themselves, but because it was a Republican administration that bailed them out.
"The supposedly more free-market party here has intervened to an enormous extent," says Chris Edwards of the Cato Institute. But the overall extent of administration intervention might seem smaller if one counts Fannie Mae and Freddie Mac as only partly private-sector firms. Investors have long considered that any US administration would rescue the pair if they got into trouble – and it turns out those investors were right. "They've been quasi-government entities all along," says Mr. Morici of the University of Maryland.
Fed Says Commercial-Bank Loans Rise to Record $19.8 Billion
The Federal Reserve said lending to commercial banks increased to the sixth record in eight weeks, while loans in an emergency program for securities firms showed a zero balance for the 11th straight week.
The Fed report, based on data through yesterday, indicates that Lehman Brothers Holdings Inc. didn't tap the so-called Primary Dealer Credit Facility, an emergency source of credit created after Bear Stearns Cos. collapsed. Lending to commercial banks through the traditional discount window rose $820 million to a daily average of $19.8 billion. As of yesterday, commercial banks had $23.5 billion of discount-window loans outstanding, the Fed reported.
Fed officials have responded to the yearlong credit crisis by narrowing the gap between the discount rate and the benchmark rate, increasing the term of commercial-bank loans to 90 days from overnight and offering overnight cash loans to bond dealers including Lehman. The discount rate is now at 2.25 percent, a quarter-point higher than the federal funds rate.
Lehman has plunged 74 percent this week in New York trading on concern about its capital, and the company entered into talks with potential buyers, people with knowledge of the situation said today. The Fed program is available for Lehman to use for funding while officials, regulators and executives seek alternative sources of cash, Fed watchers said this week.
The PDCF showed during two weeks in July average daily loans of $9 million and $3 million. That month the central bank extended the PDCF through Jan. 30 because of "continued fragile circumstances in financial markets." It was originally set to end as soon as this month. The three-month London Interbank Offered Rate in dollars was 2.819 percent today.
In March, the Fed agreed to lend $29 billion to secure Bear Stearns' takeover by JPMorgan Chase & Co. For the central bank, the Bear Stearns and PDCF lending marked the first extension of credit to nonbanks since the Great Depression, using emergency authority to act in "unusual and exigent circumstances."
The PDCF offers the 19 primary dealers that trade Treasuries with the New York Fed access to direct loans at the same 2.25 percent rate as commercial banks. Dealers can submit collateral including Treasuries and asset-backed debt, corporate bonds and municipal bonds with investment grades.
The subprime-mortgage collapse has taken a toll on banks and other financial companies, which have reported $510 billion of writedowns since the start of 2007. Yesterday, New York-based Lehman reported a $3.9 billion third-quarter loss, the largest in its 158-year history, and said it plans to spin off commercial real-estate holdings and cut its dividend.
The Fed's single-day record for discount-window lending is $45.5 billion on Sept. 12, 2001, the day after the terrorist attacks on the World Trade Center and the Pentagon. The reported daily average for that week was $11.7 billion. Fed holdings of U.S. Treasury securities rose $61 million to a daily average of $479.8 billion. The central bank had about $740 billion of Treasuries at the start of 2008.
Fed policy makers kept the benchmark rate at 2 percent at their last meeting Aug. 5, and investors expect the same outcome when officials next meet Sept. 16. The Fed reported no net misses in reserve projections. A net miss occurs when the actual reserve level in the banking system diverges from the Fed's projections for a day by $2 billion or more. If the level is outside expectations, the federal funds rate can deviate from target.
The Fed also reported that the M2 money supply fell by $5.5 billion in the week ended Sept. 1. That left M2 growing at an annual rate of 5.9 percent for the past 52 weeks, above the target of 5 percent the Fed once set for maximum growth. The Fed no longer has a formal target.
The Fed reports two measures of the money supply each week. M1 includes all currency held by consumers and companies for spending, money held in checking accounts and travelers checks. M2, the more widely followed, adds savings and private holdings in money market mutual funds. During the latest reporting week, M1 rose by $13.9 billion. Over the past 52 weeks, M1 increased 1.8 percent. The Fed no longer publishes figures for M3.
US debt burden to swell to $5.3 trillion
The U.S. government's debt burden could balloon to $5.3 trillion in the next decade, in part if it borrows more to finance another fiscal stimulus program and help ailing U.S. banks and carmakers, Goldman Sachs said.
This latest estimate is more than double the $2.3 trillion baseline forecast from the Congressional Budget Office and 50 percent higher than Goldman's previous forecast of $3.6 trillion, according to Goldman Sachs economists in a research note released late Wednesday.
Even accounting for stimulus programs and financial rescues, the two biggest components of the national debt over the next 10-year span would come from a shortfall in tax receipts worth $3.2 trillion and military spending, estimated at about $1.2 trillion.
Goldman economists also upwardly revised their federal budget deficit outlook for the next two fiscal years by more than $100 billion each compared with their prior forecasts. They now predict the U.S. budget gap will hit $565 billion in fiscal 2009 and $560 billion in fiscal 2010, adding that there are risks that could push those figures above $600 billion.
Goldman's latest forecasts "entail a much greater degree of uncertainty than in recent years, with risks tilted heavily to the side of even larger budget gaps." The deterioration in the U.S. economy and turmoil in the financial markets have compounded the grim budget outlook for the next couple of years, the bank's analysts said.
On Wednesday, the Congressional Budget Office raised its fiscal deficit forecast for fiscal 2008, which will end on Sept. 30, to $407 billion from its March estimate of $357 billion. With Congress expected to consider a second fiscal stimulus package later this month, it could cost about $50 billion, with most of it recorded in fiscal 2009, Goldman analysts said. This would follow the $168 billion package enacted earlier this year.
Moreover, the government may be poised to rescue more failing financial institutions after it seized control of mortgage finance giants Fannie Mae and Freddie Mac this past weekend. Goldman said the cost of the move to bail out the two government-sponsored enterprises was upward of $50 billion, twice the amount estimated by the Congressional Budget Office in July.
Moreover, the 11 bank closures so far this year have cost the Federal Deposit Insurance Corp $8.9 billion. While aid to the financial sector has gotten the most attention, Congress is also considering whether to grant as much as $50 billion in loan and loan guarantees to the struggling auto industry, Goldman analysts said.
US home foreclosures climb again in August
Foreclosures on U.S. properties climbed again in August, but emergency measures to help troubled homeowners may be tempering the housing crisis, foreclosures database firm RealtyTrac said on Friday.
One in every 416 U.S. households got a foreclosure filing in August, affecting 303,879 properties nationwide, for increases of 12 percent from July and 27 percent from August 2007, the firm said in its monthly analysis. The total number of properties affected and the national foreclosure rate 'were both the highest we've seen in any month since we began issuing our report in January 2005,' said RealtyTrac Inc. Chief Executive James Saccacio.
Nevada ranked again in August as the state with the highest foreclosure rate, followed by California and Arizona. As in months past, other hard-hit states included Florida, Michigan, Georgia, Ohio, Colorado, Illinois and Indiana. Behind the overall monthly default figures, RealtyTrac noted some shifting patterns that gave mixed signals about whether the nation's housing market is headed out of its deepest slump since the Great Depression.
Foreclosure normally occurs in stages, starting with the initial notice of default, followed by a notice of sale at auction, and finally bank repossession. RealtyTrac counts various types of filings to gauge overall activity. 'We've seen annual increases in default activity and auction activity moderating,' said Saccacio.
More modest year-over-year increases in default notices may mean emergency measures in some states, such as Massachusetts and Maryland, are working by giving troubled borrowers more time before foreclosure proceedings are initiated, said RealtyTrac senior vice president Rick Sharga. Some lenders are trying harder to help homeowners avoid foreclosure. In addition, some members of Congress in July asked lenders to suspend further foreclosures until federal housing rescue legislation can take effect on Oct. 1.
'The rate of growth at the early stages of foreclosure did slow down a bit. So there is probably some of that built into the numbers,' Sharga said of the emergency measures. Saccacio added, 'The question now is whether these measures will actually reduce foreclosures or simply cause a temporary lull in foreclosure activity.' Slower rates of increase in auction sale notices may have a less hopeful cause.
'We've seen fewer and fewer properties go through the auction process because there's either little equity in them or even negative equity. So there's no incentive for people to buy them at the auctions,' Sharga said. Finally, he added, 'Bank repossessions continue to grow at a pretty rapid clip.' The highest foreclosure rate in a metropolitan area was reported by Stockton, California, where one in every 50 households got a foreclosure filing during the month.
Other metro areas with high foreclosure rates included Merced, Modesto, Bakersfield, and Sacramento, all in California, as well as Cape Coral-Fort Myers, Florida. In Las Vegas, Nevada, in August one in every 75 households received a foreclosure filing, up nearly 14 percent from the previous month and up 83 percent from August 2007.
U.S. Stocks Fall on Slumping Retail Sales, Concern Over Lehman
U.S. stocks tumbled for the first time in three days, led by consumer and financial shares, as retail sales unexpectedly decreased and concern grew that the government won't fund a bailout of Lehman Brothers Holdings Inc.
Macy's Inc. lost 4.4 percent and led declines in 27 of 28 companies in the Standard & Poor's 500 Retailing Index after the Commerce Department said chain-store sales decreased 0.3 percent in August. Lehman dropped 11 percent, extending its slide over the past year to 94 percent, as the securities firm sought buyers to fend off collapse. Merrill Lynch & Co. slid 12 percent, while American International Group Inc. tumbled 20 percent. The drop capped a fourth straight weekly retreat for the S&P 500.
"We're in a prolonged period of sub-par economic growth," Jason Pride, director of research at Haverford Trust in Radnor, Pennsylvania, said on Bloomberg Television. Haverford manages $6.5 billion. "Investors need to have a heavy weight to high- quality companies with the ability to deliver consistent earnings growth in this difficult environment."
The S&P 500 is down 0.3 percent this week as three days of gains were overshadowed by today's losses and a 3.4 percent tumble Sept. 9 on concern that Lehman would fail to shore up capital. The benchmark index for U.S. equities opened the week with a 2.1 percent jump after the government's seizure of mortgage-finance companies Fannie Mae and Freddie Mac temporarily bolstered confidence in the financial system.
Excluding automobiles, retail purchases were down 0.7 percent in the U.S. last month, the most this year, according to the Commerce Department report. Consumer spending is faltering as wages haven't kept pace with inflation and the effect of the government's tax rebates fades. Americans are also confronting declining property values and stock prices, indicating even the recent retreat in fuel costs may not be enough to boost sales.
Renewed concern that higher fuel costs will weigh on consumer spending also sent retailers lower. Crude oil rebounded from a five-month low, gaining 63 cents to $101.50 a barrel, as almost all Gulf of Mexico oil production was shut down in preparation for Hurricane Ike.
The S&P 500 is down 16 percent in 2008 and poised for its first annual decline since 2002 after average earnings for companies in the index decreased for four straight quarters. Financial shares in the S&P 500 have dropped 1.5 percent as a group this week after tumbling 3.4 percent on Sept. 9. The S&P 500 Financials Index is down 37 percent over the past year after global banks racked up $511.7 billion in asset writedowns and credit losses stemming from the worst U.S. housing slump since the Great Depression.
Soaring trade deficit likely to get worse
The U.S. trade gap has hit a 16-month high, the job market is shrinking and exports, one of the rare items in the economy's plus column lately, may slow.
Those are signs that the economy may be deteriorating further, analysts and business leaders said yesterday, which could intensify the political debate on how to fix the problems less than 60 days before the presidential election. The U.S. trade deficit soared in July, the Commerce Department said, as oil imports hit an all-time high. Although exports increased, economists expect slowing economies in Europe and Asia to reduce export growth this year.
The Labor Department also reported that new applications for unemployment benefits fell less than expected last week as the economy takes a toll on workers. And in a sign that the job market could get worse, nearly one-third of top U.S. executives expect to cut payroll within months, according to a survey released yesterday by the Business Roundtable, an association of large-company CEOs.
Last week, the Labor Department said the unemployment rate jumped to a five-year high of 6.1 percent in August as employers cut 84,000 jobs, the eighth-straight month of cuts. Data released yesterday by the department indicate that the layoffs are continuing. New jobless-benefit claims dropped to a seasonally adjusted 445,000, down by 6,000 from the week before but topped analysts' expectations of 440,000.
The number of people continuing to draw jobless benefits increased to a five-year high of 3.53 million. David Rosenberg, an economist at Merrill Lynch, said the unemployment rate has jumped 1.1 percentage points since April, the steepest four-month increase since late 1981.
The July gap between imports and exports rose 5.7 percent to $62.2 billion, the Commerce Department said, worse than the $58.8 billion economists expected.
Retail Sales in U.S. Unexpectedly Dropped in August
Sales at U.S. retailers unexpectedly dropped in August as Americans retrenched in the face of mounting job losses and record foreclosures.
The 0.3 percent fall followed a 0.5 percent drop in July, the Commerce Department said today in Washington. Excluding automobiles, purchases were down 0.7 percent, the most this year. The Labor Department separately said prices paid to producers fell for the first time this year as energy costs declined.
Consumer spending is faltering as wages haven't kept pace with inflation and the effect of the government's tax rebates fades. Americans are also confronting declining property values and stock prices, indicating even the recent retreat in fuel costs may not be enough to boost sales.
"There's a big question mark over the performance of the economy over the next six months," John Lonski, chief economist at Moody's Investors Service Inc. in New York, said before the report. "We have to be braced for a decidedly slower pace of consumer spending." Producer prices fell 0.9 percent, more than forecast, in August. So-called core producer prices, which strip out fuel and food costs, rose 0.2 percent.
Treasuries rose after the reports, sending benchmark 10-year note yields down to 3.63 percent at 8:35 a.m. in New York, from 3.65 percent late yesterday. Futures on the Standard & Poor's 500 Stock Index lost 0.8 percent, at 1,242.40.
Retail sales were projected to rise 0.2 percent after an originally reported 0.1 percent drop the prior month, according to the median estimate in a Bloomberg News survey of 80 economists. Forecasts ranged from a drop of 0.5 percent to a gain of 1.1 percent.
Non-auto sales were forecast to drop 0.2 percent from the prior month, according to the median of 76 forecasts. Estimates ranged from a 0.6 percent gain to a drop of 0.6 percent. Electronics, building material, clothing and department stores all saw a drop in sales last month. Service station receipts also fell as gasoline prices retreated. Excluding gasoline, purchases were unchanged last month after a 0.6 percent decline in July.
Automakers boosted incentives in August to revive demand as the economy lost jobs for an eighth straight month and the unemployment rate reached a five-year high of 6.1 percent. Sales at car dealers and parts stores increased 1.9 percent, the first increase since January and the biggest in a year.
General Motors Corp. offered all customers the same prices paid by employees, helping boost sales in the second half of the month. GM this month said it will extend the incentive through September and has offered 72-month, no-interest financing on some vehicles since late June. "Not only is the U.S. in a recession, but the rest of the world is slowing down," Ford Motor Co.'s Chief Executive Officer Alan Mulally said in a speech this week. "I've never seen anything quite like it."
Filling station sales decreased 2.5 percent in August after a 0.2 percent gain the prior month, today's report showed. The average pump price of a gallon of regular gasoline dropped to $3.76 last month from $4.06 in July, according to AAA. The 1.5 percent decrease in purchases at department stores was the biggest since April 2007. Sales at non-store retailers, reflecting demand from Internet merchants and catalogs, declined 2.3 percent, the most since March 2007.
Excluding autos, gasoline and building materials, the retail group the government uses to calculate gross domestic product figures for consumer spending, sales fell 0.2 percent, the most this year. The government uses data from other sources to calculate the contribution from the three categories excluded.
Industry figures earlier this month showed demand weakened at retailers such as Gap Inc., Target Corp. and Abercrombie & Fitch Co., signaling merchants may be heading for the worst back- to-school season in seven years. Sales at stores open at least a year climbed 1.7 percent in August, the smallest gain in five months, the International Council of Shopping Centers said last week.
Purchases from July through September, retailing's second-biggest season after Christmas, may climb 1 percent, according to the ICSC. That would be the smallest gain since 2001. "By July, essentially all the rebates had already been distributed, and so were no longer providing support to incomes," Goldman Sachs Group Inc. economist Seamus Smyth said in a note to clients on Sept. 2. "Combined with weak job growth and tight credit, consumers had no way to fund additional consumption."
Consumer spending will stall from July to September, three months earlier than predicted last month, according to the median estimate of economists polled from Sept. 2 to Sept. 9. The slump will slow growth to less than half the prior quarter's pace.
Speculative Bets by Index Funds Didn’t Push Oil Prices Up, Report Says
Conventional wisdom in Washington holds that speculative money flooding into the market from index funds pushed up oil prices earlier this year. But a regulatory report released Thursday shows that those funds actually were cutting their stake in the oil market as prices were soaring.
That data, based on private trading data gathered by market regulators, contradicts parts of a report released by Washington lawmakers on Wednesday. That earlier report, by Michael W. Masters and Alan K. White, blamed high commodity prices on the growing role of institutional investors, specifically index funds. It was cited by several lawmakers as proof that new rules were needed to curb the impact of speculation on commodity prices.
But the new 69-page study, by the Commodity Futures Trading Commission, shows that, rather than rising, the stake of index funds in the oil market actually declined in the first half of this year. “That certainly doesn’t mesh with the story Mr. Masters is telling,” said Prof. Dwight R. Sanders, an agricultural economist at Southern Illinois University in Carbondale, who has studied both reports.
The dollar value of those fund positions did rise, to $51 billion from about $39 billion, according to the new study. But the increase reflects only the impact of rising oil prices — not the flow of new money into the market, the report found. When counted in terms of separate futures contracts, the funds’ stake fell 11 percent during that period, to 363,000 contracts from 408,000 contracts, according to the study.
The study also showed that index funds have a much smaller share of the market than previously estimated — 17 percent of all futures and options involving domestically traded commodities, as of June 30. Their net stake in oil markets was just 13 percent, not the 70 percent or more cited in previous estimates.
Mr. Masters, a hedge fund manager who has frequently testified before Congress, said in an e-mail message Thursday that he was “delving into the numbers” in the new C.F.T.C. report “to understand what they do and do not encompass.” He hoped to have more to say when he testified on Tuesday before a Senate energy subcommittee, he added.
The commission has come under withering criticism this summer, accused of failing to curtail excessive speculation in commodity markets. But so far, legislation aimed at limiting institutional commodity investments has stalled. The report does offer some support for the agency’s critics.
The agency found that on about three dozen occasions, none involving illegal trading, the total stake of 18 commercial traders exceeded regulatory limits or guidelines when their over-the-counter swaps positions were added to their stake on public exchanges.
And the commission acknowledged that it needed better tools for measuring market activity, especially in the swaps market. It is recommending several changes, including new disclosure rules for swaps dealers and the creation of a new office of data collection. It also called for a substantial increase in agency staff and resources to handle these expanded data-gathering duties.
EU finance ministers rule out coordinated bailout of European economy
EU finance ministers today ruled out a coordinated package to reboot the European economy despite mounting evidence of recession in key countries.
The 27 ministers, meeting informally under the French EU presidency, are at most expected to discuss measures - such as reduced rates of VAT - to help poorer people hurt by rising inflation and soaring food and energy prices. Peer Steinbrück, German finance minister and apostle of budgetary discipline, said: "I am against a European economic stimulus programme." Germany fears relaxing fiscal constraints could mark a return to 1970s-style stagflation.
Earlier this week the European commission slashed its forecast for EU growth this year from 2% to 1.4%, with Britain, Germany and Spain headed for recession. Jean-Claude Juncker, Luxembourg premier and finance minister, said the slowdown was worse than expected. "It is very grave but I don't think we are entering a period of protracted recession," he said.
Juncker, who had held hopes of becoming the EU's first president until the Irish rejected the Lisbon treaty, was today reconfirmed as chairman of the so-called Eurogroup for a further two years. The group, representing the 15 eurozone members, meet separately, with the slide of the currency to below $1.40 a major topic.
The 27 ministers are also due to discuss later today proposals for more coordinated supervision of Europe's banking sector in order to create early warning signals of systemic risk and contain any contagion effects if a cross-border bank collapses. There are 46 pan-European banks operating in the EU.
Sir Fred Goodwin, chief executive of RBS, and Josef Ackermann, Deutsche Bank chief, are among senior executives summoned here to debate measures ranging from beefing up existing pan-European groups of regulators to handing far greater supervisory powers to central banks, especially the ECB.
Alexandre Lamfalussy, architect of the current EU supervisory system, told a conference organised by thinktank Eurofi yesterday a central banker should sit alongside the current regulators' group and be tasked with detecting the emergence of systemic risk if any bank wobbled.
China industrial output growth lowest in 18 months
China's industrial output growth rate fell to its lowest level in 18 months in August, adding to signs its rapid economic expansion faces a sharp downturn, according to data reported Friday.
The figures supported economists' forecasts that Chinese industrial activity has dropped in recent months. That could hurt government efforts to moderate a downturn in China's growth, which is raising the threat of job losses and possible social tensions. The slowdown would hurt hopes the world's fourth-largest economy could fill the gap in global demand as American growth slows due to the U.S. credit crisis.
August's industrial output grew 12.8 percent over the same period last year, the National Burea of Statistics reported. That was 1.9 percentage points below July's growth rate and 4.7 percentage points below last August. "The root problem is sluggish consumption in the Western economies," said Sherman Chan, a Moody's Economy.com analyst, in a report to clients.
"The housing crisis in the U.S. has triggered global credit market turmoil, and this has severely damaged business and consumer demand in China's largest export markets — the U.S. and Europe," Chan said. "Although strengthening domestic consumption on the mainland has helped to support industrial production, overall output growth will not be as stunning as the previous year."
Analysts have cut forecasts of China's economic growth this year to as low as 9 percent, down from last year's stunning 11.9 percent. That still would be by far the highest growth for any major country. But Chinese leaders need high growth to reduce poverty and create jobs for millions of new workers entering the economy. The government has given tax breaks to textile exporters and is expected to roll out other measures to help struggling industries.
Retail sales in August rose 23.2 percent over the same time last year, the statistics bureau said. It said that was 6.2 percentage points above last August's growth rate. Chinese leaders are trying to encourage the country's consumers to spend more in order to reduce reliance on exports and investment to drive growth. But despite rapid growth, retail sales still lag China's huge export machine in sheer size.
Total retail spending in August was 876.8 billion yuan ($128 billion), according to the statistics bureau. By contrast, China's exports in August were $134.9 billion, the government reported this week. That was up 21.1 percent from the same month last year, but that growth was a decline from July's 26.9 percent.
Japan Economy Shrank Annual 3%, Revised Figures Show
Japan's economy contracted more than the government initially estimated last quarter after figures showed businesses cut spending.
Gross domestic product shrank an annualized 3 percent in the three months ended June 30, the Cabinet Office said today, more than the 2.4 percent drop reported last month. The median estimate of 27 economists surveyed by Bloomberg News was for a 3.1 percent contraction.
Bank of Japan Governor Masaaki Shirakawa said last week growth in the world's second-largest economy is likely to "remain sluggish for the time being." With little room for interest-rate cuts or government stimulus, Economic and Fiscal Policy Minister Kaoru Yosano said there's "nothing to be done but wait" for the country's export markets to recover.
"Japan's economy will keep slowing at least until the end of this year," said Hiromichi Shirakawa, chief Japan economist at Credit Suisse Group in Tokyo. "Compared with previous recessions, this one will be very shallow. We're at the deepest point of the downturn now." The yen traded at 107.25 per dollar at 9:17 a.m. in Tokyo from 107.14 before the report was published.
Stalled growth and the fastest inflation in a decade have created a dilemma for the Bank of Japan, which will probably have to keep interest rates unchanged for the rest of the year, according to economists surveyed this week. At 0.5 percent, Japan's key rate is the lowest among major economies.
Yosano and four other lawmakers are battling for the leadership of the ruling Liberal Democratic Party after Yasuo Fukuda announced his resignation as prime minister this month. Whoever wins will have little scope to spend on the economy because of public debt that the Organization for Economic Cooperation and Development estimates is 180 percent of GDP, the biggest in the industrialized world.
From the first quarter, the economy shrank 0.7 percent, the biggest drop since the third quarter of 2001 and more than the 0.6 percent initially reported. Economists expected a 0.8 percent contraction. Business spending slid 0.5 percent from the first quarter, more than twice the pace of the 0.2 percent drop reported last month.
The revision reflected Finance Ministry figures last week that showed capital spending fell for a fifth quarter. Slumping U.S. demand has forced exporters including Toyota Motor Corp. to cut production and jobs. A Kyushu-based Toyota subsidiary reduced output of sport-utility vehicles by at least 10 percent and fired 800 workers since June.
Markets outside the U.S. are also deteriorating. The European economy shrank for the first time in almost a decade last quarter, and EU Commissioner Joaquin Almunia said this week that the outlook is "unusually uncertain." Sales of construction equipment by companies including Komatsu Ltd. will fail to meet industry forecasts because of lower demand from India and China, the Japan Construction Equipment Manufacturers Association said last month.
"The market is heading into a turning point," said Michijiro Kikawa, chairman of the association and president of Hitachi Construction Machinery Co. "Although we expect the strength of emerging markets to continue, the speed of growth will decelerate." Exports dropped 2.5 percent and imports fell 2.6 percent. Net exports subtracted 0.1 percentage point from gross domestic product compared with the first quarter.
Even as exports weaken, economists say companies are better able to withstand the slowdown because they have shed the excess workers, factory lines and debt that contributed to a decade of economic stagnation in the 1990s.
Japan teeters on edge of recession as slowdown spreads
The Japanese economy shrank far more than was expected last quarter in the latest sign that the slowdown that started in America is spreading East.
"The economy contracted at an annual rate of 3pc between April and June following growth of 3.3pc in the first quarter of the year, and leaves the country teetering on the brink of recession. Analysts said demand for Japanese goods and services had fallen both at home and abroad. It was the sharpest contraction since a 4.5pc fall in late 2001.
The economy is unquestionably in a downturn," said Kenichi Kawasaki, an economist at Lehman Brothers.
"And with problems in the global credit markets yet to be resolved, the balance of near-term risks remains skewed to the downside." However, he added that falling oil prices could help stimulate demand.
Until now, the world's second-largest economy had escaped much of the fall-out from the credit crunch. Japan's bank loans market has not changed substantially and domestic consumers and firms still have roughly the same sort of access to credit.
The news from Japan comes after New Zealand yesterday slashed interest rates to help pull the economy out of recession and Taiwan announced plans to pump billions into the economy. Japan's export markets have been severely effected and exports fell by 2.5pc compared to the first quarter. Sharp increases in the price of energy, food and oil also eroded the spending power of Japanese consumers and the competitiveness of the country's industry.
Household spending fell 0.5pc from the previous quarter. Companies have also started scaling back their investments in order to maintain their current operations. Capital spending fell 0.5pc from the previous quarter. The Japanese government said companies should raise wages to boost spending.
"It is desirable that income for employed people increases," said Kaoru Yosano, the minister for Economic and Fiscal Policy. "We want company managers to recognise that pay rises would compensate for price rises." Politicians have also announced a £61bn stimulus package to stir up the economy. Nevertheless, economists said GDP could shrink again in the third quarter, putting the country into a recession.
Chevron caught up in oil agency scandal
A government scandal mixing alleged drug use, cronyism and sex at a federal office that handles billions of dollars in oil-drilling royalties has ensnared Chevron Corp.
The oil company, America's second largest, figures prominently in a report released this week that accuses government officials of growing far too close to their oil industry contacts. The report focuses on a little-known government agency at the heart of the offshore drilling debate, the Minerals Management Service, which leases government lands to oil companies.
The report accuses members of the Minerals Management Service of accepting thousands of dollars in industry gifts, including meals, drinks and ski trips. The report, from the U.S. Interior Department's inspector general, also accused some employees of using cocaine and having sex with oil industry representatives.
San Ramon's Chevron is one of four oil companies found to have given gifts - with Chevron giving just under $2,500 over the course of five years, most of it spent on meals and drinks. One of the government employees who had official business with Chevron also had a romantic relationship with a Chevron employee, as well as with an employee from Shell, according to the report.
In addition, Inspector General Earl Devaney singled out Chevron for criticism, saying the company refused to cooperate fully with the investigation. Chevron employees refused to be interviewed by the inspector general's office, according to the report. The company insists that it did cooperate, turning over more than 13,000 pages of e-mails and expense records that are cited repeatedly in the report. As for the employees, Chevron respected their legal right not to talk to investigators, said company spokesman Don Campbell.
"The individual employees have individual rights to decide whether to accept the interviews," he said. Campbell wouldn't say whether the company had disciplined any employees over the report's allegations but said the company is conducting its own investigation. "We take any allegation of ethics violations by our employees very seriously," he said. "We began an investigation of the allegations right away, when we first got wind of it. We've been looking at this for a while."
The Minerals Management Service leases federal property to companies that want to drill for oil and natural gas. It also takes in royalties from those leases. Critics have often called it too close to the industry. It also came under fire two years ago for a costly bureaucratic snafu - leaving out important language in some oil leases, written in 1998 and 1999, that may have cost the government as much as $7 billion in revenue.
The specific office at the center of the inspector general's investigation handled the agency's "royalty in kind" program, in which companies give the government oil instead of cash royalties. That oil - worth about $4.3 billion in 2007 - can then go into the nation's Strategic Petroleum Reserve or be sold on the market.
The inspector general's report immediately became fodder for the offshore oil drilling debate playing a central role in the presidential race. Drilling opponents said the report shows that the oil industry holds too much sway over the government officials who would be in charge of any future offshore leases.
"We do hope this gives the Senate pause about opening up more of our coasts," said Athan Manuel, a Sierra Club lobbyist on oil issues. The inspector general's report prompted expressions of outrage Thursday from both Republicans and Democrats, with most focusing on the government employees at the heart of the scandal. But at least one legislator, Rep. Jackie Speier, also sought to focus attention on the companies involved. Besides Chevron, the report counted gifts from Shell, Hess Corp. and Gary Williams Energy Corp.
Speier, D-Hillsborough, proposed that language be inserted into the Democrats' next energy bill that would bar from future oil lease sales any company not cooperating with a government investigation. The party leadership was receptive to the idea but hasn't yet made a decision, said Speier spokesman Mike Larsen. "At a time of record profits for energy companies and declining confidence among the American people in both corporate and government bodies, we cannot allow this open and rampant abuse of power and office to go unpunished," Speier said.
Brazil says it won't tolerate overthrow in Bolivia
Brazil will not accept any attempt to overthrow the government in Bolivia as opposition protests there spiraled into deadly clashes with government supporters, the Brazilian president's foreign policy adviser said on Thursday.
"We won't tolerate a rupture in the constitutional order of Bolivia," Marco Aurelio Garcia, foreign policy adviser to Brazilian President Luiz Inacio Lula da Silva, told a news conference. "Brazil will not recognize any attempt at a government that would substitute a constitutional government in Bolivia," Garcia said when asked whether this meant Brazil would send troops to aid the Bolivian government of President Evo Morales.
Brazil has supported Morales' administration as the legitimate, constitutional government in Bolivia and condemned the violence which has left at least eight dead. Garcia said Morales was prepared to receive emissaries from Brazil, Argentina and Colombia and only needed to say when.
Bolivian protesters damaged a pipeline on Wednesday, cutting one-tenth of the country's natural gas exports to Brazil, which relies heavily on them. A second incident briefly halved Bolivia's natural gas exports to Brazil on Thursday, though almost all shipments were restored, a pipeline operator said. Gas supplies to Argentina were also disrupted.
Garcia said Brazil's view was that destabilizing the country "could cause great damage" to the region and branded the protesters' actions as "terrorism." Morales told Lula he was "pessimistic" about the progress of talks with the opposition, but Bolivia had overcome serious crises before and could do so again, Garcia said.
"We hope that faced with these problems a solution can be found to avoid the hypothesis of a civil war," he said.