Dust storm. Amarillo, Texas.
Ilargi: Yesterday, I talked about the Constitution, in particular the question whether Congress can legally hand over powers explicitly assigned to it by the Constitution, to other parties. It did so in 1913 when it ceded the power over the nation’s money supply to the Federal Reserve.
Today, it looks like Congress is about to do it again. The wording of Hank Paulson’s plan to "save" the economy for the sake of "protecting the taxpayers" is nothing short of alarming. It is also highly doubtful if the plan is Constitutional. So once more: does Congress have the authority to go against the Constitution?
The plan that Paulson and Bush urge Congress to accept as fast as "legally" and practically possible, gives the Executive Branch, in the office of the Secretary of the Treasury, full, unlimited, and unchecked powers over the nation’s financial system, the entire economy, and even attempts to provide far-sweeping power over international finance. Of course the Treasury completely depends on the Federal Reserve to execute its policies, since only the Fed can "print" money.
Congress is side-tracked into a spectator role, and the courts of the country will not be allowed to judge the legality of any action the Secretary decides upon. The plan also implies that $700 billion will be provided "at any given time", which leaves open the possibilty of limitless funding, depending on how many "given times" there might be.
I am not a lawyer, and I have no doubt that even the most intelligent and experienced members of the legal corps will have trouble deciding on these issues. But I don’t see how there can be any doubt that the courts need to study a plan like this, before it can be implemented. The plan itself expressly states that after the fact, they are not allowed to.
I have read many smart people tackle the issue in the past two days, and the only one among them who hits the nail square on the head is Russ Winter. His contention: the $700 billion provision does not constitute a bail-out, it will be used to create a tar pit, in which financial institutions can be liquidated at will.
The Treasury and the Federal Reserve will be authorized to buy up securities and, more broadly, derivatives from failing financial institutions. Not just mortgage related paper, it can also include student loans and credit card-related "assets". It’s not confined to American institutions either, the Treasury can use US taxpayers’ money to buy virtually unending amounts of virtually valueless paper from foreign banks and governments.
Winter’s take is that what is really behind the "salvation" is an unprecedented power grab that will give the US Treasury enormous, perhaps unlimited, authority over the fate of banks, funds and other institutions, and on a global scale. The unelected "officials" who will be placed in charge, as monopolistic rulers, can pick out the banks they like, and those they don’t.
The group that Winter calls "Friends of Hank" will be saved and moreover allowed to take over, for pennies on the dollar, the assets from those that are not Friends of Hank. In fact, the Friends will not pay much of anything at all; the US taxpayer will. It may be a good time to wonder why Lehman was sacrificed mere days before a plan is announced that would have saved the firm.
So what can you expect from the people you elected (and those you will elect)? It looks like they know which hand feeds them. and it’s not yours. There is a huge threatening sign hanging over their heads that says they will be blamed for the inevitable further gutting of the economy, if they vote down the plan, or even try to change it or delay the vote.
Both presidential candidates have expressed initial support for the plan. I would think that anyone who does not try to stop this with the utmost urgency should get a total of zero votes in any upcoming election, but I'm not holding my breath.
The comments today from members of Congress are nothing more than fodder for late-night comedy.
""What we're spending our time doing now is writing language into the Treasury proposal that will beef up taxpayer protections," Steve Adamske, a spokesman for House Financial Services Committee Chairman Barney Frank, said in a telephone interview."
"Senate Banking Committee Chairman Christopher Dodd said any plan should "promote home ownership." "The stakes could not be higher, and there is no time to waste, but I am hopeful that we will be able to achieve these important objectives," Dodd, a Connecticut Democrat, said in a statement."
"Minority Leader John Boehner of Ohio, [called] for "straightforward" legislation. "Efforts to exploit this crisis for political leverage or partisan quid pro quo will only delay the economic stability that families, seniors, and small businesses deserve," Boehner said. "I hope we all can agree that we should keep any legislation as straightforward as possible while doing everything we can to protect American taxpayers."
Many people ask you to call and write to your representatives. You might want to hold on to that money.
PS: Kudo’s also go to Karl Denninger for pointing out this beauty:
"(3) designating financial institutions as financial agents of the Government, and they shall perform all such reasonable duties related to this Act as financial agents of the Government as may be required of them;"
"That's right - every bank and other financial institution in the United States has just become a de-facto organ of the United States Government, if Hank Paulson thinks they should be, and he may order them to do virtually anything that he claims is in furtherance of this act. This might include things like demanding that a bank or other financial institution sell him its paper, even if it forces that firm to collapse and be assumed by the FDIC! "
Update 7.00 PM EDT: Ilargi: I’ll admit, I'm skeptical, but Obama -or his campaign- did issue this on the Paulson Plan:
Obama calls bailout a 'blank check'
Sen. Barack Obama (D-Ill.) heaped criticism Sunday on President Bush's mortgage-bailout blueprint, calling it a "blank check" for the administration and Wall Street with insufficient safeguards for taxpayers and homeowners.
"[T]hus far, the administration has only offered a concept with a staggering price tag, not a plan," Obama said in a statement. "This crisis started with homeowners and they bear the brunt of the nearly unprecedented collapse in housing prices. We cannot have a plan for Wall Street banks that does not help homeowners stay in their homes and help distressed communities."
Obama on Friday had embraced the concept of the bailout, and his statement does not change that. Sen. John McCain (R-Ariz.), his rival for the presidency, has been noncommittal.
Treasury Secretary Henry Paulson said on Sunday shows that the administration would resist additions to the skeleton of the $700 billion plan sent to Capitol Hill on Saturday. Specifically, Paulson said he was opposed to limits on executive compensation for financial institutions — an idea embraced by the Obama response.
Like some congressional leaders, Obama said the administration's three-page outline does not permit sufficient oversight.
"If we grant the Treasury broad authority to address the immediate crisis, we must insist on independent accountability and oversight," Obama said. "Given the breach of trust we have seen and the magnitude of the taxpayer money involved, there can be no blank check."
Here is the text of Obama's statement:
“The era of greed and irresponsibility on Wall Street and in Washington has led to a financial crisis as profound as any we have faced since the Great Depression.
“But regardless of how we got here, the circumstances we face require decisive action because the jobs, savings and economic security of millions of Americans are now at risk.
“We must work quickly in a bipartisan fashion to resolve this crisis and restore our financial sector so capital is flowing again and we can avert an even broader economic catastrophe. We also should recognize that economic recovery requires that we act, not just to address the crisis on Wall Street, but also the crisis on Main Street and around kitchen tables across America.
“But thus far, the administration has only offered a concept with a staggering price tag, not a plan.
“Even if the Treasury recovers some or most of its investment over time, this initial outlay of up to $700 billion is sobering. And in return for their support, the American people must be assured that the deal reflects some basic principles.
• No blank check. If we grant the Treasury broad authority to address the immediate crisis, we must insist on independent accountability and oversight. Given the breach of trust we have seen and the magnitude of the taxpayer money involved, there can be no blank check.
• Rescue requires mutual responsibility. As taxpayers are asked to take extraordinary steps to protect our financial system, it is only appropriate to expect those institutions that benefit to help protect American homeowners and the American economy. We cannot underwrite continued irresponsibility, where CEOs cash in and our regulators look the other way. We cannot abet and reward the unconscionable practices that triggered this crisis. We have to end them.
• Taxpayers should be protected. This should not be a handout to Wall Street. It should be structured in a way that maximizes the ability of taxpayers to recoup their investment. Going forward, we need to make sure that the institutions that benefit from financial insurance also bear the cost of that insurance.
• Help homeowners stay in their homes. This crisis started with homeowners and they bear the brunt of the nearly unprecedented collapse in housing prices. We cannot have a plan for Wall Street banks that does not help homeowners stay in their homes and help distressed communities.
• A global response. As I said on Friday, this is a global financial crisis and it requires a global solution. The United States must lead, but we must also insist that other nations, who have a huge stake in the outcome, join us in helping to secure the financial markets.
• Main Street, not just Wall Street. The American people need to know that we feel as great a sense of urgency about the emergency on Main Street as we do the emergency on Wall Street. That is why I call on Sen. McCain, President Bush, Republicans and Democrats to join me in supporting an emergency economic plan for working families — a plan that would help folks cope with rising gas and food prices, save one million jobs through rebuilding our schools and roads, help states and cities avoid painful budget cuts and tax increases, help homeowners stay in their homes and provide retooling assistance to help ensure that the fuel-efficient cars of the future are built in America.
• Build a regulatory structure for the 21st century. While there is not time in a week to remake our regulatory structure to prevent abuses in the future, we should commit ourselves to the kind of reforms I have been advocating for several years. We need new rules of the road for the 21st century economy, together with the means and willingness to enforce them.
“The bottom line is that we must change the economic policies that led us down this dangerous path in the first place. For the last eight years, we’ve had an 'on your own-anything goes' philosophy in Washington and on Wall Street that lavished tax cuts on the wealthy and big corporations; that viewed even common-sense regulation and oversight as unwise and unnecessary; and that shredded consumer protections and loosened the rules of the road. Ordinary Americans are now paying the price. The events of this week have rendered a final verdict on that failed philosophy, and it is a philosophy I will end as president of the United States.”
Paulson's $700 Billion Bank Rescue Seeks 'Absolute Control' for Treasury, Unchecked by Courts
The Bush administration sought unchecked power from Congress to buy $700 billion in bad mortgage investments from financial companies in what would be an unprecedented government intrusion into the markets.
Through his plan, Treasury Secretary Henry Paulson aims to avert a credit freeze that would bring the financial system and the world's largest economy to a standstill. The bill would prevent courts from reviewing actions taken under its authority. "He's asking for a huge amount of power," said Nouriel Roubini, an economist at New York University. "He's saying, 'Trust me, I'm going to do it right if you give me absolute control.' This is not a monarchy."
As congressional aides and officials scrutinized the proposal, the Treasury late yesterday clarified the types of assets it would purchase. Paulson would have authority to buy home loans, mortgage-backed securities, commercial mortgage- related assets and, after consultation with the Federal Reserve chairman, "other assets, as deemed necessary to effectively stabilize financial markets," the Treasury said in a statement.
The Treasury would also have discretion, after discussions with the Fed, to make non-U.S. financial institutions eligible under the program. The plan would raise the ceiling on the national debt and spend as much as the combined annual budgets of the Departments of Defense, Education and Health and Human Services. Paulson is asking for the power to hire asset managers and award contracts to private companies. Most provisions of the proposal expire after two years from the date of enactment.
Paulson spent the morning today appearing on the Sunday television talk shows to build public support for his plan. He urged quick approval by Congress, saying financial markets are "fragile." While the plan should have "mortgage relief components," he suggested legislative changes should be kept to a minimum.
"We want this to be clean, we want this to be quick," Paulson said on Fox News Sunday.
Speaking on NBC's "Meet the Press, he said: "This is not a position where I like to see the taxpayer, but it is far better than the alternative." He added that assets bought by the Treasury would later be sold, recovering some money for the government.
A failure by the government to support the U.S. financial system could lead to "a depression," Senator Charles Schumer, a New York Democrat told reporters yesterday. "To do nothing is to risk the kind of economic downturn this country hasn't seen in 60 years."
The Treasury is seeking authority to step in as buyer of last resort for mortgage-linked assets that few other financial institutions in the world want to buy, following government takeovers of mortgage giants Fannie Mae and Freddie Mac and insurer American International Group Inc. "Democrats will work with the administration to ensure that our response to events in the financial markets is swift," House Speaker Nancy Pelosi said in a statement.
The majority party will seek to reduce mortgage foreclosures and create "fast-track authority" for an overhaul of financial regulation, Pelosi said. Democrats will ensure "the government is accountable to the taxpayers in any future actions under this broad grant of authority, implementing strong oversight mechanisms."
The proposal will include curbs on executive pay for the companies whose assets the government will be buying, Steve Adamske, a spokesman for Representative Barney Frank, said yesterday in an interview.
Democrats also will include a plan to stem foreclosures, which may involve tapping the loan-modification abilities of the Federal Housing Administration, the Federal Deposit Insurance Corp., and Freddie Mac and Fannie Mae, Adamske said. Frank, a Democrat from Massachusetts, is chairman of the House Financial Services Committee.
Senate Majority Leader Harry Reid said that while he has misgivings about the rescue plan, "the consequences of inaction could be catastrophic." "While the Bush proposal raises some serious issues, we need to resolve them quickly," he said yesterday in a statement. "I am confident that, working together, we will."
House minority leader John Boehner, an Ohio Republican, said yesterday he is reviewing the proposal but didn't say whether he was inclined to support it. "The American people are furious that we're in this situation, and so am I," Boehner said in a statement. "We need to do everything possible to protect the taxpayers from the consequences of a broken Washington."
Congress, which may pass legislation as soon as Sept. 26, needs to "make sure there are protections built in for taxpayers," said Schumer, a New York Democrat on the banking committee. Lawmakers should ensure "taxpayers who gave the money will be put ahead of the stockholders, bondholders and others."
Yesterday on Capitol Hill, legislative aides wearing polo shirts and jeans instead of their usual business suits filed into the House Financial Services Committee hearing room to question Treasury officials including David Nason, assistant secretary for financial institutions, and Neel Kashkari, a senior adviser to Paulson and former investment banker at Goldman Sachs Group Inc., where the Treasury secretary was previously chief executive officer.
Paulson is seeking an expansion of federal influence over markets that hasn't been seen since the Great Depression, said Charles Geisst, author of "100 Years of Wall Street" and a finance professor at Manhattan College in New York. Geisst likened the plan to the Reconstruction Finance Corp., which was chartered by Herbert Hoover in 1932 with the goal of boosting economic activity by lending money after credit markets seized up.
President George W. Bush said he called leaders in both houses of Congress and "found a common understanding of how severe the problem is and how necessary it is to get something done quickly." "This is going to be a big package because it's a big problem," Bush said following a meeting with Colombian President Alvaro Uribe at the White House. "We need to get this done quickly, and the cleaner the better."
Democratic presidential nominee Barack Obama said in a radio address that he "fully supports" Paulson and Fed Chairman Ben S. Bernanke's efforts to stabilize the financial system. The plan, however, should benefit both main street and Wall Street, he said. Republican Presidential nominee John McCain "looks forward" to reviewing the proposal while focusing at least in part on "minimizing the burden on the taxpayer," said Jill Hazelbaker, communications director for the McCain campaign.
The ban on legal challenges of actions by Treasury is "distasteful, it's unfortunate and it's bad precedent, but this is an emergency and you have to act," said Jerry Markham, a law professor at Florida State University and author of "A Financial History of the United States." "What you don't want happen is to have lawsuits that will slow things down and cause problems," he said.
The proposal would raise the nation's debt ceiling to $11.315 trillion from $10.615 trillion and require the Treasury secretary to report back to Congress three months after Treasury first uses its new powers, and then semiannually after that. Paulson would gain discretion to act as he "deems necessary" to hire people, enter into contracts and issue regulations related to a revival of U.S. mortgage finance, according to a three-page proposal. The Treasury would "take into consideration" protecting taxpayers and promoting market stability.
The Treasury may hire managers to purchase the assets through so-called reverse auctions, seeking the lowest prices, Treasury said yesterday. The document specifies that Treasury may buy only assets issued or originated on or before Sept. 17. The House will pass legislation to implement the plan by the end of this week, and the Senate will act soon after, Frank said on Sept. 19 in an interview on Bloomberg Television's "Political Capital with Al Hunt."
Bush said yesterday he's unconcerned that the price tag on the package may seem high. "I'm sure there are some of my friends out there that are saying, 'I thought this guy was a market guy, what happened to him?"' the president said. "My first instinct was to let the market work, until I realized, while being briefed by the experts, how significant this problem became."
The Bush administration seeks "dictatorial power unreviewable by the third branch of government, the courts, to try to resolve the crisis," said Frank Razzano, a former assistant chief trial attorney at the Securities and Exchange Commission now at Pepper Hamilton LLP in Washington. "We are taking a huge leap of faith."
Massive Bailout? Hardly, a Massive Tar Pit Instead
Naturally I need to weigh on what is being called the biggest “bailout in history”. I do not believe that is what is going down at all. Instead the US Government is facilitating the greatest asset grab of securities since Alexander Hamilton’s agents and cronies picked off the Continentals from the Rubes back in 1790.
Hamilton’s associates (friends of Hamilton) did not pay anything close to par either, instead these Continentals went for enormous discounts. And Paulson’s new Leviathan hedge fund (the US Treasury) will end up paying deeply distressed prices as well. Therefore it is most important to follow the real bouncing ball on this, and not be fooled. This post is going to be my primary framework over the next several months, so any discussion with me or use of my ideas is meaningless unless you are aware of my thinking.
Tucked away in the hyperbole of this story is the following key element. These are competitive capitulations, and will hardly result in higher security prices, at least not yet. Initially they will simply reinforce low prices. Because these are government transactions there will be higher public transparency to them for all to see, and I doubt if the early response will be necessarily bullish either, but just more conformation as to how much fictitious capital has already evaporated.
The use of the word “request” is poor confusing writing style, as I think the operative word is “offer”.The Treasury would hold several rounds of buying, first purchasing securities from the banks that request the lowest prices,in order to limit the cost to taxpayers. The plan could be broadened to include securities based on other kinds of loans, such as student loans and commercial real estate.
Instead it suggests that the first rounds of Government bids will be mostly stinky or low ball bids. I am convinced this will be done in tandem with a series of bank closures and seizures accompanied by fresh rounds of panic and crisis. This will have the effect of forcing liquidations into the Tar Pit where the stinky bid awaits. Here are the bullet points of how this plays out.
• The friends of Hank (FOH) have already been hard at work picking up the modern day Continentals right and left, and this will continue, but there has to be a mechanism to force the sale, otherwise the carrion hold out. If I had to hazard a guess, securities that might be worth 60-70 of par at the end of the day are being scarfed at 20-40.
When these are marked up later, you are left with well capitalized financial institutions, even new ones. As for the losers, well they deserved it anyway will be the refrain. It will not even matter what is fair either. If you want to know who the winners are from all this, FOH is it, and who they are really should be included as the basis of any investment decision.
• Also keep in mind that this process will go on in the productive or non-financial side of the US economy too, and that might be the safer option to play. The elimination of shorting on financials may have the “unintended consequence” (?) of pushing the Berserkers and other short selling criminal rackets into looking for non-financial squeeze targets instead.
• A list of carrion has been drawn up. There is also another list of FOH (visualize Saber-toothed Tigers). A very high percentage of FOH will be the new foreign masters and their front men, who will need to redeploy Dollars into distressed US assets. I have read people making remarks such as, “where does this money come from?”, to which I say, “are you serious? Take a look at Treasury prices, the last great Bubble. That is your answer.
Treasuries will be sold and utilized to buy these distressed, bargain US assets. Creditor status gets converted into equity status as part of a large scale defacto foreclosure and wealth transfer. And to ensure that Treasury yields don’t back up too much, the Fed is there to do occasional monetizations. Just how much is an open question, but if this operation goes as quickly as I think (the last four months of the Bush administration) it might not be that much.
The operational concept, repeated for clarity.
• The operational plan therefore is to work closely with the FOH on the Tar Pit scarfs, and also pressure and push the carrion off the cliff into the Tar Pit. What you have to remember about this, is that when a carrion goes to the Pit, that institution absorbs (officially takes the loss) on a portion of the fictitious capital (FC) that had been on the books. FC goes to money heaven, is wiped out or cleaned (nao existe).
• Questions have been raised about all the derivative exposure out there. Derivatives (mostly fictitious anyway just like the AAA ratings were) will be subject to novation, effectively renegotiated or even eliminated. Therefore billions in derivatives will go to money heaven also, and of course that will push more uninsured financial institutions into the Tar Pit. This will be conducted at run rate that can be effectively devoured by FOH, with Leviathan controlling the bleed rate.
• The Government already has Paulsenstein usury creditor loan hooks into a number of these carrion. These institutions may just as well have gone to see Vito and Guito’s “pawn shop” to cover their gambling debts. This is not a bailout at all, this is THE Tar Pit.
Indeed, Leviathan (Hank’s hedge fund) already controls a couple king mastodons out right such as Fannie and Freddie. AIG is the prime example right now of another. AIG has given up control, and is about to be liquidated quickly in a “national emergency”. Of course this will be allowed to pass because no one wants to see a situation where Aunt Millie’s annuity or insurance policy has little backing.
• Finally for this operation to have legs the monster Leviathan hedge fund has to show positive returns for taxpayers. So the the initial results will imply favorable outcomes. The MSM media well suddenly herald how Leviathan got a big loan paid back with a nice return. Watch for this to happen within weeks, and then the Tar Pit machine can really get turned loose.
Paulson Plan May Spark Showdown Between Democrats, Republicans
Congressional Democrats want to use the Bush administration's $700 billion rescue plan for U.S. financial companies to curb executive pay, spur the economy with infrastructure spending and help people avoid foreclosures, setting the stage for a possible fight with Republicans and the Bush administration.
Republicans object to adding extras to Treasury Secretary Henry Paulson's proposal, which would authorize the administration to spend an amount almost 50 percent larger than the Pentagon's annual budget to buy banks' bad mortgage debt. "This proposal is, and should be kept, simple and clear," Senate Minority Leader Mitch McConnell of Kentucky said in a statement yesterday. "Now is not the time for partisan plans or pet projects."
Both sides risk getting blamed for delaying passage of the bill. Senator Charles Schumer, a New York Democrat, said yesterday that the U.S. could "risk a depression" without the measure. "They should be feeling the fire," said Jennifer Duffy, of the Cook Political Report in Washington. "If they put it off they'll be playing a game of chicken to see who blinks first."
Democratic lawmakers including House Speaker Nancy Pelosi of California and Schumer promised to act on the plan by end of next week. So far no leader has voiced objections to what Pelosi called the "sweeping and unprecedented powers," such as barring courts from reviewing actions taken by the Treasury under the measure, that Paulson is asking for.
"The package that Secretary Paulson presented was a good foundation that can stabilize our markets quickly but it does not fill in what we're going to do to protect the taxpayer and to protect the homeowner," Schumer said yesterday at a news conference in New York.
The Treasury yesterday asked congress for unchecked power to buy $700 billion in bad mortgage investments from U.S. financial companies to help stabilize the financial system. In the last two weeks the government has seized three major firms, Fannie Mae, Freddie Mac and American International Group Inc., while watching another, Lehman Brothers Holdings Inc., go bankrupt.
Lawmakers yesterday had already begun work adapting the Treasury proposal. "What we're spending our time doing now is writing language into the Treasury proposal that will beef up taxpayer protections," Steve Adamske, a spokesman for House Financial Services Committee Chairman Barney Frank, said in a telephone interview.
The Democratic proposal will include curbs on executive pay for the companies whose assets the government will be buying, Adamske said. It also will include a plan to stem foreclosures, which may involve tapping the loan-modification abilities of the Federal Housing Administration, the Federal Deposit Insurance Corp., and Freddie Mac and Fannie Mae, he said.
Pelosi said Congress would ensure more accountability than in the Treasury plan by "implementing strong oversight mechanisms, and establishing fast-track authority for the Congress to act on responsible regulatory reform." Senate Banking Committee Chairman Christopher Dodd said any plan should "promote home ownership."
"The stakes could not be higher, and there is no time to waste, but I am hopeful that we will be able to achieve these important objectives," Dodd, a Connecticut Democrat, said in a statement. McConnell was joined by his House counterpart, Minority Leader John Boehner of Ohio, in calling for "straightforward" legislation.
"Efforts to exploit this crisis for political leverage or partisan quid pro quo will only delay the economic stability that families, seniors, and small businesses deserve," Boehner said. "I hope we all can agree that we should keep any legislation as straightforward as possible while doing everything we can to protect American taxpayers."
World Stocks Lose $19 Trillion In Past Year, $3 trillion In Past Week;
China, Thai Central Bankers Claim 'Little Impact'
China and Thailand's central bankers said there has been limited fallout for their banks from the U.S. credit crisis that sent Lehman Brothers Holdings Inc. into bankruptcy and wiped $19 trillion from world stocks in the past year. "There is not much impact on Asia this time because the problems haven't taken place here,"
Bank of Thailand Governor Tarisa Watanagase told reporters today in Bangkok, where she is hosting a meeting of central bankers. "So far the impact on Thai banks is very little." The region's policy makers this week played down concerns that their countries will be subjected to a meltdown similar to that of 1997, saying contagion from the U.S. turmoil is unlikely to infect their financial systems.
Asia's key stock index rebounded yesterday from a three-year low as central banks pumped cash into money markets and the U.S. worked on plans to shore up banks and insurers. "The direct impact of the subprime crisis is currently limited," China central bank Deputy Governor Su Ning said at a financial conference today in Shanghai. Still, "China will be highly alert to the negative effects of unstable global financial markets and decreasing overseas demand."
The MSCI Asia Pacific index rose 5.5 percent yesterday and Asian currencies, including the South Korean won, Philippine peso and Indonesia rupiah, advanced. The U.S. government announced plans to purge banks of bad assets and crack down on speculators who drove down shares of financial companies.
The U.S. plan "should help encourage new investors to have more confidence to inject liquidity into U.S. financial institutions," Paisarn Lertkowit, a foreign-exchange dealer at Bangkok Bank Pcl, said today in a telephone interview. "Capital outflows from Asia may continue for a while," he said. "When it becomes clear that the U.S. is gradually recovering, funds will start to flow back."
Central banks in Japan and Australia pumped $113 billion into money markets this week, joining European and U.S. counterparts in supporting the financial system and attempting to revive confidence. Earlier in the week, China cut interest rates for the first time in six years and allowed most banks to set aside less reserves. "We central bankers need to be watchful and decisive," Tarisa said today. "We have a swap arrangement between us and standby credit to inject liquidity if problems arise."
Central banks around the region have boosted cooperation to strengthen their financial markets and set up emergency measures to bail out their systems in case of crisis. Japan, South Korea, China and Asean countries are discussing the creation of a pool of $80 billion in Asian foreign-exchange reserves to be tapped in case the nations need to protect currencies.
The reserve pool is an expansion of a current arrangement that only allows for bilateral currency swaps. It is designed to ensure central banks have enough to shield their currencies from speculative attacks like those that depleted the reserves of some countries during the Asian financial crisis a decade ago. The region has since accumulated more than $3.3 trillion of reserves, about half of the global total.
Thailand, which triggered the Asian financial crisis with the devaluation of its baht in July 1997, has no shortage of capital and the nation's lenders are "strong and resilient," Tarisa said this week. AIG Retail Bank Pcl, a Thai unit of American International Group Inc., has adequate assets and isn't affected by the problems that led to the U.S. government's $85 billion takeover of its parent, President Charly Madan said on Sept. 18.
Chinese banks may sustain limited negative effects from the plummeting value of related investments, said Ken Peng, an economist at Citigroup Inc. in Shanghai. Lehman filed the biggest bankruptcy in history on Sept. 15, listing $613 billion of debt. Chinese banks including Industrial & Commercial Bank of China and Bank of Communications have $454 million at risk as a result, according to data compiled by Bloomberg.
"The direct linkages between Chinese financial institutions and American ones are fairly limited," Peng said today in a telephone interview. "The direct holdings are very small compared to the asset base of Chinese firms, so the direct effect is not that significant." China will strike a balance between controlling inflation and supporting economic growth, the central bank's Su said today.
"We should continue to be alert to inflation," he said. "We are confident about maintaining the stability of the financial market." While China's growth is the fastest of the world's 20 biggest economies, policy makers are concerned that weakening global growth has increased the risk of a slump. The People's Bank of China cut the one-year lending rate to 7.20 percent from 7.47 percent on Sept. 15.
The meltdown: They saw it coming
James Grant, whose cluttered office at Two Wall Street overlooks Trinity Church, has been warning about financial disaster of one form or another for nearly 25 years. Two years ago, for example, when the now-beleaguered Morgan Stanley was trumpeting a 61 percent jump in profits, Grant wrote a pessimistic analysis titled "over the cliff with Morgan Stanley."
Now much of the financial industry has gone over the cliff. And as one of the most incorrigible bears on the street, the editor and author of the gloomy Grant's Interest Rate Observer should be doing a victory lap and saying "I told you so." When reached by phone this week, Grant tried not to gloat. "What are the costliest words in finance?" he said. "One is 'it's different this time' and the other is 'I told you so.' It brings down the wrath of the gods."
The gods have sent down plenty of wrath already, so much that even Grant admits he has been surprised by the "ferocity and violence" of events that have shaken the financial world over the past two weeks.
"Nobody has been bearish enough," Grant said. "I, looking back on it, was not nearly enough of a calamity hollerer. What you did not read in Grant's was that the socialization of credit risk, a long-run trend, would yield in a few weeks an outright nationalization of our financial system. That sentence we did not write. So many things have happened in so dramatic and so violent a way that one is thunderstruck."
Kenneth Rogoff, an economics professor at Harvard University and former chief economist of the International Monetary Fund, also has reason to point to his foresight. At a conference a year ago, he predicted that a major bank would fail. In July he doubted Treasury Secretary Hank Paulson's assertion that Fannie Mae and Freddie Mac could remain in the same form. They were "toast," Rogoff said.
And then a month ago, after many analysts thought the worst of financial instability had passed with the rescue of Bear Stearns, Rogoff told another group that more failures were on the way among the financial institutions that had been reporting awe-inspiring profits and annual bonus payments in the tens or even hundreds of millions of dollars.
Profiting from that sort of wisdom is no easy thing, however. Charles D. Zender, portfolio co-manager of the Grizzly Short Fund at Leuthold Weeden Capital Management in Minneapolis, said his fund has been betting on a decline in financial stocks for the past two years. But, Zender said, "Our philosophy has always been that there have been up markets and down markets," he said. "They go up about 70 percent of the time and down about a third of the time. This is one of those ugly times."
That's made the Grizzly fund look like a beautiful creature -- at least for now. It was up 40 percent from Jan. 1 through the close of business Wednesday. "Who knows where it will be tomorrow," Zender said. Tomorrow? Long-term pessimists are still pessimistic. "I think the central banks are going to next wear the goat horns," said Grant, saying that the Fed and other central banks would lose credibility as they wade deeper into managing banks and insurance companies.
The Mother Of All Frauds
Well now we have it - since this is a proposed bill (public) and in the interests of fair use, here you have it as reported by Fox:LEGISLATIVE PROPOSAL FOR TREASURY AUTHORITY
TO PURCHASE MORTGAGE-RELATED ASSETS
Section 1. Short Title.
This Act may be cited as ___________________.
Sec. 2. Purchases of Mortgage-Related Assets.
(a) Authority to Purchase.—The Secretary is authorized to purchase, and to make and fund commitments to purchase, on such terms and conditions as determined by the Secretary, mortgage-related assets from any financial institution having its headquarters in the United States.
(b) Necessary Actions.—The Secretary is authorized to take such actions as the Secretary deems necessary to carry out the authorities in this Act, including, without limitation:
(1) appointing such employees as may be required to carry out the authorities in this Act and defining their duties;
(2) entering into contracts, including contracts for services authorized by section 3109 of title 5, United States Code, without regard to any other provision of law regarding public contracts;
(3) designating financial institutions as financial agents of the Government, and they shall perform all such reasonable duties related to this Act as financial agents of the Government as may be required of them;
(4) establishing vehicles that are authorized, subject to supervision by the Secretary, to purchase mortgage-related assets and issue obligations; and
(5) issuing such regulations and other guidance as may be necessary or appropriate to define terms or carry out the authorities of this Act.
Sec. 3. Considerations.
In exercising the authorities granted in this Act, the Secretary shall take into consideration means for—
(1) providing stability or preventing disruption to the financial markets or banking system; and
(2) protecting the taxpayer.
Sec. 4. Reports to Congress.
Within three months of the first exercise of the authority granted in section 2(a), and semiannually thereafter, the Secretary shall report to the Committees on the Budget, Financial Services, and Ways and Means of the House of Representatives and the Committees on the Budget, Finance, and Banking, Housing, and Urban Affairs of the Senate with respect to the authorities exercised under this Act and the considerations required by section 3.
Sec. 5. Rights; Management; Sale of Mortgage-Related Assets.
(a) Exercise of Rights.—The Secretary may, at any time, exercise any rights received in connection with mortgage-related assets purchased under this Act.
(b) Management of Mortgage-Related Assets.—The Secretary shall have authority to manage mortgage-related assets purchased under this Act, including revenues and portfolio risks therefrom.
(c) Sale of Mortgage-Related Assets.—The Secretary may, at any time, upon terms and conditions and at prices determined by the Secretary, sell, or enter into securities loans, repurchase transactions or other financial transactions in regard to, any mortgage-related asset purchased under this Act.
(d) Application of Sunset to Mortgage-Related Assets.—The authority of the Secretary to hold any mortgage-related asset purchased under this Act before the termination date in section 9, or to purchase or fund the purchase of a mortgage-related asset under a commitment entered into before the termination date in section 9, is not subject to the provisions of section 9.
Sec. 6. Maximum Amount of Authorized Purchases.
The Secretarys authority to purchase mortgage-related assets under this Act shall be limited to $700,000,000,000 outstanding at any one time
Sec. 7. Funding.
For the purpose of the authorities granted in this Act, and for the costs of administering those authorities, the Secretary may use the proceeds of the sale of any securities issued under chapter 31 of title 31, United States Code, and the purposes for which securities may be issued under chapter 31 of title 31, United States Code, are extended to include actions authorized by this Act, including the payment of administrative expenses. Any funds expended for actions authorized by this Act, including the payment of administrative expenses, shall be deemed appropriated at the time of such expenditure.
Sec. 8. Review.
Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.
Sec. 9. Termination of Authority.
The authorities under this Act, with the exception of authorities granted in sections 2(b)(5), 5 and 7, shall terminate two years from the date of enactment of this Act.
Sec. 10. Increase in Statutory Limit on the Public Debt.
Subsection (b) of section 3101 of title 31, United States Code, is amended by striking out the dollar limitation contained in such subsection and inserting in lieu thereof $11,315,000,000,000.
Sec. 11. Credit Reform.
The costs of purchases of mortgage-related assets made under section 2(a) of this Act shall be determined as provided under the Federal Credit Reform Act of 1990, as applicable.
Sec. 12. Definitions.
For purposes of this section, the following definitions shall apply:
(1) Mortgage-Related Assets.—The term mortgage-related assets means residential or commercial mortgages and any securities, obligations, or other instruments that are based on or related to such mortgages, that in each case was originated or issued on or before September 17, 2008.
(2) Secretary.—The term Secretary means the Secretary of the Treasury.
(3) United States.—The term United States means the States, territories, and possessions of the United States and the District of Columbia.
I'm speechless. Let's disassemble this monster piece by piece.
First, this is a de-facto nationalization of the entire banking, insurance, and related financial system. Specifically:
"(3) designating financial institutions as financial agents of the Government, and they shall perform all such reasonable duties related to this Act as financial agents of the Government as may be required of them;"
That's right - every bank and other financial institution in the United States has just become a de-facto organ of the United States Government, if Hank Paulson thinks they should be, and he may order them to do virtually anything that he claims is in furtherance of this act.
This might include things like demanding that a bank or other financial institution sell him its paper, even if it forces that firm to collapse and be assumed by the FDIC! You didn't buy any bank stocks last week did you?
"(a) Authority to Purchase.—The Secretary is authorized to purchase, and to make and fund commitments to purchase, on such terms and conditions as determined by the Secretary, mortgage-related assets from any financial institution having its headquarters in the United States."
This, at first blush, would seem to indicate that only American firms would be covered. Nothing is further from the truth. If the Chinese wish to unload some of their purchased toxic sludge they merely sell it to, oh, Goldman Sachs for 40 cents on the dollar and then Goldman sells it to the Treasury for 50.
This, under the black letter of the law here, is perfectly legal, which means that one must assume that Paulson will in fact foist off all the bad paper on world markets that was originally based on a mortgage in the United States, while allowing his banker buddies here to loot the taxpayer by acting as an intermediary in the transaction!
"(2) entering into contracts, including contracts for services authorized by section 3109 of title 5, United States Code, without regard to any other provision of law regarding public contracts;"
Contracts can (and presumably will) be "no bid, no solicitation" and given to whomever Secretary Paulson favors, without regard to the public interest or normal competitive bidding processes. Must be nice to be a "Friend of Hank."
"In exercising the authorities granted in this Act, the Secretary shall take into consideration means for—
(1) providing stability or preventing disruption to the financial markets or banking system; and
(2) protecting the taxpayer."
Notice which comes first.
"(c) Sale of Mortgage-Related Assets.—The Secretary may, at any time, upon terms and conditions and at prices determined by the Secretary, sell, or enter into securities loans, repurchase transactions or other financial transactions in regard to, any mortgage-related asset purchased under this Act."
Having bought these securities for any price Mr. Paulson would like (and he can compel institutions to sell at his demanded price as noted above!) he can then sell those assets at any price he wishes, to anyone he wishes. It certainly is nice to be a "Friend of Hank", and it most certainly sucks if you're not.
"The Secretarys authority to purchase mortgage-related assets under this Act shall be limited to $700,000,000,000 outstanding at any one time"
This is clever and nobody in the mainstream media has figured it out. If you think the cost of this bill is $700 billion, you're wrong. The cost is actually infinite and the entire bill constitutes a giant money-laundering scheme.
Paulson can (and presumably will) buy up to $700 billion of these "assets", then sell them.
Let's say he decides to buy them at 60 cents on the dollar and sell them for 10. You, the taxpayer, will eat the fifty cents, for an immediate cost of $350 billion dollars. Having done so, he is then authorized to do so again, since the $700 billion is no longer on the government's balance sheet.
In fact, he can do this without limit, other than possibly due to the federal debt ceiling, which of course Congress will raise any time we get close to it. Oh yeah, this bill does that right up front too. No need to bother with it the first time around. Folks, $700 billion isn't even close to the total cost of this monster.
If Paulson and his successor decide to, they could literally cycle all $5.3 trillion of Fannie and Freddie's debt through this scheme, potentially sticking the taxpayer for 20% or more of the total, plus as much private debt on various bank balance sheets as they can manage to nationalize until (and possibly beyond) the point where the bond market tells him to go to hell.
Bottom line: This bill gives Paulson the ability to nationalize an UNLIMITED amount of private debt and force YOU AND YOUR CHILDREN to pay for it.
Sec. 8. Review.
Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.
If you are a bank, investor, or other entity who is forcibly gang-raped by Secretary Paulson due to his actions as "King" (crowned by Congress) under this law, you are unable to seek redress in the courts or by administrative action. The claim is that this is intended to "promote confidence and stability" in the financial markets. It will do no such thing.
It will instead strike terror into the hearts of investors worldwide who hold any sort of paper, whether it be preferred stock, common stock or debt, in any financial entity that happens to be domiciled in the United States, never mind the potential impact on Treasury yields and the United States sovereign credit rating.
I predict that if this passes it will precipitate the mother and father of all financial panics, although exactly when the "short bus" riders who inhabit the equity market will figure it out remains to be seen. If they have an IQ larger than their shoe size it will commence at 9:30:01 AM Monday morning, although given history and the lack of intelligence displayed by the crooning media market euphoria may continue until the first couple of firms are dismantled by Paulson's newly-crowned Kingly powers with the scraps handed out to his favored few.
The best part of this outrageous fraud is that those who get bent over the table can't even sue - their only recourse will be the (literal) deployment of pitchforks and torches. That Paulson and Bernanke circulated this document, irrespective of what actually gets reported out onto the floor of the House and Senate (if anything) tells you everything you need to know about his intentions and the safety of your financial assets in the United States markets.
That this "proposal" hasn't resulted in Congress calling for both Bernanke and Paulson to resign for their blatant attempt to crown Paulson King tells you everything you need to know about Congressional integrity as well. My advice: Don't be caught with any stock or debt instruments linked to a United States financial firm in your portfolio past 9:30 AM Monday morning.
Takeovers of AIG, Fannie and Freddie raise business and political questions
Uncle Sam is turning into Uncle CEO. But will the new corporate suit be a good fit?
By agreeing to bail out insurance giant American International Group Inc. and mortgage lenders Fannie Mae and Freddie Mac, the federal government has put itself in the unprecedented position of running huge private companies. In the case of American International Group, or AIG, the government is now the majority shareholder, acquiring 80% of the company in exchange for lending it as much as $85 billion over two years to keep the business out of bankruptcy as it is dismantled.
But some lawmakers and financial experts wonder whether U.S. officials are up to the task of directing large corporations through such turbulent times. AIG, for instance, has 116,000 employees and does business in about 100 countries. Fannie Mae and Freddie Mac together hold or guarantee $5.4 trillion of mortgages, about half of the nation's home loans.
"The government does not have a core competency to run an insurance company of the magnitude of an AIG," said David M. Walker, former head of the Government Accountability Office, the congressional watchdog agency. "It's clearly not going to be able to effectively manage AIG and do what needs to be done."
Top Bush administration officials say they authorized the controversial bailouts to prevent corporate failures that could have crippled the U.S. economy. But many details about how the government will run the companies, and for how long, are still being worked out.
Some critics of the bailouts are heartened that federal officials moved quickly to place seasoned, private-sector executives into key leadership positions at the companies. For example, Edward M. Liddy, former chairman and chief executive of Allstate Corp., was installed as the new head of AIG and told employees that he didn't think the government intended to "hamstring" the company.
Yet questions remain about what influence federal officials such as Treasury Secretary Henry M. Paulson -- who reportedly sought the ouster of AIG Chief Executive Robert Willumstad as a condition of the bailout -- will exert over the companies, and what role politics might play in their operation.
"When you have these things going on behind closed doors, it's a little disconcerting," said Dean Baker, co-director of the Center for Economic and Policy Research, a left-leaning think tank in Washington. "When you do have sell-offs of the parts of AIG, we want to make sure that is done on a fair-market basis. You don't want to have sweetheart deals."
Still, given the dire financial problems faced by AIG, Fannie Mae and Freddie Mac, Baker said, it won't be difficult for the federal government to improve on their management. "It's hard to see how they could do worse," he said.
The history of federal bailouts has been generally good, said Benton E. Gup, a finance professor at the University of Alabama and editor of the 2003 book "Too Big to Fail: Policies and Practices in Government Bailouts." The government even turned a $313-million profit on stock options it received when it provided $1.5 billion in loan guarantees to automaker Chrysler Corp. in 1980, he noted.
In those bailouts, however, the government did not take control of the companies. It simply provided guarantees for loans. The Federal Reserve and Treasury did the same thing in March when they authorized $29 billion in loan guarantees to JPMorgan Chase & Co. to facilitate its purchase of struggling brokerage Bear Stearns Cos.
But the bailouts of AIG, Fannie Mae and Freddie Mac are new territory, fueled by an attempt to avoid a global financial disaster. "They are not taking over because they believe they can manage them better, but rather because it's a way to provide a government guarantee," said Pablo Spiller, a professor of business and technology at UC Berkeley. "This is the biggest financial crisis in the last 80 years."
The subprime mortgage mess crippled Fannie Mae and Freddie Mac, private companies known as government-sponsored enterprises because they were originally chartered by the federal government. Many investors believed the companies -- which buy mortgages from savings and loans, banks and other lenders to generate more cash for those lenders to make more home loans -- had the implicit financial backing of Washington.
Two weeks ago, the federal government seized control of the companies. The Treasury Department plans to buy as much as $100 billion in stock in each, expand their portfolios of mortgages and mortgage-backed securities until 2010, then slowly reduce their holdings.
To do that, the government placed Fannie Mae and Freddie Mac into a conservatorship run by the Federal Housing Finance Agency, a body created by Congress this summer. Paulson said having a government-appointed conservator was the only way he would commit taxpayer money to the bailout.
The agency's director, James Lockhart, appointed new CEOs and board chairmen after consulting with the Treasury Department. The conservator cannot liquidate the companies, but otherwise has full power to run them. But President Bush's successor is likely to appoint a new director of the agency, who will run the conservatorship, as well as a new Treasury secretary.
In the AIG bailout, the government received 80% of the stake in exchange for loans from the Federal Reserve that kept the company from bankruptcy. The Federal Reserve Board, which authorized the bailout, said the loan was designed to let the company sell some assets "in an orderly manner."
The government appointed Liddy as CEO and probably will replace the board. The government will have veto power over major corporate decisions, including whether to pay dividends to shareholders.Sen. Charles E. Schumer (D-N.Y.) said Liddy's hiring was a good sign.
"They've appointed a very capable executive who was the head of another major insurance company," Schumer said. "Most of the parts of AIG are still making money. . . . So the idea is to keep the mainstay, this biggest American insurance company, still working." AIG is the largest U.S. insurer as measured by assets and the second-largest by premiums.
Insurance is regulated at the state level, so the sale of assets by AIG would have to be approved by the industry regulator in the state where an asset is based. The National Assn. of Insurance Commissioners has formed a working group to assist federal officials with the sales of AIG properties.
"We want to make sure they don't damage the health of the insurance properties," said California Insurance Commissioner Steve Poizner, a member of the working group. Five AIG companies are headquartered in the state, and 25 others do business there. Daniel J. Mitchell, a senior fellow at the Cato Institute, a libertarian Washington think tank, opposed the AIG bailout. But he said U.S. officials were making responsible decisions about how to run the firms.
"It appears like they're doing the wrong thing in the best way possible," he said. "I assume that it's going to be somewhat akin to a company going into receivership, and we're not going to have the government so much running the company as giving approval process for the people who are left to run the company."So far, it does not appear that political affiliation has played a role in placing executives at the companies.
Liddy has given campaign money to Bush and Republican presidential nominee John McCain, according to contribution data from the Center for Responsive Politics. David M. Moffett, the new Freddie Mac CEO and a former chief financial officer of U.S. Bancorp, has contributed to GOP congressional candidates.
But new Fannie Mae CEO Herbert M. Allison Jr., who was chairman of investment firm TIAA-CREF, has contributed to Republicans and Democrats, including Democratic presidential nominee Barack Obama. New Fannie Mae Chairman Philip Laskawy, who served as chairman and CEO of accounting firm Ernst & Young, has given most of his contributions to Democrats. And new Freddie Mac Chairman John Koskinen, former president of the U.S. Soccer Foundation, worked in the Clinton White House.
Still, Rep. Tom Feeney (R-Fla.) said politics was bound to play a role in how federal officials run the companies. And that's one reason he opposed the bailouts. "Government's not equipped to successfully run any of these entities," he said. "We will do a lousy job. Worse than they did."
The Fed, now with more junk
Once upon a time—just six months ago, in fact—financial services firms sank or swam on their own and the Federal Reserve had a clear mission and a nearly pristine balance sheet of safe Treasury securities. No more. Treasuries accounted for only half of the Fed’s $978 billion reserve balances as of Sept. 17. Of that, less than $200 billion worth remains that hasn’t yet been committed for loans, by some economists’ estimates.
Much of the Fed’s balance sheet now consists of riskier securities, some obtained as collateral from investment banks getting emergency loans and some acquired in the U.S. central bank’s bailout of American International Group and Bear Stearns. They could include junk bonds, mortgage-backed securities, credit default swaps, real estate and even equities.
To replenish the Fed’s coffers, the Treasury Department said last week it would sell securities to add $200 billion in cash. Fed chairman Ben Bernanke’s actions have drawn rave reviews from economists who praised the potential effectiveness of the bailouts, even as both Democratic and Republican lawmakers criticized him for their magnitude and lack of transparency.
At the same time, some economists expressed concern that the Fed’s cash infusion could fuel inflationary pressures and its acquisition of risky assets could burden taxpayers if the economy tanks. “If you have a really bad fever, you don’t want just aspirin, you want a strong prescription from a doctor,” said Adam Posen, deputy director of the Peterson Institute for International Economics. “But there are probably going to be some side effects.”
The Fed’s new multifaceted role, a departure from its traditional function of adjusting interest rates to redirect the economy, has also drawn lawmakers’ attention. “It’s hard for them to do monetary policy, which is their primary task, and then run all these businesses,” Sen. Charles Schumer (D-N.Y.) said last week. But help may be on the way.
Treasury Secretary Henry Paulson called Friday for a comprehensive approach to transferring troubled assets—especially the mortgage-backed securities at the root of the crisis—off banks’ balance sheets. Some options being floated would relieve the Fed of the burden of holding troubled assets. House Financial Services Committee chairman Barney Frank (D-Mass.) has talked about establishing an agency similar to the Resolution Trust Corp. to buy and dispose of toxic securities.
It’s possible that another option under consideration—using Fannie Mae and Freddie Mac to buy assets—could add risky securities to the Fed’s balance sheet. With the government’s take-over of the mortgage companies this month, the Treasury pledged to buy up to $200 billion of their stock to keep them solvent. Under this option, which hasn’t been spelled out, it’s possible the Fed could be asked to exchange Treasuries for mortgage-backed securities, as it has with AIG.
Still other help for the Fed could come from Congress. Lawmakers may move up the date on which the Fed would be allowed to pay commercial banks interest on reserves held at the Fed, Mr. Frank said last week. Such interest payments would give banks an incentive to store money at the Fed, giving the central bank more flexibility to pump cash into the economy without lowering interest rates. While the Fed is due to get that authority in 2011, it wants it sooner.
Last week saw unusual activity at the Fed, as it loaned a near-record $121 billion to AIG and investment and commercial banks in an effort to ease the credit bottleneck. Commercial bank borrowing rose from $24 billion to $33 billion, in part because of a “squeeze” after the Fed provided only $74 billion of excess reserves to the banking system, according to the Wrightson ICAP research firm.
Those excess reserves were increased an extraordinary amount last Thursday, from $74 billion to $190 billion, according to Wrightson ICAP. The Fed also agreed to provide up to $247 billion in dollars to foreign central banks to satisfy demand from their commercial banks.
While the Fed can expand its balance sheet by printing money and buying Treasuries with no effect on interest rates, some experts warn such “sterilization” efforts could become more difficult as investors flee to the safety of Treasuries. “I’m very much concerned about inflationary pressures,” said Dimitri Papadimitriou, president of the Levy Economics Institute, although he noted that such pressures “may prove to be very limited in a deflationary economy.”
Still, poor performance of companies under U.S. control could trigger unforeseen federal expenditures. Suresh Sundaresan, a Columbia University economics professor, predicted federal commitments to Fannie and Freddie could rise eventually to $500 billion—considerably more than the $200 billion pledged by Treasury to keep them solvent.
“The funding needs of Fannie and Freddie are pretty huge,” Mr. Sundaresan said. For example, if Fannie or Freddie try to issue short-term debt and can’t get it done in the market, they may turn to the Treasury, he said.
And if insurance giant AIG goes belly up, the Fed would be stuck holding nearly 80% of its assets. “In the event of a major downturn or AIG’s failure, you’re much closer to an event with implications for taxpayers,” said Peter Hooper, chief economist at Deutsche Bank Securities. “But the Fed’s going to be liquidating assets over time and could well end up making significant money.” Like so many aspects of the fast-moving 2008 financial meltdown, the fate of the Fed’s balance sheet remains a great unknown.
Ambac warns downgrade would put unit under pressure
Ambac Financial said late Friday that a downgrade by ratings agency Moody's Investors Service would leave its guaranteed investment contract business short of collateral to meet liabilities.
The company also said plans to pump $850 million into a new municipal bond insurance business called Connie Lee have been postponed. It also cancelled a $50 million share buyback plan that was announced earlier this year. Moody's warned late Thursday that it may downgrade the main bond insurance units of Ambac and rival MBIA Inc.again because losses on mortgage-related securities they guaranteed are likely to get much worse.
Ambac shares slumped 42% on Friday after the warning, while MBIA stock fell 8%. Ambac shares fell another 7% to $3.60 during after-hours trading. Ambac said late Friday that a downgrade would increase pressure on its financial services business, which includes guaranteed investment contracts, or GICs.
GICs provide institutions a certain rate of return on specific amounts of money. Providers promise to pay an agreed rate and get the money to invest in return. Profits are made on the spread between the rate the provider offers the buyer and the returns it can generate itself. Municipalities often use GICs when they get large sums of money from a recent bond offering, but don't want to spend the cash straight away. Ambac and MBIA have large GIC businesses.
When GIC providers are downgraded by ratings agencies, they are often required to post more collateral to support the agreements, or come up with collateral when the contracts are terminated. Ambac estimated late Friday that if it's downgraded there won't be enough assets in its GIC portfolio to cover the projected cumulative collateral requirement and terminations.
If Ambac is cut to A+ or A1, the shortfall will probably be $1 billion, the company estimated. If it's downgraded to A/A2 or A-/A3, the shortfall would increase to $1.9 billion.
Ambac said it's talking with its insurance regulator "to review alternatives to meet a potential collateral shortfall in our GIC business in the event of a ratings downgrade." Ambac also said its Connie Lee project will be delayed while the company deals with the potential consequences of a possible downgrade by Moody's.
Connie Lee is a unit of Ambac that is already licensed in many states in the U.S. The company has been trying to pump $850 million of new capital into the subsidiary and launch it as a new bond insurance business focused on guaranteeing municipal debt and global infrastructure deals. If the plan works, Ambac may be able to generate more new business, improving the company's longer-term prospects.
But on Friday, Ambac said the planned injection of $850 million in capital has been postponed. "We had hoped to launch this new financial guarantee subsidiary focused on the municipal sector in the fourth quarter and have been working tirelessly to do so," the insurer said. "However, the recent market turmoil and Moody's action cause us to decelerate our timeline."
A planned $50 million share buyback announced earlier this year has been cancelled, Ambac also said. No shares had been purchased under the program. The move will help liquidity at Ambac's parent company, it explained.
Wall Street's Ills Seep Into Everyday Lives
Bradford Roth, the 56-year-old chairman of a Chicago law firm, had a clear strategy for dealing with Wall Street's gyrations when he stopped by a local Fidelity Investments branch Wednesday.
He'd make a deposit to his cash-management account, but he wasn't going to check the balance of his retirement account.
"The less you know," he said, "the better you feel. There's nothing wrong with working in your 80s." The crisis gripping global finance is filtering into the everyday lives of Americans, spawning confusion and denial, avarice and anxiety, stoicism and black humor.
For some, it has meant putting off retirement or long-planned moves. For others, it meant moving their money out of stocks and bonds and into foreclosed homes, gold, livestock or even just having a good time. "I've been talking to my banker and telling him to get all my money out of the market," said Pat Hurley, a 57-year-old electrical contractor from Phoenix. "I'm really worried -- I think the stock market is going to get worse and worse," he said.
Mr. Hurley has $440,000 in his retirement fund, a sizable chunk but not nearly the million dollars he was hoping for. "I finally got back to where I was in 2001 and now the stock market's diving again," he said. Bob Conrad, a 59-year-old budget director at the U.S. District Court in Dallas, sees his chance for retirement next year slipping further away. After his nest egg lost 10% of its value, he moved his money a few months ago out of stocks.
He thought he was set, but soaring food prices and seesawing energy prices already had him worried. And now, "this thing looks like it's going to get worse before it gets better," he said. "That's just my luck. Looks like I'll be working a while longer." On the other hand, Antonio D'Souza, a 28-year-old software engineer from San Francisco, sees today as the rainy day to spend his savings. As he watched his 401(k) retirement account lose half its value as of last month, he said, he soured on investing in the market and "decided I was just going to spend."
He bought a $350 juice extractor and a $700 bicycle, spent $600 on four pairs of pants, and then splurged on a trip to Japan. He celebrated, with "the most expensive meal I've ever had," he said, an eight-course Japanese feast. This week's collapses at American International Group Inc. and Lehman Brothers Holdings Inc. have reinforced his view that "the money is worth more if spent now," he said.
But for many others, the tumultuous events unfolding this past week added to financial strains that have been piling up for more than year. "It starts to make you sick," said 52-year-old Mandisa Lewis, of Maple Heights, Ohio. After losing her job as a secretary, she said she had to tap into her 401(k) account this summer to make house payments. The recent financial news only makes her more anxious: "It gets to where you cry a lot at weird times."
For every person paralyzed by fear or blissfully in denial, there was another leaping into action to preserve what amounted to the fruits of a lifetime of work. Carolyn Sloane, a 43-year-old paralegal in Wallingford, Vt., officially marked the end of the bull market by investing in cows. Ms. Sloane has been playing the stock market since 1989, but the rattling of Wall Street, she said, gave her a "desire for hard assets."
She recently sold all of her stocks and bailed out of mutual funds, and put part of the money in certificates of deposit. But she also wanted the kind of assets she could see in her own yard, so she bought three cows, two of which were delivered on Sunday. "This is my commodity play," she told perplexed relatives. Her plan is to breed the cows, black-and-white Belted Galloways. "When they have offspring, that's your dividend."
One investor, Robert, a 37-year-old trader for a private-investment firm who lives in the San Francisco Bay area, lost faith in paper currencies long ago -- especially the U.S. dollar -- and has been buying gold from a mint in Perth, Australia. He keeps it stored there, ready to ship anywhere in the world at a moment's notice. He also said he keeps $100,000 worth of gold coins at his home, which is why he asked that his last name not be used, fearing burglars.
Robert said he witnessed three previous financial crises first-hand as a derivatives trader -- the Japanese bust of the 1990s, the Asian financial crisis of 1997 and the downfall of Long-Term Capital Management in 1998 -- and this is the worst situation he's seen. "Yesterday was the first time I've been spooked in a long time," he said.
In San Diego, 29-year-old Robert Brown, himself a banker, has decided against keeping his money in a savings account or a certificate of deposit. Mr. Brown sees an opportunity in the financial crisis, and plans to invest in buying and reselling foreclosed properties in the Dallas-Fort Worth area. As for the stock market: "I am more of the aggressive type. I can handle the swings and everything, but what I can't handle is that this is not the type of market that is going to make me money," Mr. Brown said.
Those who operate far outside the realm of high finance are having a more difficult time deciding what to do. With their retirement savings building in a pension fund since 1983, Seattle residents Pat Williams and her husband, Jim, are now questioning their savings strategy. The retirement accounts, which are run by Smith Barney, a unit of Citigroup Inc., were worth a little more than $1 million until four months ago. Since then, Ms. Williams said the combined accounts have lost $170,000.
Now the stock-market plunge caused by the fall of Lehman Brothers and the sale of Merrill Lynch & Co. had their accounts losing an additional $40,000 a day for the past two days. So tomorrow, Ms. Williams said she and her husband are pulling out roughly 75% to 80% of the money invested in their retirement accounts and putting it in a money-market account while they figure out what to do next.
"We just don't have the staying power," said Ms. Williams, 58. "I can't watch anymore of our money go away." "It's scary to watch this all," said Palo Alto, Calif., attorney Glennia Campbell, 47, who plans to sit down this weekend with her husband to discuss how to allocate their 401(k) investments. "What keeps going through my mind is that scene from the movie 'It's a Wonderful Life' where everyone rushes to the bank and demands to take their money out," she said.
Some people remain defiant. "I'm not going to panic," said Robert Wilson, 78, a retired banker from Amarillo, Texas, whose money is socked away in bread-and-butter stocks he thinks will be a safe refuge. "You still drinking Coca-Cola?" he asked. "You still washing your clothes? That's Procter & Gamble."
Predictably, all the confusion and anxiety already is leading to some doomsday humor. On the train Thursday from Chicago's suburbs into the city, two traders were overheard having this mordant exchange:
First: "Hey, good to see that you haven't jumped off a building yet."
Second: "Not yet. I'm waiting to move to a higher office."
Borrowing costs go bonkers
Rising at 5 a.m. every morning on her vacation was not part of Pitney Bowes treasurer Helen Shan’s plans. But then she didn’t expect her getaway last week to Sedona, Ariz., to coincide with an unprecedented financial meltdown on Wall Street that would require her to be awake and briefed before the markets opened each day on the East Coast. “It really wasn’t much of a vacation,” Ms. Shan conceded.
Vacation or not, Ms. Shan and finance heads across the country spent the week fielding daily calls and e-mails from brokers, investment managers and lenders, all of whom wanted to convince their clients of their own financial solvency and to discuss changes in corporate finance strategy. CFOs, too, were reaching out to assess exposure to any potential risks.
“As a CFO, I never used to come in and get on the phone to find out what was happening to commercial paper lines, but I am now,” said Ben Fowke, finance chief of Xcel Energy. As they pondered a Wall Street without an independent Lehman Brothers, Merrill Lynch or American International Group, questions quickly arose about access to credit and cash management, following news that money market fund shop the Reserve had “broke the buck” as investors fled even the safety of money funds.
“It’s scary when you have to worry about what money-market fund your overnight cash is in or which bank you use,” Mr. Fowke said. “It has caused us to pay a lot more attention to things that used to run themselves. We’re trying to get our arms around how bad this storm can get, and what are the scenarios that we have to prepare for, and they’re things we never imagined.”
Borrowing costs for companies skyrocketed last week, exacerbating an already difficult situation. The average yield on high-yield corporate bonds Sept. 18 was 12.55%, and the spread was 947 basis points over the average of the five- and 10-year Treasury notes, the widest since November 2002, according to Moody’s. The yield on non-financial investment-grade companies was 6.5%, and the spread over the 30-year Treasury bond was 231 basis points.
Though financial firms have clearly been hit the worst, borrowing is more difficult for companies across the board, said Ioana Barza, senior market analyst at Thomson Reuters Loan Pricing Corp.
“It’s hard to gauge the big picture, because you have some issuers that are investment-grade issuers, some that are leveraged issuers, and some that rely on the CP market more than others. But no matter what you rely on, it’s tightened drastically,” she said.
While borrowing has become more expensive for Applied Industrial Technologies, CFO Mark Eisele said he does not plan to change the company’s borrowing strategy—yet. Mr. Eisele said his company has about $100 million in short-term, Libor-based debt. “Even with the increases, the short-term rates are still really low by historic standards,” he said.
Because the market was in borrowers’ favor up until last year, some companies may also have a “saving grace,” explained Ms. Barza of Thomson Reuters, if they were able to negotiate five-year credit facilities before the market worsened. “They may have a few years before that five-year runs out,” she said.
In the second quarter of last year, five-year loans took up 55% of the market, compared with a current 21%, a five-year low, according to Reuters LPC data. Companies that have a backup five-year credit facility are lucky in that they’re able to steer clear of their bankers for a time, Ms. Barza said, because certainly banks’ lending is constrained.
“What [the financial crisis] has been doing progressively is reducing the ability of banks across the world, whether they’re large banks or small banks, to extend credit to their clients,” said William Longbrake, a director at First Financial Northwest bank in Renton, Wash., and former chief financial officer of Washington Mutual. “In some cases they can’t provide it at all.”
More cash on the balance sheet may also help tide companies over until the market improves, noted Ben Garber, an economist at Moody’s. “Fortunately, compared with the last recession, companies have been much better at managing their inventories, and they find themselves with much bigger cash hoards,” Mr. Garber said. The total liquid assets of non-financial companies stands at 23% of total debt, he said, compared with 18% in the 1990s.
Following the Reserve “breaking the buck” last week, Mr. Eisele of Applied Industrial Technologies held discussions with investment advisers about where to place the company’s cash. “We’re making sure our excess cash is going into the most solid group of investors we can think of,” he said, declining to identify exactly where the company put its money.
While Mr. Eisele isn’t concerned about his own immediate cost of debt, he said he does worry the credit crunch will cause clients to scale back expansion plans, which help fuel Applied’s sales growth.
At Pitney Bowes, Ms. Shan said she expected to see fewer competitors seeking to lend to the company and higher rates on borrowing as a result. The company’s $1.5 billion credit facility remains intact, she said. Its chief lenders are J.P. Morgan Chase and Citibank.
The company usually uses overnight or seven- to 14-day commercial paper, although last Monday and Tuesday it was only able to receive overnights. Conditions loosened slightly later in the week, and the company was able to secure several seven-day loans, as well as a 19-day sub-Libor loan.
As of now, Pitney Bowes will not change its long-term financing plans, but it will continue to evaluate the markets, Ms. Shan said. “What I don’t want to do is panic and run out and issue and lock us in to higher rates if I don’t have to.” The good news, said Moody’s Mr. Garber, is that borrowing conditions should improve, given the government’s plan to step in and rescue faltering banks.“I would expect much lower yields from the seriously distressed levels we saw [last] week.”
Default by the US government is no longer unthinkable
So, here we are - the start of a new world order. After the tumultuous events of the last fortnight, the global economic landscape will never look the same again. Power has tangibly shifted - away from the United States and the Western world generally, and towards the fast-growing giants of the East.
That's been happening for some years now. But September 2008 marks the moment when the scale of our excesses, the extent of our debts and the moral bankruptcy of our financial regulatory system finally began to be truly exposed.
I say began to be exposed. Back in March, Standard and Poor's, the US ratings agency, estimated some $285bn (£156bn) of mortgage-backed securities would eventually be written-off by the global banking sector. On Friday, almost unnoticed amid the panic, that forecast was upped to $378bn.
In reality, total credit losses will be much higher - at least $750bn in my view. But the extent of the 33 per cent one-off increase in S&P's estimate speaks volumes. It reflects just how little anyone truly knows about either the ultimate size of the sub-prime losses or who ultimately holds the related securities. But with one in ten US mortgages now "delinquent" or "in foreclosure", and house prices still falling, such "toxic waste" is burning holes in balance sheets wherever it sits. That's why this crisis is far from over.
It's difficult to overstate the enormity of what happened last week. By any standard, the collapse of Lehman Brothers was a dramatic - and alarming event. One of the biggest names on Wall Street, the 158-year old bank was consumed by the scale of its losses and crippled by executive feuds. Deemed by the US Federal Reserve to be "sufficiently unconnected" to the rest of the global financial system, Lehman was allowed to fold.
In contrast, American International Group, the world's largest insurer, was judged "too interconnected" to collapse. So the Fed effectively "nationalised" AIG - the biggest rescue of a private firm in human history. And it's only a few weeks, of course, since the even more expensive bail-out of quasi-government lenders Fannie Mae and Freddie Mac - which, between them, account for a mind-boggling $5,300bn of mortgages, around half of America's home loans.
On top of all that, US Treasury Secretary Hank Paulson sent an $800bn financial rescue plan to Congress. He wants to create a second "Resolution Trust Corporation" - or government-owned asset management company - to take on illiquid mortgage-related debts. The original RTC was established to rescue the US Savings and Loans Associations that went bust in the 1980s.
And by the way, the Fed has also just offered another $125bn of liquidity to banks outside the US that are desperate for dollars and can't access America's frozen credit markets - a move co-ordinated with central banks in Japan, the Eurozone, Switzerland, Canada and here in the UK.
The combination of these measures - each of them of enormous significance in its own right - sent stock markets shooting-up on Friday. America's S&P 500 rose 4.03 per cent and London's FTSE 100 soared 8.84 per cent, its largest one-day rise ever. But, despite the end-of-week euphoria and trader-talk that "the only way is up", despite America's undoubted resolve and Paulson's determination to do "whatever it takes", the situation remains very fragile.
Nothing better reflects the amount of fear among banks in America - banks everywhere - than the sky-high rates they're continuing to charge when lending to each other. Ordinarily, inter-bank (or Libor) interest rates are only slightly above base rates.
But with so much uncertainty remaining about the scale and occurrence of "sub-prime" - and with desperate bank executives still so reluctant to "fess-up" their losses - the US Libor rate on money to be paid back in three months is now a staggering 1.5 per cent above base. In recent weeks, Libor rates have shot up in other countries too.
Paulson's latest liquidity injection has lowered over-night Libor rates for now. But, despite the torrent of cash the US has directed at the credit markets, longer-term inter-bank rates have stayed stubbornly high, and some have gone up further. In other words, even the banks themselves don't think the rescue plan will work. Expect more - and bigger - liquidity operations in weeks to come.
The trouble is, though, as the bill for these bail-outs keeps rising, so does the possibility that the political consensus will crack and there'll be an almighty, and debilitating, dust-up. Paulson's RTC plan, in theory, could restore confidence. By taking sub-prime loans off banks' books, it could de-ice the inter-bank market, restoring credit lines to households and firms and preventing the "credit crunch" from shifting wholesale, in that fabled phrase, "from Wall Street to Main Street".
But, in the run-up to the US election in November, Democrats in Congress - and even some Republicans - may decide they're simply not having it. How much more can the US taxpayer take? It sounds insane, but the liabilities being taken on by the Fed and the US Treasury are now so enormous that the government itself could default. No?
Check out the chart showing the recent spikes in the US 10-year credit default swap. In other words, the market is now pricing-in the genuine possibility that the US will struggle to pay-back some of its long-term T-bills.
That possibility is still deemed to be quite low. But the ultimate financial question - until recently, unthinkable - is now being asked. Yes siree, the mighty US government could default. That's how much the world has changed.
A Professor and a Banker Bury Old Dogma on Markets
For the last year, as the nation’s economy lurched from crisis to crisis, the chairman of the Federal Reserve, Ben S. Bernanke, had been warning Henry M. Paulson Jr., the Treasury secretary, that the worsening situation might ultimately force a sweeping federal intervention.
A longtime student of the Great Depression, Mr. Bernanke was acutely aware of what could happen without a decisive move. Finally, the moment that called for action arrived late Wednesday. Less than 24 hours after the Fed bailed out American International Group, the giant insurer, it was clear the turmoil gripping Wall Street was only growing worse and that ad hoc solutions were not working.
Talking into a speaker phone from his ornate office, Mr. Bernanke told Mr. Paulson that it was time to adopt a comprehensive strategy that Congress would have to approve. Mr. Paulson understood. Reluctant in recent days to send Congress a plan that lawmakers had warned had little chance of quick passage, he had worried that a rejection would only further shock the markets.
But during two conference calls Wednesday night and Thursday morning, he agreed that they had no choice. “It just happened dramatically,” Mr. Paulson said in an interview on Friday. “There was only one way that we could reassure the markets and deal with a very significant and broad-based freezing of the credit market. There was no political calculus. It was overwhelmingly obvious.”
Just like that, Mr. Bernanke, the reserved former Ivy League professor, and Mr. Paulson, the hard-charging former Wall Street deal maker, launched what would be the government’s largest economic rescue operation in modern times, one that rivals the Iraq war in cost and at the same time may redefine Washington’s role in the marketplace for years.
The plan to buy $700 billion in troubled assets with taxpayer money was shaped by two men who did not know each other until two years ago and did not travel in the same circles, but now find themselves brought together by history. If Mr. Bernanke is the intellectual force and Mr. Paulson the action man of this unlikely tandem, they have managed to create a nearly seamless partnership as they rush to stop the financial upheaval and keep the economy afloat.
Befitting their roles and personalities, Mr. Paulson has become the public face of their team — he plans to appear on four Sunday talk shows — while the less visible Mr. Bernanke provides the historical underpinnings for their strategy.
Along the way, they have cast aside the administration’s long-held views about regulation and government involvement in private business, even reversing decisions over the space of 24 hours and justifying them as practical solutions to dire threats.
“There are no atheists in foxholes and no ideologues in financial crises,” Mr. Bernanke told colleagues last week, according to one meeting participant. The improvisational nature of their effort has turned President Bush and Congressional Democrats into virtual bystanders, sometimes uncertain about what comes next and left to wonder about the new power dynamics in the capital.
Seemingly every time lawmakers tried to get a handle on what was happening and what role they might play with elections around the corner, Mr. Paulson and Mr. Bernanke would show up again on Capitol Hill for another evening meeting with another surprise development.
The two men have been working early and working late, tracking Asian markets and fielding calls from their European counterparts, then reconnecting with each other by phone eight or nine times a day, talking so often that they speak in shorthand. Mr. Paulson has powered through the long days with a steady infusion of Diet Coke. Asked twice to testify by the Senate last week, he begged off.
“He told me he had like four hours of sleep,” said Senator Christopher J. Dodd, Democrat of Connecticut and chairman of the Banking Committee. But there were limits to Mr. Dodd’s sympathy. “The public wants to know what’s going on,” he said he replied.
Mr. Bernanke (his drink: Diet Dr Pepper) has made a point of leaving the office by midnight to get at least some rest, but friends say the toll on him is clear as well. Alan S. Blinder, a longtime friend and former vice chairman of the Federal Reserve, recalled seeing Mr. Bernanke at a conference last month in Jackson Hole, Wyo. “He looked like he had the weight of the world on his shoulders,” Mr. Blinder said.
And that was before last week. Mr. Bernanke took office in February 2006 and Mr. Paulson five months later, both Republicans and Bush appointees, yet arriving from starkly different places. Mr. Bernanke, 54, had managed the academic politics of the Princeton economics department, where he served as chairman, by developing a conciliator’s style. Mr. Paulson, 62, rose to the top of Goldman Sachs by pounding the phones, and the occasional table.
“Hank is just the most hyperactive, get-it-done kind of guy who’s always trying to get the problem solved and move on. He’s impatient to fix things,” said Allan B. Hubbard, a former national economic adviser to Mr. Bush. “Ben is much more low-key. He’s very thoughtful. He’s an incredible thinker, listens well, analyzes well and is not intimidated by anyone. It’s probably a great pair.”
While Mr. Bernanke talks in lofty terms and Mr. Paulson speaks in great bursts of Wall Street jock language, the new Washington odd couple bonded in part over baseball. The Treasury secretary is a Chicago Cubs fan and the Fed chairman is a Boston Red Sox fan who has adopted the Washington Nationals and shares season tickets with the White House chief of staff, Joshua B. Bolten.
But neither Mr. Paulson nor Mr. Bernanke has been deeply involved in the political process before. As they try to navigate Washington together, they have surrounded themselves respectively with advisers drawn from Goldman and career professionals at the Fed.
Mr. Paulson initially declined to join the cabinet. He changed his mind only after extensive lobbying by Mr. Bolten, a former Goldman executive, and commitments by Mr. Bush to let him truly run economic policy, unlike his predecessors. The Hammer, as Mr. Paulson has been called since his days on the Dartmouth football squad, brought to Washington his characteristic intensity.
“He is a hurricane. He is used to living in a turbulent world,” said John H. Bryan Jr., a close friend and former chief executive of the Sara Lee Corporation. “He has lived in a world of deadlines, decisions and pressure-packed things.”
Mr. Paulson, a Christian Scientist, does not drink or smoke. Once, at a cocktail party where he was giving a speech, recalled Andrew M. Alper, a former Goldman colleague, Mr. Paulson accidentally took a gulp from a glass of vodka, thinking it was water. His face turned bright red and his eyes were watering for an hour. “He just kept going,” Mr. Alper said. “It did not slow him down.”
Mr. Bernanke has a more obscure nickname, Helicopter Ben, after a speech he gave in 2002 in which he talked about the Fed’s “helicopter drops” of emergency money to keep the system liquid. For Mr. Bernanke, the current crisis is the culmination of a lifetime of figuring how the system works from a theoretical viewpoint.
Mr. Bernanke made clear long ago that he realized he might someday be called on to act on his studies. Vincent R. Reinhart, a former Fed official, said Mr. Bernanke’s research into Japan’s financial crisis in the 1990s reinforced his view that the government had to be aggressive in intervening during market crises.
And at a party he had in 2002 to honor the 90th birthday of Milton Friedman, the famed economist, Mr. Bernanke, then a governor of the Federal Reserve, brought up the mistakes the nation made in the face of the Depression and promised not to repeat them. “We did it,” he said then. “We won’t do it again.”
Mr. Paulson, in the interview Friday, said that Mr. Bernanke had long warned that a moment might come like the one they saw last week. “Going back a long time, maybe a year ago, Ben, as a world-class economist, said to me, ‘When you look at the housing bubble and the correction, if the price decline was significant enough,’ ” the only solution might be a large-scale government intervention, Mr. Paulson said. “He talked about what had happened when there had been other situations historically.”
Mr. Paulson said he agreed but hoped it would not come to that. “I knew he was right theoretically,” he said. “But I also had, and we both did, some hope that, with all the liquidity out there from investors, that after a certain decline that we would reach a bottom.”
He was also hearing as late as last Monday from senior Democratic and Republican lawmakers, including Steny H. Hoyer, the House majority leader, and Representative John A. Boehner of Ohio, the House Republican leader, that there was no chance Congress would adopt any legislation before it planned to leave town in September.
Even Representative Barney Frank, a proponent of a greater role for the government in the market, said on Monday that the issue would have to be resolved by the next president and the new Congress next year. By Tuesday, however, the troubles were only deepening. Lehman Brothers had declared bankruptcy, Merrill Lynch had agreed to be bought by Bank of America and A.I.G. was on the verge of collapse.
Mr. Paulson and Mr. Bernanke put together an $85 billion bailout of A.I.G. and presented it to Mr. Bush. But the two warned the president that it might not be enough to stabilize the broader crisis. A senior administration official, who spoke on condition of anonymity to discuss internal deliberations, paraphrased their message to Mr. Bush this way: “There may still be problems after this, and if there are, we’ll come back to you.”
They did, two days later, after plunging stock prices and frozen credit markets made clear the case-by-case strategy was not working. Mr. Paulson had been talking with Mr. Bush by telephone throughout Wednesday and early Thursday. The decision to finally take a radical, systemwide step came after an endless stream of conference calls involving Fed, Treasury and Securities and Exchange Commission officials, one participant recalled, when Mr. Bernanke said: “We have got to go to Congress.” Mr. Paulson concurred.
On Thursday afternoon, the two men, along with Christopher Cox, the S.E.C. chairman, went to the White House to explain their plan. “The president said, ‘Let’s do it,’ ” an official said. “There was no hesitation.” Within hours, Mr. Paulson and Mr. Bernanke were in the office of House Speaker Nancy Pelosi, briefing Congressional leaders on how bleak the situation was. Lawmakers were shaken but offered tentative support.
Torn by conflicting imperatives to take action and to go home to campaign, they seemed alternately grateful and resentful of the new power couple in Washington. Some referred to “President Paulson” and others groused about an unelected central bank chairman doling out hundreds of billions of dollars.
Mr. Paulson and Mr. Bernanke came under fire for being too aggressive and for not being aggressive enough. Senator Jim Bunning, Republican of Kentucky, said they were killing the free market. R. Glenn Hubbard, former chairman of Mr. Bush’s Council of Economic Advisers, said they should have acted sooner.
“The opportunity to have taken bold action would obviously have been better had they done it months ago,” he said. “But better late than never.” In the end, what left so many lawmakers and economists frustrated was the sense that no one had a better idea. So they waited for Mr. Paulson and Mr. Bernanke to give them more details about what they wanted to do.
Nowhere to hide: Money funds not such a safe habor
Yet another irony of these credit-crunched times: Even the seemingly safest investment vehicles can pose the most significant threats to financial companies and their customers.
Risk-rattled institutional investors yanked at least $176 billion out of money market mutual funds last week, according to the most recent data from the Investment Company Institute. That’s one-third of all the institutional money that had been plowed into these supposed safe havens over the last year as investors fled volatile and exotic markets laden with uncertainties.
By week’s end, these redemptions had crippled one of the largest managers of money-market funds, caused another prominent money manager to shut down a $12 billion institutional fund, and prompted several other firms to prop up their funds with new billions. The U.S. Treasury Department was forced to step in last Friday and offer to temporarily insure money-market funds, while the Federal Reserve acted to shore up liquidity. The intervention came just two days after demand for the safest short-term assets around—three-month Treasury bills—surged so high it pushed the yield into negative territory for the first time in almost 70 years.
“If a treasurer at a large company is getting the same low, but safe returns on their cash as everyone else, his constituents can accept that,” said Denise Valentine, senior analyst at Aite Group, who focuses on cash management. “But if you’re in a money fund that loses even one cent on the dollar right now? That can cost you your job.”
All it took to shell-shock a market that has been watching one white shoe drop after another was for an asset management firm to go ahead and do the unthinkable.
The Reserve Management Corp., the creator of money-market funds, acknowledged that its largest and oldest fund held $785 million in commercial paper issued by Lehman that had become worthless with the brokerage’s bankruptcy last Monday. This exposed investors in the Reserve’s $62 billion Primary Reserve Fund to losses—the first time in more than a decade any money-market fund had reported seeing that—as net asset value (NAV) fell to $0.97 a share, or “broke the buck.”
“Everyone thinks that money-market funds are super secure,” said Jeff Rubin, director of research at Birinyi Associates. “When an event doesn’t happen for decades, it’s a shock to the system, especially one that’s so big, and so prominent, and so old.”
The Reserve had two other funds that broke the buck last week, but the money manager froze redemptions from a number of its offerings after a run targeting the Primary fund. Over the course of last week, the $62 billion fund had redemption re-quests of $60 billion, the Reserve confirmed late Friday.
The Reserve has since been hit with at least two separate lawsuits, including one on Friday from Ameriprise Financial, which has clients with more than 300,000 accounts invested in the Primary fund, according to the suit. An official with the Reserve declined to comment.
The run fueled fears among institutional investors that other funds could be next. Evergreen Investments, Bank of New York Mellon, Russell Investments and Columbia all disclosed holding Lehman paper in their money-market funds. Unlike the Reserve, they each have a large parent company capable of backing their funds to ensure investors didn’t sustain losses.
Wachovia, parent to Evergreen, for instance, pumped money into three Evergreen funds (which held a combined $494 million in Lehman debt, according to filings) to keep investors whole and NAVs above the magic $1 mark.
The money-market mayhem wasn’t confined to funds that held Lehman debt—or indeed any paper from on-the-brink financials. “It seems if you’re a money fund manager, you’re just guilty by association,” said Cathy Gregg, partner at Treasury Strategies. “Even if the assets you’re holding are of quality, it doesn’t appear that investors care.”
Nowhere was this more obvious than at Putnam Investments. The Boston-based firm last Thursday was forced to abruptly close one of the largest institutional money funds around, its Prime Money Market Fund, after investors rapidly redeemed assets from the fund early last week. This happened even though Putnam officials noted that the fund had no exposure to Lehman, derivatives-battered AIG or struggling thrift Washington Mutual.
A Putnam spokeswoman declined to specify how much money institutional investors had pulled from the fund, but acknowledged it had assets of $12.3 billion at the end of Sept. 16. A public filing shows it had more than $15 billion in assets at the end of August.
Elsewhere, typically accessible officials in the steady-Eddie money-market world were nowhere to be found last week, as the stream of redemptions had portfolio managers scrambling to sell off assets in as orderly a way as possible, while executives reached out to quell the concerns of clients.
More than a dozen of the largest asset managers—including Federated Investors, BlackRock, Fidelity, J.P. Morgan, Deutsche and State Street—wrote letters to clients or issued public statements, sometimes both, to affirm the health of their funds and discuss their holdings. Some set up unscheduled conference calls with clients: Federated, manager of more than $270 billion in money-market assets, drew more than 1,000 callers for an impromptu dial-in last Wednesday morning.
Despite these efforts, many of the firms were still smacked around by investors. Federated, for one, reported that assets in its money funds had declined by $1.7 billion as of 1 p.m. on Thursday.
As tumultuous as things were in the money-fund industry, it could have been worse: Had the government not announced its $85 billion bailout of AIG, money funds that held debt issued by AIG likely would have faced even more pressure in preserving value for investors—triggering an even more substantial run on these funds. “We’re thankful for the AIG resolution,” Debbie Cunningham, chief investment officer for taxable money funds at Federated, noted during the call last Wednesday.
While that action insulated money funds from further impairment, it was the federal government’s insurance intervention last Friday that may spare the industry from ultimate harm. Said Peter Crane, president of money fund researcher Crane Data: “Apparently, they have now deemed a $3.5 trillion industry too big to fail.”
Home Sales, Durables Orders Probably Fell: U.S. Economy Preview
U.S. home sales and orders for long-lasting goods probably fell in August, indicating growth had already slowed heading into the latest financial meltdown, economists said before reports this week.
Combined sales of new and existing homes dropped to a 5.45 million pace last month, down 1.2 percent from July, according to the median estimate of economists surveyed by Bloomberg News. Orders for durable goods, products meant to last several years, probably fell 1.8 percent.
"There was a fairly significant slowdown in progress even before we got to the financial fireworks," said Brian Bethune, director of financial economics at Global Insight Inc. in Lexington, Massachusetts. The three-year housing slump that precipitated the subprime crisis, triggering losses that brought down giants such as Lehman Brothers Holdings Inc. and American International Group Inc., may spell the end of the economic expansion.
Consumers are unlikely to benefit immediately from federal efforts to shield financial firms from tainted assets. "The government's bailout plan may be great for investors, but it doesn't do much for the economy over the near-term," said Russell Price, a senior economist at H&R Block Financial Advisors in Detroit. "Consumers are still going to find financing everything from homes to big-ticket appliances tough to come by."
The National Association of Realtors' report on home resales is due Sept. 24. Purchases declined to a 4.94 million annual pace from 5 million in July, according to the survey median. Sales reached a 4.85 million pace in June, the fewest since comparable records began in 1999.
A day later, the Commerce Department is forecast to report that sales of new houses dropped to an annual pace of 510,000 from 515,000 in July, according to survey estimates. Sales of existing and new homes are down 35 percent from their July 2005 peak.
As sales shrank, builders scaled back construction projects to pare swelling inventories. Work began in August on the fewest houses since 1991, the Commerce Department reported last week. The number of building permits issued also fell, signaling construction cutbacks will continue to hurt the economy.
"The biggest issue is consumer confidence in housing right now," Ara Hovnanian, chief executive officer of Hovnanian Enterprises Inc., New Jersey's largest homebuilder, said in a Sept. 19 interview on Bloomberg Television. "It remains a very challenging environment."
Hovnanian said sales in "some select markets," such as northern California and the Washington suburbs in Virginia, "have really started to pick up." It's "absolutely" too early to call a bottom for the market, he said. Stricter lending regulations and tumbling home prices make it harder for Americans to tap home equity for extra cash. Consumer spending in the third quarter will probably be the weakest since 1991, according to economists surveyed earlier this month.
"Tight credit conditions, the ongoing housing contraction and some slowing in export growth are likely to weigh on economic growth over the next few quarters," the Federal Reserve said Sept. 16 as it held the benchmark lending rate unchanged at 2 percent.
Three days later, the government announced it would move to cleanse banks of troubled assets as part of a plan that Treasury Secretary Henry Paulson said would cost "hundreds of billions." The report on durable goods, due from the Commerce Department on Sept. 25, is also projected to show that orders excluding transportation equipment fell 0.5 percent in August, according to the Bloomberg survey.
Automakers have led the slump in durables. Sales of cars and light trucks over the last three months were the weakest since 1993, according to Bloomberg calculations based on industry figures. Struggling to regain market share from foreign carmakers, General Motors Corp., Ford Motor Co. and Chrysler LLC last week urged U.S. lawmakers to fund $25 billion in low-interest loans to help develop more fuel-efficient vehicles.
"Your urgent attention to this issue is critical to the future of the American economy and the manufacturing sector," GM's Rick Wagoner, Ford's Alan Mulally and Chrysler's Robert Nardelli, chief executive officers of the three U.S.-based automakers, wrote to House Speaker Nancy Pelosi. On Sept. 26, the Reuters/University of Michigan final estimate of consumer sentiment for September may show confidence rose for a third month after reaching a 28-year low in June as gasoline prices tumbled.
More hoarding by the herd
The great unwind that's occurring on Wall Street can probably best be seen in the huge amounts of cash building up in margin accounts, according to research firm Birinyi Associates. The net cash position in the margin accounts of New York Stock Exchange customers totaled $56.9 billion as of the end of July, up about 54% from the end of June, Birinyi found.
And customers only began keeping a net positive cash position in the accounts—which they use to buy securities with money borrowed from brokers—since the end of April, the firm said. These four months are the first time since at least 1959 that investors have shied away from borrowing to make more money, Birinyi said.
The data are some of the strongest evidence yet of how much the financial landscape is changing, said Jeff Rubin, director of research at Birinyi. Though August data aren’t yet available, the amount of net cash in margin accounts will surely go higher, Mr. Rubin noted, given the pervasive “flight to safety.”
“The safest thing right now is Treasury bills, because at the end of the day, Treasury can just turn on the printing presses.” Given the paltry yield on T-bills, “It’s flight to quality in hyperbole,” he said.
In this environment, investment banks may go back to acting more like middlemen, instead of borrowing to buy their own stakes in investments, and they may get more of their revenue from fees, said Donald Marron, founder of Lightyear Capital and former chief executive of PaineWebber.
“What happens to investment banks is they probably become less of a long-term investor in these things, and more of an agent,” Mr. Marron said in an interview. “They certainly will have less leverage available to them.”
Still, given the cyclicality of the business, and the need to make better returns, the restraint won’t last forever, Mr. Marron said. “Any observer of this business will say that all this will happen for a while, and then the industry will move back toward more leverage later.”
All that cash also spells pent-up demand for and interest in deals, which can generate some real money, he said. “Eventually, as the markets calm, [investors] will have to move away from that short-term investing, because it doesn’t get the kind of returns that they need,” Mr. Marron said. “More capital will be available. That’s the next installment of this whole thing.”
Ex-SEC Official Blames Agency for Blow-Up of Broker-Dealers
The Securities and Exchange Commission can blame itself for the current crisis. That is the allegation being made by a former SEC official, Lee Pickard, who says a rule change in 2004 led to the failure of Lehman Brothers, Bear Stearns, and Merrill Lynch.
The SEC allowed five firms — the three that have collapsed plus Goldman Sachs and Morgan Stanley — to more than double the leverage they were allowed to keep on their balance sheets and remove discounts that had been applied to the assets they had been required to keep to protect them from defaults.
Making matters worse, according to Mr. Pickard, who helped write the original rule in 1975 as director of the SEC's trading and markets division, is a move by the SEC this month to further erode the restraints on surviving broker-dealers by withdrawing requirements that they maintain a certain level of rating from the ratings agencies.
"They constructed a mechanism that simply didn't work," Mr. Pickard said. "The proof is in the pudding — three of the five broker-dealers have blown up." The so-called net capital rule was created in 1975 to allow the SEC to oversee broker-dealers, or companies that trade securities for customers as well as their own accounts.
It requires that firms value all of their tradable assets at market prices, and then it applies a haircut, or a discount, to account for the assets' market risk. So equities, for example, have a haircut of 15%, while a 30-year Treasury bill, because it is less risky, has a 6% haircut.
The net capital rule also requires that broker dealers limit their debt-to-net capital ratio to 12-to-1, although they must issue an early warning if they begin approaching this limit, and are forced to stop trading if they exceed it, so broker dealers often keep their debt-to-net capital ratios much lower.
In 2004, the European Union passed a rule allowing the SEC's European counterpart to manage the risk both of broker dealers and their investment banking holding companies. In response, the SEC instituted a similar, voluntary program for broker dealers with capital of at least $5 billion, enabling the agency to oversee both the broker dealers and the holding companies.
This alternative approach, which all five broker-dealers that qualified — Bear Stearns, Lehman Brothers, Merrill Lynch, Goldman Sachs, and Morgan Stanley — voluntarily joined, altered the way the SEC measured their capital.
Using computerized models, the SEC, under its new Consolidated Supervised Entities program, allowed the broker dealers to increase their debt-to-net-capital ratios, sometimes, as in the case of Merrill Lynch, to as high as 40-to-1. It also removed the method for applying haircuts, relying instead on another math-based model for calculating risk that led to a much smaller discount.
The SEC justified the less stringent capital requirements by arguing it was now able to manage the consolidated entity of the broker dealer and the holding company, which would ensure it could better manage the risk.
"The Commission's 2004 rules strengthened oversight of the securities markets, because prior to their adoption there was no formal regulatory oversight, no liquidity requirements, and no capital requirements for investment bank holding companies," a spokesman for the agency, John Heine, said. In addition to computerizing the risk calculations, the new program required time-consuming oversight of the broker dealers by SEC officials, and in many cases, the use of subjective judgment calls.
"An important component of the CSE program is the regular interaction of Commission staff with senior managers in the firm's own control functions, including risk management, treasury, financial controllers, and the internal auditor, as well as onsite testing to determine whether the firms are implementing robustly their documented controls," SEC chairman Christopher Cox testified in a hearing of the House Committee on Financial Services in July.
Despite the increased oversight and supposed strengthening of the rule, the SEC did reexamine its efficacy after the Bear Stearns collapse. "Immediately after the events of mid-March, when the run-on-the-bank phenomenon to which Bear Stearns was exposed demonstrated the importance of incorporating loss of short-term secured funding into regulatory stress scenarios, the CSE program revised the analysis of liquidity risk management, with enhanced focus on the use and resilience of secured funding," Mr. Cox testified at the July hearing.
"The SEC has also worked closely with the Federal Reserve in directing this additional stress testing." Two months after Mr. Cox testified, however, two more broker dealers have collapsed, and yesterday there were reports that one of the two remaining broker dealers — Morgan Stanley — is now in talks to merge with Wachovia.
"The SEC modification in 2004 is the primary reason for all of the losses that have occurred," Mr. Pickard, who is now a senior partner at the Washington, D.C.-based law firm Pickard & Djinis, said. The director of equity research at Fusion IQ and an influential Web logger, Barry Ritholtz, called the 2004 rule change "a hornets nest" that "proves the importance of having stringent rules in place."
The SEC said it has no plans to re-examine the impact of the 2004 changes to the net capital rule, and last week, it put out a proposal to revise the rule once again. This time, it is looking to remove the requirement that broker dealers maintain a certain rating from the ratings agencies.
"The SEC doesn't want to appear they are endorsing the efficacy of ratings agencies, but once again, they are going to simply cause more problems down the road," Mr. Pickard said.
Market freak-out forces massive improvisation
Wall Street opened last week in a full-on panic, with many people, from high-level government officials to financial industry workers, abruptly changing plans. All it took to calm them down was the biggest government bailout of the financial markets since the Great Depression.
As the markets opened for trading last Monday following the news of Lehman Brothers’ bankruptcy and Merrill Lynch’s merger with Bank of America, many people were canceling or rearranging plans—big and small. Bruce Haber, a New York dentist who serves a number of Wall Street traders, brokers and investment bankers, said 15% of his appointments were rescheduled last week. “They all feel a need to be at their desks, because there’s concern that they have to be available all the time,” said Dr. Haber, who has run his practice since 1977.
And who could blame them? The market’s reaction to the news was swift and punishing, as all the major stock indexes plummeted on Monday: The Dow fell 504.48 points, the S&P 500 was down 58.17, and the Nasdaq tumbled 81.36. By the end of the day, approximately $700 billion had evaporated from retirement plans, government pension funds and individual portfolios.
As the day unfolded, the International Swaps and Derivatives Association canceled its regional conference, which had been scheduled for Tuesday in New York. And Treasury Secretary Henry Paulson canceled his appearances before the Senate Banking Committee and at the Brookings Institution. Meetings that were carried out had an air of fear and disbelief.
“Can we kill ourselves now?” one lawyer shouted at the Helmsley Park Lane Hotel in Manhattan on Tuesday, according to Bloomberg News, as a crowd of restructuring advisers and lawyers waited while the office of the U.S. Trustee interviewed candidates to form a committee of Lehman’s unsecured creditors that would attempt to quickly sell the firm’s assets.
When the Federal Reserve announced late Tuesday that it was extending an $85 billion loan to AIG to keep it from going bankrupt, the markets spiraled downward again. The panic led many companies to make announcements to calm investors.
Morgan Stanley released its third-quarter results Tuesday, a day early, to stop its shares from free-falling on rumors that it too had serious capital needs. Even though the bank’s results came in ahead of analyst estimates, its stock price had fallen 47% by Wednesday. The investment bank reportedly went into merger talks with Wachovia.
Bank of New York Mellon issued two press statements emphasizing that it has no outstanding loans to Lehman. And pension funds with positions in the failed institutions made pre-emptive announcements detailing their exposures.
The California Public Employees’ Retirement System said its portfolio has about $409 million in eight troubled financial institutions, a fraction of its $220 billion in assets under management. The Florida State Board of Administration listed its assets in Lehman, Merrill, Washington Mutual, AIG and Bank of America at about $2.6 billion, or 1.76% of the pension’s total assets. And Texas Employee Retirement System spokeswoman Mary Jane Wardlow said its quick handling of investment operations allowed it to “mitigate recent losses related to Fannie Mae, Freddie Mac, Lehman Brothers and Merrill Lynch.”
At an analysts conference in New York last week, several investor relations professionals marveled at the whipsaw effect short-sellers and hedge funds had on companies’ values. Mark Aaron, VP of investor relations at Tiffany & Co., said his company’s stock price “is more volatile now than it ever was,” noting that both investors’ and companies’ obsessions with quarterly earnings guidance have driven the volatility even before the recent crisis.
Barbara Gasper, group executive for investor relations at MasterCard, agreed, telling attendees her company’s stock has been moving “wildly” in recent months, noting a large hedge fund investor base as the potential cause.
The Securities and Exchange Commission and the U.K.’s Financial Services Authority took steps to curb short-selling. In FSA’s case, short-selling was halted in financial stocks possibly until January, while the SEC banned short-selling in 799 financial stocks until Oct. 2, with a 10-day extension possible.
And no crisis would be complete without lawsuits. A shareholder is suing Merrill Lynch and its CEO, John Thain, for selling the company to Bank of America at too low a price. The New Orleans pension fund filed a lawsuit last Wednesday against AIG for “grossly imprudent risk-taking,” noting that the company’s stock has dropped by nearly 95% since June 2007.
Shareholders are suing the firm behind the Reserve Primary Fund for halting redemption of its shares when its net asset value dropped below $1 after the Lehman bankruptcy. The suit says the fund invested $785 million in commercial paper issued by Lehman which “deviated from its stated investment objective by sacrificing preservation of capital and liquidity in pursuit of higher yields.”
Whatever. The worst of the storm appeared to have passed by Friday, as the Dow soared more than 375 points on news of the U.S. government’s plan to fight the crisis, adding to the 410 points it gained Thursday. Of course, who knows what this week will bring?
Shaky Economy Suddenly Dims Russian Prospects
This week, Moscow looked every inch the glittering financial capital it aspires to be. Luxury cars were jammed up for blocks outside a lavish art opening at the Red October chocolate factory, where long-legged models congregated around works by Andy Warhol and Picasso.
President Dmitri A. Medvedev, flanked by the country’s commercial titans, talked of his longtime dream of building a trade and commerce hub that would challenge New York and London. But that prospect has begun to look less certain. The stock market plunged so precipitously earlier this week that the government halted trading for two days. Stocks roared back with a 28 percent gain on Friday. But the market is still down by nearly half since May.
The price of oil, the mainstay of Russia’s commodity-driven economy, has dropped sharply. And as Washington and Moscow exchanged icy words over Russia’s military action in neighboring Georgia, the Russian Parliament was reviewing a bill that would increase defense spending by a hefty 25 percent.
The Russia that has regained such confidence under Vladimir V. Putin — a success anchored in stable politics, predictable economic growth and firm state control over natural resources industries — now looks distinctly volatile. The crisis was worrying enough to the billionaire developer Sergei Polonsky that on Wednesday he announced a freeze on all new projects.
“Probably a period of struggle for existence and survival is coming,” said Dmitri Lutsenko, a member of the board of directors for Mr. Polonsky’s Mirax Group, which is building Europe’s tallest skyscraper beside the Moscow River. “The strong businesses will become stronger, and the weak ones will be wiped out of the market,” he said.
In the Friday edition of Komsomolskaya Pravda, a cheeky city tabloid, there was only one headline on the front page: “How to Make It Through the Financial Crisis Without Losses.” It was illustrated with the face of a yuppie, his hands clasped over his mouth in horror.
Many countries were jolted by the markets this week. And the recovery on Friday of the Moscow stock markets — so swift that the government was forced to close the markets twice during the day because the growth “exceeded technical limits” — suggests that government emergency measures had helped to restore investor confidence.
Mr. Medvedev came into power this spring in a country with enormous cash reserves. His agenda was a modernizing one: institutional reform would allow small businesses, and the middle class, to grow; the economy would be weaned from excessive dependence on oil profits; government initiatives would build domestic industry and the high-tech sector.
Now, more urgent tasks stand before him. Russia’s military, which was left to deteriorate in the 1990s, must be updated. The government said it would devote $44 billion to shoring up banks and markets in the near future to prevent the kind of meltdown that paralyzed the country in 1998. On Friday the president made the defiant statement about Russia’s sticking to its modernizing course, but acknowledged that recent events made that more difficult.
“We are in fact being pushed onto the development track which is not based on sound, normal and civilized cooperation with other countries, but rests on autonomous development behind thick walls and an ‘iron curtain,’ ” Mr. Medvedev said, referring to the recent tensions with the West over the war in Georgia.
“I would like to stress once again: This is not our track,” he said, according to the Interfax news agency. “There is no use in returning back to the past. We have made our choice.” Russia must pursue “economic development, the expansion of business, creative and personal freedom,” he added, without “any reference to whether the country is in a particular situation surrounded by enemies.”
Meanwhile, a city brimming with new wealth went about its daily rhythms. On Friday, bankers and traders filtered into their offices. Lexuses and BMWs lined up in front of Romanov Dvor, an elegant pre-Revolutionary building whose interior is sleekly modern, fitted with smoky glass walls and a cascade of purple orchids suspended in midair.
As the finance workers slipped outside for smoking break, they traded gossip from a nervous financial sector. Most said they felt confident that the government would manage the crisis, but there were hints of fallout: investment bankers mourning their lost bonuses, a client canceling a trip abroad to stay home and monitor his stock price.
Many bankers have spent recent days on the phone trying to soothe rattled investors, said Pavel Prosyankin, who works in the financial sector. “They were worried, because our clients were worried,” Mr. Prosyankin said. At 36, he is old enough to remember the crisis of 1998, when a drop in the price of oil devastated every corner of the Russian economy.
The fundamentals of the economy, he said, are much stronger than they were in 1998. But “in terms of investor behavior, it’s very much the same,” he said. “The way people become irrational is very much the same.”
Still trying to get shorty: what the SEC’s Ban on Shorting Really Means
The Securities and Exchange Commission took the dramatic step of banning for ten days short-selling on 799 financial stocks.And of course with any hastily planned regulatory intervention, potholes have opened. And ironically, the SEC’s new ban giving shelter to the 799 financial companies is also protecting famous short-seller David Einhorn from the shorts.
The SEC’s ban could be extended for up to 30 days, and comes after Wall Street executives say short sellers have caused catastrophic declines in stock prices that have led to the downfall of Bear Stearns, Lehman Bros, and American International Group.
The SEC’s moves follows close on the heels of Great Britain’s decision to ban short selling in 29 stocks until the end of the year. U.K. investors have accused short sellers of causing shares in HBOS Plc to plunge before it entered into a $18.9 bn takeover by Lloyds TSB Group Plc.
Short-sellers profit from falling share prices. They borrow shares from brokers and then sell them. When the price declines, they turn back the shares at the lower price and pocket the difference. In a naked short sale, the short seller does not borrow the shares and physically have them in hand.
Some $3 tn was wiped from stocks globally this week as financial shares plunged, causing the SEC to go on the offensive.
The fear is that shorts are causing massive price plunges, triggering credit downgrades, slamming capital and forcing companies to sell assets at garage-sale prices.
The SEC acted after it met with heated entreaties to intervene from Wall Street executives including Goldman Sachs Group chief executive Lloyd Blankfein and John Mack, chief executive of Morgan Stanley. A stock price plunge in recent days could still force Morgan into the arms of a commercial bank like Wachovia.
Short interest in Morgan Stanley is triple the levels of a year ago. Both Mack and Blankfein have discussed short sellers five or six times in the last week, Mack told employees. In taking the emergency action, the SEC says it wants to “prohibit short selling in financial companies” to protect the integrity of the securities market and boost investor confidence.
Who is on the List? Wall Street titans Morgan Stanley, Merrill Lynch, Citigroup, JPMorgan Chase are on the SEC’s new list, as are Washington Mutual and Wachovia. The SEC had met with criticism in mid summer when it initially banned a form of short selling in 19 financial stocks and left off the list Wamu and Wachovia.
Damaged bond insurers Ambac Financial and MBIA also made the list, which couldn’t have come too soon as Moody’s Investors Service once again just placed the ratings of Ambac and MBIA on review for possible downgrade. Warren Buffett’s Berkshire Hathaway is on the list, Blackstone Group is on it, as are beaten-up companies E*Trade Financial, Dollar Financial and Conseco.
Even Greenlight Capital, the reinsurance company that is a wing of famous short David Einhorn’s hedge fund Greenlight Capital, is on the list. Einhorn earlier this year made his case for shorting Lehman Bros., arguing the now-collapsed firm was engaging in questionable accounting.Not on the list: CIT Group, now asking the SEC to be put on the list.
Market analyst Paul Kedrosky, who writes for the website SeekingAlpha.com, notes ironically that Lehman is on the list, though it is in bankruptcy status, that the SEC has Silver State Bancorp on the list, though it’s a failed bank already seized by the FDIC, and that the SEC is blocking shorting of NAHC. That ticker doesn’t exist, unless it stands for the Nigerian Aviation Holding Company, Kedrosky says wryly.
The Securities and Exchange Commission is also clamping down on “naked” short-selling, where the underlying stock in a short sale is neither borrowed nor delivered by the short-seller. The SEC is not outlawing the practice. Instead, short sellers and broker dealers must now actually deliver securities borrowed for short sales–or risk being accused of securities fraud and of being permanently barred from engaging in naked short selling.
The SEC’s moves comes fast on the news this week that the SEC has subpoenaed 50 hedge funds to find out if they were engaging in rumor mongering in order to drive down shares in 19 financial companies they had shorted in naked short sales to book a profit. The SEC now wants to force hedge funds to make disclosures of daily short positions, a move that would let regulators assess the impact of short-selling at funds with $100 mn or more.
Currently shorts file forms with the SEC that disclose their long positions and options on a quarterly basis. In the past, the hedge fund industry has gone so far as to sue the SEC to stop any regulation of the industry, litigation which could arise again. The disclosures may help, though famous short James Chanos, who blew the whistle on Enron, says it would be the equivalent of forcing Coca-Cola to reveal its secret formula.
Check out the most recent filing from Greenlight Capital, run by David Einhorn, who raised serious questions about accounting problems at Lehman. Einhorn gave speeches and went on t.v. with his criticism, but his latest filing only shows about 581,000 in put options on Lehman, with little else detail.
After writing to 60 other pension funds asking them to follow its lead, the largest U.S. public pension fund Calpers, the California Public Employees’ Retirement System, said it is no longer lending out shares of financials like Goldman, Morgan Stanley or Wachovia to short. New York State and Texas pension funds are considering similar moves.
And New York Attorney General Andrew Cuomo said he was opening investigations into short sellers who he believes are engaging in false rumor mongering to manipulate stocks down in order to take profits. Cuomo went so far to say he’ll use the state securities-fraud law to go after short sellers, the Martin Act, which permits criminal and civil actions.
The SEC’s emergency ban on shorting coincides with the US government’s announcement that it will set up a Resolution Trust-type entity, harking back to the S&L crisis, that would act as an assisted living facility for financial companies across the country, a mega-dumpster for their toxic subprime waste.
Now Wall Street and other banks would not have to pricetag these toxic assets and record losses on their own, an accounting endeavor called “marking to market,” which lately is the equivalent of sticking a finger in the wind. Instead the government is “marking to taxpayers” these assets.
A so-called mega bad bank structure for thousands of banks around the country, a structure that Lehman desperately clung to in its final hours. An entity far different from the RTC structure of the S&L crisis, where the government got assets dumped on it from insured thrifts that had bellyflopped, then liquidated them.
The new entity would buy frozen solid assets from banks and then sell them, likely at auction, into the market. The move might entail an $800 bn fund to purchase these so-called failed assets and a separate $50 bn pool at the Federal Deposit Insurance Corp. to insure investors in money-market funds, as a mini-run on these funds is now underway.
Setting up this government warehouse would take the pressure off of the Fed’s discount window, now strained with record bank borrowing. The Treasury in the past two days announced $200 bn in special bill sales to help the Fed expand its balance sheet. Already banks around the world have taken more than $510 bn in writedowns and losses from the housing and credit crisis. Wall Street created about $1.2 tn of subprime mortgage-backed securities, some $200 bn to $300 bn are now thought to be sitting at FDIC-insured banks and thrifts.
It’s estimated that Citigroup, JPMorgan Chase, Bank of America Corp., Goldman Sachs Group Inc., Merrill Lynch & Co. and Lehman Brothers had more than $500 bn of the most illiquid, toxic stuff, the so-called Level 3 assets as of June 30, according to research firm CreditSights Inc.
The governments’ moves have sent the markets soaring. Shorts now are racing to cover their positions, helping to send stocks higher as well. Volatility is hitting record levels. The closely watched CBOE Volatility Index, the VIX or the Fear Index, has easily blown through the 30 ceiling in recent days, and briefly rose higher than 42.
A heated debate is now underway over the SEC’s ban, namely, that the companies under attack were rightfully shorted as they are insolvent, reflected in their stock prices. An insolvency some say may have been inadvertently created by the SEC itself, as the agency did not do enough to force Wall Street firms who shoved debt into off-balance sheet vehicles that many thought went the way of Enron.
The agency also is being criticized for not doing enough to get Wall Street firms to bolster their capital cushions, and instead let five firms weaken their capital positions. The question too is when the SEC is going to pursue executives of defunct companies, or companies now on life support, when they’ve walked away with lucrative compensation packages they won after their companies essentially reported artificially higher profits from their management decisions.
Another irony, too, is that shorting selling has fueled the profit engines at the very Wall Street firms now complaining about the practice, including the big, bulge-bracket broker dealers like Morgan, Goldman and Merrill. The SEC’s move too would ban the investing strategies used by hundreds of mutual funds, hedge funds, pension funds, endowments and governments.
Also, short sellers can still short synthetically, via puts, exchange traded funds that carry many of the names on the SEC’s list of 799 companies via the option market. And market analyst David Merkel warns that the SEC’s move could hurt in the interim merger arbitrage funds, statistical arbitrage funds and other quant funds. He also warns that the implied volatility for put options would go up.
It’s unclear now whether the collapse of Bear Sterns, Lehman Bros. and AIG, and the near demise of Merrill Lynch, Fannie Mae and Freddie Mac were caused largely by short sellers. Gut-clenching price declines on a daily basis of 40% in companies thought to be healthy should give you pause. Our equity and credit markets are suffering from a crisis of confidence that touches all securities and all investors across the country.
It is a crisis of confidence exacerbated by the news that Lehman Brothers wanted to suddenly double the dollar amount of its Kryptonite assets shoved into a bad bank structure in a matter of days, from $40 bn to $80 bn. It is a crisis of confidence aggravated by the news that American International Group can now borrow up to $85 bn in a credit facility from the Fed, more than double in a matter of days what it said it needed, $40 bn.
It is a crisis of confidence worsened by the news that Congress had to hire Morgan Stanley to go find out what landfill was sitting on the books of Fannie Mae and Freddie Mac. It is a crisis of confidence over solvency. And over the fact that our nation’s financial chieftains really don’t know what they are doing.