Chicago River east from Rush Street Bridge
Update 6.00 PM EDT: Ilargi: US Treasury's Fannie Mae and Freddie Mac bail-out is imminent. It'll happen over the weekend, perhaps even tonight.
Treasury Is Close to Finalizing Plan to Backstop Fannie, Freddie
The Treasury Department is close to finalizing a plan to help shore up mortgage giants Fannie Mae and Freddie Mac, according to people familiar with the matter.
Precise details of Treasury's plan couldn't be learned. The plan is expected to involve a creative use of Treasury's new authority to make a capital injection into the beleaguered giants. The plan includes changes to senior management at both companies, according to a person familiar with the plans. An announcement could come as early as this weekend.
On Friday, a series of high-level meetings were planned between Federal Reserve Chairman Ben Bernanke, Treasury Secretary Henry Paulson, the chief executives of Fannie Mae and Freddie Mac and the companies' new regulator, the Federal Housing Finance Agency.
Treasury has been working with bankers at Morgan Stanley to use its newfound authority, granted by Congress in July, to devise a way to prop up the mortgage giants, which have been pummeled by investors in recent weeks. The two giants are vital cogs in the U.S. housing market and their financial woes have threatened to worsen the bursting of the housing bubble.
Ilargi: You know things are really going awfully wrong in the global economy when Wall Street plunges like a mob made-man with cement feet in the East River, and then that still is not the no.1 story of the day in the global economy (and global it is, alright; decouple my derrière).
For that matter, the news on the wrecked US economy doesn’t even make it to second place. Or third. Even with job figures black and blue and bleak all over, with yet another record high set in foreclosure numbers, with financial stocks being hammered, and downgraded to bathroom tissue, there are other stories that are more important today.
In third place, we find the fallen empire of Albion. Automobile sales these days are on par with those in 1966, when the majority of Britons didn’t even own a car. And it’s not just sales: don’t forget that Britain’s auto manufacturing industry is a major employer.
Or rather, make that "was". Millions in England now face negative equity in their homes, and prices are nowhere near a low. The Bank of England is under pressure to set up another "emergency" liquidity lending window for the City banks, but even if it does, what will it look like?
With most UK banks deeply indebted to the ECB as well, and government finances in a black hole, the BoE’s hands are tied. Which is certain to bankrupt at least a handful of the banks. The days when Britain could afford a Northern Rock bail-out are over.
Moving on to second place, for the silver medal. It goes to the global economy itself. Besides the long-term life support cases, the US and UK, this is the moment that dozens of other countries in the world can no longer hide their very painful hemorraging.
When China’s central bank runs out of money, it’s time to pay attention. It won’t sink yet, but it will have to raise additional capital. Problem is, so will everybody else, from central banks through commercial and investment banks to industries in every sector in every country of the economy.
Not only does that competition make it much harder and more expensive to raise capital, to add grave insult to grave injury, it happens at a point in time when available capital and credit are shrinking. And none too slowly either. There are parties out there who need to roll-over long term or short-term debt, and who won’t succeed in doing it. Simple as that. End of story.
In Korea, Thailand, Japan, and undoubtedly the rest of Asia, the -bad, bad, bad!- financial news is closely tied to politics. There is very little patience with politicians who lead their people into poverty. Take note, Gordon Brown.
And if you take a look at the economies, especially the stock exchanges, in the BRIC quartet of Brazil, Russia, India and China, you will see huge losses. Which lead increasingly to social upheaval. Which in turn will be one of the main news stories for the years to come, and not just in these far-away lands: it will soon come to a street near you. Count on it.
That said, let’s go to number one, our hands-down gold medal winner for today’s News Story of the Day. Any idea? Been paying attention?
Our No.1 is the Unwinding of the Yen Carry Trade.
Yes, that may come as a bit of a surprise to you, it’s a mostly unknown competitor after all, which is no doubt largely due to its shyness. Allow me to explain.
The Bank of Japan has for years kept its key interest rate close to zero percent. It’s still at 0.5%. The result has been that everyone with substantial assets and investments to manage, has borrowed yen at the close to zero rate, and invested the money in other countries with -often much- higher interest rates.
That is what you call free money. This has been going on for more than ten years. And this is in all likelihood the prime reason for the entire global asset and credit bubble, the one that is now joining its maker.
A good example: through the past decade, plenty of stories have been told of real estate in countries like Latvia and Hungary that was financed through mortgages denominated in yen.
But the yen carry trade fairy tale is now grinding to a halt. That means that for all of the major players in the world finance system, their no.1 source of cheap credit is gone, and precisely at a time when they need it most. The world's central bankers have tried for the past two years to prolong and revive it, but all attempts have failed; and this time it's for good.
What makes this much more hurtful than you might think at first glance is that the borrowed yen were not just invested, they were used to leverage investment gambles 10, 20, 60 times. Which inevitably leads to the fact that if the yen appreciates 10 or 20% (or G-d forbid more) against the US dollar or the Euro, the game is over.
And that is what’s happening: the yen gains vs other world currencies. And all the players have to leave the casino, if only because they fear that the Bank of Japan will raise interest rates to, for instance, 2%. That is still very low, you’d say, but then you realize that interest rates due on borrowed yen would go up 300% if it happened.
It may seem a bit counterintuitive, but what unwinds the trade is the perception that the yen is safe to invest in. It starts to make sense once you realize that the 0.5% interest rate has kept the yen -artificially- very low and undervalued. And of course, as demand for the yen goes up, so does the currency itself. Supply and demand.
The total amount of outstanding derivatives in the world economy has reached a guesstimated $800 trillion, about 15-20 times the annual world GDP. Much of it has been financed through the yen carry trade. That is why this is the No.1 financial news story of the day. To top that, the Dow Jones would have to lose 20% in one day.
Trust me this once: It’s time to check your levees.
Yen Rises Against Euro, Dollar as Carry Trade Unwinds on Deepening Recession Concerns
The yen climbed to the highest in more than a year against the euro on concern the credit-market slump will lead the world into a recession, prompting investors to sell higher-yielding assets funded in Japan.
The dollar fell versus the yen before a U.S. government report that will probably show employment dropped for an eighth month. The yen also jumped to a two-year high against the Australian and New Zealand dollars as investors reversed so- called carry trades after stocks and commodities slumped. The pound weakened for a ninth day versus the dollar.
"There is a big move in terms of risk aversion and we can see the yen getting stronger from here," said Martin McMahon, a currency strategist in Zurich at Credit Suisse Group. "The world is not particularly rosy and the credit crunch and financial problems haven't gone away. It's not appealing to stay in carry-trade type positions."
Japan's currency had its seventh straight gain versus the euro as stocks and commodities around the world tumbled. The MSCI World Index fell to its worst weekly slump since 2002 and U.S. stock-index futures dropped. The UBS Bloomberg Constant Maturity Commodity Index reached a seven-month low. The yen may rise to between 103 and 104 per dollar and to 150 yen per euro in the coming week, McMahon said.
Japan's currency often gains when demand for higher- yielding assets declines, as traders reverse carry trades. In such trades, investors get funds in a country with low borrowing costs and buy assets where returns are higher. Japan's 0.5 percent benchmark interest rate compares with 4.25 percent in Europe, 7 percent in Australia and 8 percent in New Zealand.
Volatility implied by dollar-yen options expiring in one- month rose to 13.13 percent, the highest since mid-July, showing market swings may erase carry-trade profits. "These currency moves are huge," said Toru Tokoyoda, head of foreign-exchange sales in Tokyo at Lehman Brothers Holdings Inc., the fourth-largest U.S. securities firm. "Volatility is likely to squeeze higher on further gains in the yen as that would spur demand to hedge against that move."
The yen also benefited on concern Russia's conflict with Georgia will escalate. Investors have taken about $30 billion out of Russia since the start of its five-day war with Georgia on Aug. 8, according to BNP Paribas SA. The U.S. and the European Union have demanded Russian soldiers withdraw to their pre-war positions.
"This issue is serious and the yen is the safest place in this massive geopolitical problem,"' said Toshi Honda, a currency strategist at Mizuho Corporate Bank Ltd. in London. "The yen move is all due to risk aversion and the risk is mostly deriving from the deterioration of relations with Russia. The yen is enjoying a safe-haven status."
Russia's ruble snapped three days of declines after the central bank said it sold a "significant" amount of foreign reserves yesterday to prop up the currency. The euro dropped for a seventh day against the dollar, its longest decline since October 2006. The ECB yesterday kept its main refinancing rate at a seven-year high of 4.25 percent and President Jean-Claude Trichet told a press conference growth risks are on the "downside."
The euro has dropped more than 10 percent against the dollar from the record high of $1.6038 set on July 15. The ECB lowered its 2008 economic growth forecast yesterday to about 1.4 percent from 1.8 percent. The pound fell for a ninth day, reaching a two-year low of $1.7538 after the Bank of England yesterday kept its target lending rate at 5 percent. Policy makers judged the fastest inflation in more than a decade outweighed the risk that the British economy is sinking into a recession.
Concern that the financial crisis will deepen was heightened as the ECB said yesterday banks in the U.K., Spain and Ireland that have relied on the central bank for low-cost funding will soon have to pay more. The ECB will increase the so-called `haircut' on most asset-based securities from Feb. 1 to 12 percent from as low as 2 percent, the central bank said yesterday. That means it will lend just 88 percent of the value of the paper.
"The liquidity situation continues to be severe and this could be one reason for the euro to weaken," said Masafumi Yamamoto, head of foreign exchange strategy for Japan at Royal Bank of Scotland in Tokyo and a former Bank of Japan currency trader. "This also focuses attention on the divergence in banks and economies in the euro region."
Jobs Figures Hurt All Over
August's dismal employment numbers signal a bleak economic outlook.
On Friday, the U.S. Labor Department reported an unemployment rate that floated up to 6.1%, as nonagricultural employers slashed yet another 84,000 jobs. The figure marks the highest jobless rate in five years, following eight consecutive months of cuts. Pink slips were being handed out across industries and sectors.
"The most important detail is the substantial increase in the unemployment rate over a six-month period, which was the largest in 25 years," said Carl Riccadonna, senior U.S. economist at Deutsche Bank, "and such a stark backdrop is not the stuff of a solid economy or a Fed that will raise rates."
Riccadonna added that Friday's figure corroborates his view that the U.S. Federal Reserve will hold rates steady through the end of 2009. "The big concern now is a growth recession, which is an extended period of below-trend growth accompanied by rising unemployment." Investors can take some minor comfort knowing that extended unemployment benefits padded August's figure.
Employment figures are arguably the most insightful tool Wall Street has in discerning the economy's condition, and August's dramatic reading sent futures into a nose dive. In morning trading, the Dow Jones industrial average fell 1.2%, or 129 points, to 11,059, while the S&P 500 index dropped 1.4%, or 17 points, to 1,220. The employment numbers were worse than the already weak 5.8% jobless rate and the loss of 75,000 jobs economists were expecting.
Friday's report comes in the wake of a brutal trading day Thursday, fueled by the ADP jobs report that employers pulled the plug on 33,000 jobs in August, which was 3,000 more than the expected figure and much worse than July’s revised figure of a 1,000 job increase. The numbers reinforce the widespread notion that the economy is weakening, with the now debate turning to "how much" it will slow before seeing a turnaround.
Riccadonna described the outlook as "bleak" for growth, particularly with consumer spending unlikely to recover in the second half of the year. "The pullback in consumer spending is due to a whole host of factors such as income growth not keeping pace with inflation, [the] rising cost of household goods, tight credit and falling household and stock equity," said Riccodonna.
"It's basically a perfect storm, and add on top of that a labor market falling apart faster than most economists and even the Fed were expecting." Since it constitutes about two-thirds of economic activity in the United States, consumer spending ultimately defines the country's economic health. "Exports are helping, to be sure," Riccadonna noted, "but as go consumers, so goes the broader economy."
Goldman Convicts Merrill; Poor, Poor AIG
SELL MERRILL NOW, GOLDMAN SAYS Of course, the new world order doesn’t necessarily eradicate every vestage of the old hierarchy. So as much as the courant trade is to short commodities, there’s also still an opportunity to say something nasty about brokerages.
Goldman Sachs obliged Friday. It cut its rating on Merrill Lynch. In fact, it added the stock to its America’s conviction sell list, which is kind of like apologizing for calling your sister ‘’stupid” by saying, ”I’m sorry you’re stupid” in terms of manifesting the injury.
Goldman argued that Merrill has the highest price-to-book multiple among large-cap brokerages. But inasmuch as it also holds some of the highest levels of exposure to credit-default obligations, cratered mortgages and leveraged loans, the firm is odds-on likely to post fresh write-downs when it records its third-quarter results.
The expectation has been that Merrill would post a loss for the period - which would be its fifth consecutive quarter of losses - of about $3.75 a share, according to concensus estimates. Goldman had been forecasting losses of $4.75; that figure now goes to $5.75. ”We expect this multiple to compress,” Goldman said. Merrill fell 6%.
AIG AIN’T OUT OF THE WOODS American International Group (AIG) has recorded three straight quarters of losses, and in May, raised $20 billion in a dilutive debt-and-stock offering. That led, directly or indirectly, to the ouster of its management, and the imposition of a new regime. Which regime is currently in the process of figuring out just how to bolster its ailing balance sheet.
To what end? According to Morgan Stanley, ”a sizeable capital raise is likely.” When the new management unveils the results of its strategic review on Sept. 25, it may say it needs as much as $15 billion in fresh capital, a move that would, of course, come with some consequence for current shareholders. And not the good consequence, either.
The short-term outlook ”is heavily clouded,” Morgan Stanley said, recommending that fresh money find a lumpy mattress to park under instead of wending its way to AIG. The firm cut its rating, and lowered its price target on AIG by 29%. Shares have fallen 3% Friday. (Just as an aside: our records show Morgan Stanley has been sitting on an over-weight rating on AIG since April 2005, when AIG was trading at nearly $60, and since which time has fallen some 60%. For what it’s worth.)
Record 1.2 million US homes hit by foreclosure
Loans in foreclosure have doubled over the past year, while delinquency rates continue to soar. A record 1.249 million homes were in foreclosure during the second quarter of 2008, according to a report released Friday by the Mortgage Bankers Association.
And new foreclosure proceedings were started on about 490,000 of the 45 million home mortgages serviced by MBA members. That's up 9% from the 448,000 starts recorded in the previous quarter. Mortgage delinquencies continued their grim rise during the three months ended June 30, with 2.9 million homeowners falling behind on their loan payments, apart from those already in foreclosure.
Compared with a year ago, delinquencies are up more than 25%, while loans in foreclosure have nearly doubled. Both levels were the highest ever recorded by the survey. "The national foreclosure numbers continue to be driven by the hardest hit states continuing to get much worse," said Jay Brinkmann, MBA's Chief Economist.
"The increases in foreclosures in California and Florida overwhelmed improvements in states like Texas, Massachusetts and Maryland." California and Florida accounted for 39% of all foreclosures started during the quarter. Those two states as well as six others - Nevada, Arizona, Michigan, Rhode Island, Indiana, and Ohio - all had foreclosure start rates higher than the national average.
Once again, subprime adjustable rate mortgages (ARMs) weighed heavily on the down side. Subprime ARMs, which represent only 6% of all loans outstanding, accounted for 36% of all foreclosures started during the quarter. In other words, 6.63% of all subprime ARMs went into foreclosure during the period - nearly 20 times the rate for fixed rate prime mortgages.
"Even if subprime stabilizes," said Mike Larson, a real estate analyst with Weiss Research, "I would anticipate that prime loans would start to play catch-up. We're not just confronting a credit crisis any more, we're dealing with broad economic problems that are contributing to delinquency rates."
On the bright side, Larson says the deterioration in home prices has slowed in the last couple of months, which could help delinquencies level off as well. "They'll continue to worsen," he said, "but not at the pace of the last year."
Nevertheless, Jay Brinkmann warned that it would be fruitless to try an call a bottom in this market any time soon.
"Real estate markets are local and some markets are already improving," he said in a statement. "For example, even Michigan, one of the worst hit markets in the country, has now gone three quarters with little to no increase in its rate of foreclosures. Likewise, Massachusetts showed a very large drop in foreclosure starts, perhaps signaling a bottom."
"Because of the sheer size of California and Florida, an improvement in the national numbers, whether delinquencies, home prices or any other measure, is unlikely until we see some turnaround in those two states."
U.S. Payrolls Fell 84,000; Jobless Rate Jumps to 6.1%
The U.S. lost more jobs than forecast in August and the unemployment rate climbed to a five- year high, heightening the risk that the economic slowdown will worsen.
Payrolls fell by 84,000 in August, and revisions added another 58,000 to job losses for the prior two months, the Labor Department said today in Washington. The jobless rate jumped to 6.1 percent, matching the level of September 2003, from 5.7 percent the prior month.
Workforce reductions at companies from UAL Corp. to Gannett Co. are adding to the woes of Americans hurt by lower home values, scarcer credit and higher prices. The report may fuel concern that consumer spending, the biggest part of the economy, will decline and bring the expansion to a halt. Stock-index futures dropped and Treasury notes climbed.
"It certainly increases the probability that we really are in a recession," William Poole, former president of the Federal Reserve Bank of St. Louis, said in an interview with Bloomberg Television. "It is a weak number, including the revisions."
Payrolls were forecast to drop 75,000 after a previously reported 51,000 decline in July, according to the median estimate of 76 economists surveyed by Bloomberg News. Estimates ranged from declines of 40,000 to 150,000.
The jobless rate was projected to remain at 5.7 percent. Factory payrolls dropped 61,000 after decreasing 38,000 in July. Economists had forecast a drop of 35,000. The decline included a loss of 39,000 jobs in auto manufacturing and parts industries.
Today's report also showed the effects of the housing slump and the credit crisis that it triggered. Payrolls at builders fell 8,000 after decreasing 20,000. Financial firms trimmed payrolls by 3,000 for a second consecutive month. Service industries, which include banks, insurance companies, restaurants and retailers, subtracted 27,000 workers after cutting 12,000 in July. Retail payrolls fell by 19,900 after a drop of 18,100.
"We're losing jobs in all kinds of industries now," Roger Kaubarych, chief U.S. economist at UniCredit Global Research in New York, said in an interview with Bloomberg Radio. "This is the clearest recessionary signal we've seen." Government payrolls increased by 17,000 after rising 6,000. That meant private payrolls fell by 101,000 in August. Today's report brings the total decline in payrolls so far this year to 605,000. The economy created 1.1 million jobs in 2007.
Employment is among the indicators tracked by the National Bureau of Economic Research, the official arbiter of U.S. economic cycles, in calling a recession. The others are sales, incomes, production and gross domestic product. The group defines a recession as a "significant" decrease in activity over a sustained period of time, and usually takes six to 18 months to make a determination.
Job losses are one reason economic growth will soften after a second-quarter rate of 3.3 percent. The economy may expand at an average 0.7 percent annual pace from July through December, according to the median forecast in a Bloomberg survey. Consumer spending, which accounts for more than two-thirds of the economy, in July posted the biggest drop in four years after inflation.
The economy "is close to stagnating," Jan Hatzius, chief U.S. economist at Goldman Sachs Group Inc. in New York, said in an interview with Bloomberg Radio. In part because of continued gains in worker productivity, employers will keep cutting jobs, sending the U.S. unemployment rate to 6.75 percent next year, he said.
Dow To Extend Drop Below 20%
The bear is back. He’d been gone for a while - at least a month - but the bear is back, and the victims of his attacks have littered the Street this week. With Thursday’s drop of 345 points, the Dow Jones Industrial Average once again tumbled 20% below the October highs at just over 14,000 points.
It initially crept into the bear’s cave in early July (most research would regard a 20% decline from the top as the definition of a bear, though there is always some well-schooled equivocation about the details, such as length of time spent scarpering below the 20% level). It reached its nadir July 15 at a 22% decline, then effectively emerged from the bear cave - seemingly for good - in the waning days of July.
From the July 15 trough through the rebound that reached its apex Aug. 11, the Dow added nearly 8%, but since then - including the two straight dispiriting losses Wednesday and Thursday of this week - the industrial average relinquished 5%, and sank back so it was more than 20% off the October record.
It’s going to get worse in Friday’s early trading - though, of course, you can’t ever rule out an intraday reversal, especially off some short-term over-sold conditions. Futures suggested the Dow is going to open 50 points lower, the S&P 500 down about 7 points. Fundamentally, the discouraging labor report for August released ahead of trading Friday, which showed the unemployment rate climbed to a five-year high above 6%, is going to provide some rationality for further selling.
That is going to add to the broader fundamentals backdrop: the worries about global economic growth that now seems to be suddenly convulsing, which has sent commodities lower on worries about declining demand, and hurt the euro. The failing European currency has strengthened the dollar, which has weakened oil prices, which has magnified the pressure on commodities. May the circle be unbroken, as the old protest song writ.
Meanwhile, the weakness in those commodity prices has robbed the fast-money world of the one convincing and successful trade it has been able to make this year. Suddenly, a lot of wrong-headed bets on further inclines in prices for crude, coal, base metals and gold have been unwound.
There’s been wide-spread rumors that massive hedge funds are on the brink of failure, worries that got underscored earlier this week when Ospraie Funds were shuttered after suffering severe losses in August.
The rumor-mongering has climbed to a scale comparable to the vicious back-biting that ultimately led to the collapse of Bear Stearns earlier this year, and has left Lehman Brothers battered on the ropes for much of the last three months. (Of course, in the case of Lehman, truth may provide some defense against slander, even if the courts don’t recognize such posturing.)
The result has been an indiscriminate rush for the exits, as solvent hedge funds bolt for the very egress they think the heaving funds are going to have to repair to. There’s been wide-spread, pervasive selling pressure that’s mounted as the trading day has worn on.
The cycle that used to take several days - if not weeks - of trading has collapsed into a single trading session. By next week, it could shrink to an hour. Friday promised to offer a lot of drama, but mostly of the form of rubber-necking past the scene of an accident.
Europe and Asia Follow Wall Street Lower
Markets in Europe and Asia dropped on Friday, following the Dow’s 344.65 point decline Thursday, as investors positioned themselves for a test of the lows for the year on many indexes.
Futures on New York also fell Friday morning before the release of the August employment report. Economists expect the country to have lost another 70,000 jobs last month — the eighth consecutive monthly decline. The decline in Europe was led by banks, amid fears that further capital raising would be required, and semiconductor stocks, which would be adversely affected by the weaker global outlook.
“This market is very, very unstable at the moment,‘ said Philippe Gijsels, senior equity strategist at Fortis Global Markets in Brussels. “The credit crunch is continuing; that’s hitting earnings. It seems logical to retest the lows.”
By midday Friday, the DAX index was off 1.45 percent in Frankfurt, while the broader European DJ Stoxx 600 had fallen 1.1 percent. In Asia, the Nikkei 225 index in Tokyo closed down 2.75 percent, the Shanghai A-share market dropped 3.3 percent and the Australian market declined 2.1 percent.
Also hit in Friday’s trading was the Hang Seng index in Hong Kong, which tumbled 2.2 percent and fell below 20,000 for the first time in 17 months. Goldman Sachs this week announced that it was reducing its forecast for the territory’s economic growth to 4.2 percent this year and 4 percent next year, from previous estimates of 5.2 percent and 5 percent respectively.
Asian stock markets have fallen every day this week. Particularly troubling for many investors has been a sharp increase in the volatility of currencies, which has made the returns on cross-border investments even more volatile.
The yen has surged even more against the euro than the dollar. The euro has been hit by fears on the outlook in Europe, while the yen climbed as investors unwind so-called carry trades that had previously used yen to buy assets in higher yielding currencies like the Australian dollar, analysts said.
“People are wondering what market might be next,” the chief Asia-Pacific equity strategist for HSBC, Garry Evans, said. Earnings per share are barely growing in many Asian stock markets, and were actually down from a year earlier during the second quarter in at least five markets.
Many business people and economists worry that Asian exports could slow sharply in the months ahead as Europe appears to have joined the United States in an economic slump. In Europe, fragile confidence has been dented by fears a recession and no hint of lower interest rates from the European Central Bank.
In New York on Thursday, the Dow Jones industrial average plummeted on a confluence of poor news about the economy, although investors could not pin the drop on any overriding reason. Reports showed that retail sales were weak last month, just as more Americans filed for unemployment benefits. Anxiety lingered about a global slowdown. Fears of another financial crisis refused to go away.
“Boy, it’s hard to say,” Douglas M. Peta, a market strategist at J.& W. Seligman, said when asked about a reason for the decline. “All of us were scratching our heads. Why today?” Speculation ran rampant that some major hedge funds were rapidly selling assets; Atticus Capital, a $14 billion hedge fund based in New York, was forced to issue a statement denying that it was shutting down.
S.& P. cut the credit ratings of two prominent regional banks, National City and First Horizon National, on concerns about credit and losses related to subprime mortgages. Bill Gross, the head of Pacific Investment Management, said banks were at risk of a coming “financial tsunami.”
The Labor Department reported that the number of Americans who filed initial claims for unemployment benefits last week rose to 444,000, near a five-year high. And many retailers said that sales were weak in August, as consumers opted to shop at discount stores.
By the end of the session, the S.& P. 500, the broadest measure of the American stock market, had sunk back into a bear market, as had the Dow and the Nasdaq composite index. The S.& P. 500 fell 38.15 points, to 1,236.83. The Dow Jones industrial average lost 3 percent, to 11,188.23. The Nasdaq composite index declined 3.2 percent, or 74.69 points, to 2,259.04.
Meanwhile, rather than being greeted as a relief for consumers, the decline in oil prices this week is being seen as a sign of weaker demand. In Europe, the decline was led by chip makers and banks. STMicrolectronics, the largest semiconductor maker in the region, lost 3 percent after UBS cut its recommendation. The brokerage also slashed its 2009 revenue-growth forecast for semiconductors worldwide to 4 percent from 8 percent previously.
ASML, a manufacturer of semiconductor equipment, lost 1.9 percent. Infineon, another maker of semiconductors, slipped 1.3 percent. Banks were damaged by fears that reluctant investors would have to be asked to raise capital for some time. On Thursday the French bank Natixis said that it would sell new shares at a 61 percent discount to raise 3.7 billion euros to cover write-downs. On Friday, Barclays, the British bank, declined 2.2 percent.
And Goldman Sachs predicted that consumption spending in Hong Kong will grow more slowly than previously expected, as residents feel less affluent because of falling share prices and weakening demand for workers.
Investment banks have already been laying off workers in some departments, although not on the scale of layoffs in New York or London. Hiring continues in some categories of financial services, notably for employees with expertise in transactions in mainland China.
Asian stock market analysts were divided on how much longer share prices might fall. Francis Lun, the general manager of Fulbright Securities in Hong Kong, said that investor confidence was collapsing around the globe in response to slowdowns in the economies of the United States, the European Union and Japan. “We don’t see any light at the end of the tunnel, there is no silver lining in any cloud right now,” Mr. Lun said.
Andrew To, the sales and research director for Taifook Securities Company in Hong Kong, was more optimistic, pointing out that Hong Kong’s stock market has already lost two-fifths of its value since reaching a record of 31,958.41 on Oct. 30 last year. “Personally, I see this as a golden buying opportunity,” he said.
Detroit bailout may be around the corner
Plunging auto sales, high gas prices and election year politics could help convince Congress to approve a $50 billion loan package to embattled U.S. automakers that Detroit's Big Three claim is key to their future success.
On Wednesday, General Motors, Ford Motor and Chrysler LLC reported monthly sales declines of at least 20% from a year ago, as American car buyers continued to turn away from SUVs and pickups and towards more fuel efficient car models. The Big Three are now in the process of closing truck assembly lines and rushing to catch up with hybrid and other fuel efficient offerings from Toyota Motor and Honda Motor.
But with GM and Ford saddled with junk bond debt ratings and privately-held Chrysler with the thinnest capital cushion of the three, Detroit is caught in a credit squeeze that will make such investment difficult if not impossible.
"Funding such a shift is a tough lift even under optimum circumstances," said GM spokesman Greg Martin. "The credit markets are suffering. You had this seismic inversion of the market where no one wants to buy a full-size truck."
Thus, the automakers have deployed what one industry official describes as a "surge" of lobbyists and executives at both the Democratic and Republican Party's political conventions. The Big Three's hope is that if they can win speedy passage of the loan package, they can move more quickly to retool their plants to produce more smaller cars.
The $50 billion loan package, first proposed by the auto industry last month, has won the support of presidential candidates Barack Obama and John McCain as their campaigns eye key votes in Michigan and Ohio. On Tuesday, White House Press Secretary Dana Perino signaled the outgoing Bush administration was open to approving the loans.
"It's something we're aware of and we're talking to the members of Congress and also the people in the industry, and thinking about what they might think would be required from their perspective," she said. But as much support as the idea has, the automakers say they can't let up until the loan package is not only signed into law but also funded by Congress.
Last year's energy bill included up to $25 billion in loans to the Big Three, but lacked the necessary funding to actually make the money available. That earlier legislation would allow automakers and suppliers to borrow the money at Treasury bill rates for up to 25 years as a way to fund the conversion of plants and the development of new technology. Because of their poor financial status, the automakers would be forced to borrow money at rates well above 10% in the open market.
The automakers have argued this is not a bailout and point out that the estimated cost of complying with new, tougher fuel efficiency standards for vehicles is just over $100 billion. "Borrowing capital at a lower cost than the double-digit rates we're looking at will allow us to accelerate the technology, and transform the business quicker," said Ford spokesman Mike Moran.
Industry experts say that while the savings from the lower interest rates would amount to billions of dollars for the automakers, the program may not necessarily save a member of the Big Three from eventual bankruptcy in the way that federal loan guarantees rescued Chrysler in the 1970's.
"I'm not sure it's either essential for their survival or a guarantee of their turnaround," said Bob Schnorbus, chief economist with J.D. Power & Associates. "They're going to need a lot of liquidity over the next two years. Even $50 billion, with a lot of strings attached, isn't going to make or break them."
But David Cole, chairman of the Center for Automotive Research, said the loan package could be enough to keep some plants open that would otherwise be closed. Cole added that the package is important to help keep GM, Ford and Chrysler competitive against their Asian rivals. So far this year, the Big Three have captured only 47% of U.S. auto sales, down from 51% in the same period last year.
"More than anything else, [the loan program] would ensure the viability of the companies over the longer-term," said Cole. "Right now they have to invest an enormous amount of cash in new technology at a time when their cash is low."
Under language of the bill, the loans would also be available to overseas automakers that have plants here, but industry officials say it's unlikely any would make use of the money. That's because foreign-based auto companies have strong enough balance sheets to finance the investment in new technology without the U.S. government's help.
Toyota spokeswoman Martha Voss said the company is neutral on the loan proposal at this time but that it will continue to monitor the discussions in Congress.
Cole argues the loan package could be a relatively cheap alternative to the economic harm that would take place if one of the automakers were to fall into bankruptcy. The estimated cost of the program is less than $8 billion, which factors in the risk of default on the loans.
"It's like with the Bear Stearns bailout," he said, referring to the investment bank that was sold to JPMorgan Chase with the help of the Federal Reserve earlier this year. "With so many jobs depending on each assembly line job, a failure could trigger a much more serious problem."
Cole and the automakers also think winning the support for the loans will be easier now that Congress has moved to help mortgage finance giants Fannie Mae and Freddie Mac as well as home owners who borrowed more than they could afford on their mortgages.
"This is a technology partnership, it's not a blank check like for Fannie and Freddie," said Linda Becker, a spokeswoman for Chrysler. "This is a critical time to improve the country's fuel economy." But while Cole thinks there's a 75% chance the automakers will win what they're seeking, the automakers themselves say they have a relatively small window to get what they need.
Congress is likely to be in session for about a month before the pre-election recess and winning approval in a new Congress could be difficult. And even if a loan package is approved by Congress next year, the automakers say they need to get access to the cash sooner than later as auto sales continue to slide.
So the Big Three is likely to put more pressure on Obama and McCain as well as members of Congress in the next few weeks. "It's got the attention of both candidates and the battleground states are our states. It's where we do business," said Becker. "Every time they come through those states, they're going to hear from us and the employees and constituents."
UK car sales collapse to lowest level since 1966
Car sales fell to their lowest level for more than 40 years last month in the most dramatic sign yet that the country is heading into a recession. Britain’s biggest industry gave warning of deeper cuts in production to come as consumers, worried about the high cost of fuel and the economic downturn, shy away from big purchases and abandon the showrooms.
Traders reported just 63,225 new cars sold, the worst August figures since 1966, sending a chill through the automotive industry from manufacturers to the secondhand market. Premium brands, many of which are made in Britain, were among the hardest hit, with Aston Martin suffering a 67 per cent drop to just 19 cars sold. Land Rover saw a 58 per cent fall to 422 cars and Jaguar a 41 per cent slump to 422 cars.
There was further bad news as property prices were shown to have fallen sharply – with more than £25,400 wiped off the value of an average home in the past 12 months. New figures from Halifax revealed the fastest rate of decline since the lender started its house price index in 1983.
Consumers were offered no respite by the Bank of England, however, as interest rates were kept on hold. Despite official confirmation that growth has slowed to a stop, rates were kept at 5 per cent. The latest slew of bad news came as Gordon Brown struggled to maintain a political fightback that is becoming mired in internal discord.
The Prime Minister insisted that he was “cautiously optimisitic” about the economy in what his opponents portrayed as a rebuff to Alistair Darling’s weekend claim that Britain was facing its worst economic conditions for 60 years. In a speech to the CBI in Glasgow, Mr Brown pledged more help for low and middle-income families. While people understood that no government could on its own “put everything right that is creating hardship”, he said that they did look to ministers to help them through difficult times.
“We will not let them down,” Mr Brown said. “We will do what it takes to bring security to families on modest and middle incomes. And we will ensure that no one who is prepared to work hard and adapt to change will lose out as a result of global forces.” But measures to help with rising energy bills were in disarray last night after Downing Street admitted that proposals to raise £500 million to fund fuel vouchers were in tatters.
George Osborne, the Shadow Chancellor, said Mr Brown was in denial over the severity of the downturn. “At a time when Britain needs strong and united leadership with a clear sense of direction, we have a Labour government descending into civil war and a Chancellor and a Prime Minister who publicly disagree on the severity of the problems we face,” he said.
The slump in car sales prompted the heads of the main car industry groups to call for urgent government and economic action to restore confidence. The Society of Motor Manufacturers and Traders wants Mr Brown to set out an emergency economic plan. Paul Everitt, the chief executive, said it was “concerned by the reluctance of boost the economy and restore confidence.”
Sue Robinson, the director of the Retail Motor Industry, said: “Continuing economic pressure on households has made consumers wary of making big purchases, so by deciding against an interest rate reduction, the Bank of England has missed an opportunity to kick-start the economy.”
Britain’s automotive industry, which employs 815,000, sells overseas predominantly but faces terrible markets in Europe and the United States as well. Industry experts described the sales figures as dreadful and gave warning that they would impact on carmaking in Britain. Already Toyota and Land Rover have announced production cutbacks because of falls in orders.
Brent Dewar, head of marketing for General Motors in Europe, told The Times that the “headwinds in the UK market are concerning to us”. He said that consumer confidence in the UK and Ireland was a “burgeoning issue” for GM, the world’s biggest carmaker, which operates Vauxhall’s factory at Ellesmere Port, Merseyside.
Garel Rhys, a car industry economist at Cardiff University, said that the figures were “truly dreadful” and forecast that the British market would probably not recover until the second half of 2010. Ten years ago, August was a strong month for car sales as the new registration plate was issued. This was changed in 1999, however, to two plates issued in March and September.
Roy Kishor, automotive partner at Kroll, the restructuring and advisory consultancy, said that the car industry was facing a perfect storm of “depressed sales, depressed residual values, cheap offers and margin pressure”. He added that some mainstream used car prices had fallen 10 per cent in two months.
The British Car Auctions (BCA) Used Car Market Report found that car volumes and values fell last year even before the most recent plunge in consumer confidence. Sales of used cars dropped by 5 per cent, to seven million, with both dealers and private owners affected. Estimates for the first half of this year suggest that the average value of a used car bought at auction has fallen by more than £1,000, to £4,765.
Tim Naylor, spokesman for BCA, said: “You do tend to find that, when sales of new cars are down, then there is a smaller supply of cars of a certain age in the used car market. Buyers of used cars could just be deferring their purchase in the short term or could be putting it off indefinitely.”
UK Treasury, Bank of England urged to clarify future funding support for banks
Pressure is building on the Bank of England (BoE) to set out how it will provide funding support to Britain's banks amid mounting concern that the end of the current scheme in six weeks will tighten the screw on lenders.
Analysts speculate Britain's banks may have borrowed 200 billion pounds ($352 billion) from the BoE under an innovative Special Liquidity Scheme (SLS) launched in April, but the central bank plans to close the window on Oct. 20. It is looking to replace it with a more permanent arrangement, but has not said how it will work.
That has stoked concern bank funding will stay tight and become more expensive as securitisation markets remain closed, and has contributed to a fall in UK bank shares this week. Shares in HBOS, Britain's biggest home lender and with the largest funding gap between loans and deposits, have dropped 12 percent this week. Lloyds TSB, Barclays and others have also sagged and the UK bank sector has lost 5 percent.
The European Central Bank, which also provides funds for UK banks, on Thursday unveiled plans to tighten rules on the assets it takes as collateral to borrow funds, further unsettling investors. "Although the SLS has a finite life, we expect the Bank will announce a new facility using similar principles," said Paul Measday, analyst at JP Morgan Cazenove.
"We believe it makes sense to maintain a scheme that has successfully provided liquidity to the banking system whilst funding conditions remain difficult and the future is so uncertain," he said in a note.
Several other analysts agreed, but said there were jitters about the mechanics.
"There is uncertainty (about) what it will be replaced with... there seems to be a battle going on, with politicians happy to provide support to the mortgage lenders but the Bank more reluctant," one analyst said. "The Bank clearly doesn't want anyone to fail but on the other hand they (banks) have to manage their liquidity risk."
Politicians are concerned that lenders will pull back even harder on lending if funding becomes more difficult, heaping more pressure on the brittle housing market. BoE Governor Mervyn King said in June the SLS would be replaced by a liquidity facility that works under both "normal and stressed" market conditions.
It will be part of its red book review of open market operations, expected to be unveiled before the SLS window closes. The new plan is expected to run separately to any government measures introduced as part of James Crosby's review of the mortgage finance market. That review is expected this month.
King said the liquidity backstop represented "a balancing act, between avoiding a major shock to the system and encouraging future reliance on the same cheap but risky funding sources". The SLS was brought in in April to help ease strains on banks and building societies and boost confidence in the financial system by allowing lenders to exchange hard-to-trade mortgage assets for government bills.
The BoE said initial demand for the scheme was likely to be about 50 billion pounds but never set an upper limit. Analysts reckon near 100 billion pounds has been taken, and UBS estimated the amount could top 200 billion.
The Council of Mortgage Lenders this week urged the government to make an early announcement "of the renewal/extension" of the SLS or any other measures being planned to "help to resolve market uncertainty". The CML said mortgage funding problems remain a bar to meaningful housing market recovery.
Critics of the scheme say it has allowed banks to bundle up toxic mortgage paper, securitise it and sell the package to itself so it can pledge it to the BoE.
UN forecaster says global slump will pose huge risks for British economy
Global economic growth will slump to below 2 per cent next year, posing “enormous risks” to a UK economy that is already weak, a leading United Nations economist forecast yesterday.
Heiner Flassbeck, the director of globalisation and development strategy at the United Nations Conference on Trade and Development (Unctad) said that, like the United States, Britain is in for a rough ride from a slowing global economy and a domestic housing crisis that will last for at least another year or two.
Mr Flassbeck said: “The pound may be dropping like a stone, but relief from devaluation only comes quite a bit later, especially after the UK’s shift from manufacturing to financial services over the past 15 years.” Manufacturing industries are quicker to benefit from currency devaluations, which can quickly translate into cheaper exports.
Unctad, which focuses on integrating emerging countries into the global economy, forecasts that the UK economy will grow by 1.6 per cent this year, barely half of the 3 per cent recorded in 2007. It did not give a forecast for next year. Mr Flassbeck pointed out that 2 per cent growth would mean recession for many parts of the world, with Europe, Japan and the US particularly vulnerable.
The 10 per cent growth that China is expected to record this year could easily fall, possibly to 8 per cent, in 2009, he said. An Unctad report released yesterday forecast that the global economy would grow by 2.9 per cent this year, compared with 3.8 per cent in 2007 and the lowest since the 1.9 per cent recorded in 2002. The forecasts for next year were Mr Flassbeck’s own estimates and were not contained in the report.
Unctad said: “The financial turmoil that erupted in August 2007, the unprecedented oil price increases and the possibility of tighter monetary policy in a number of countries presage difficulties for the world economy in 2008 and 2009.
“The impact of the sub-prime crisis has spread well beyond the United States, causing a widespread squeeze in liquidity and credit. And price hikes in primary commodities, fuelled partly by speculation that has shifted from financial instruments to commodity markets, adds to the challenge for policymakers intent on avoiding a recession while at the same time keeping inflation under control.”
The report said that poorer countries should offer tax breaks and other incentives to support investment during the credit crisis. The agency gave warning that developing economies would be hit hard by a continuing global slowdown. Commodity-producing countries in Africa and Latin America that have benefited from high prices for metals, minerals and energy products may also face pressure if demand for those raw exports cools, the report added.
Million of Britsh homeowners about to go underwater
The UK housing market is unlikely to recover before 2011, according to a leading estate agent, as it emerged today that 1.3 million homeowners face negative equity if prices continue to fall.
Savills, which specialises in selling upmarket properties in the South East and London, made its gloomy prediction in its latest report on the residential housing market. The company blamed restrictive mortgage conditions for the delay to any market recovery, citing the Financial Services Authority's report in July that availability of mortgages will persist through to the end of 2010.
Savills said today that its forecast that house prices will fall by 25 per cent over this year and next was looking like an increasingly safe bet. The extent of the problems in the housing market was underlined further by forecasts that up to 1.3 million British homeowners could find themselves in negative equity, when mortgage debt is higher than the house's value, if prices fall and the economy moves into recession.
If true, the prediction, made by leading banking analysts, would mean that more than 10 per cent of the nation's homeowners would be sitting on properties worth less than they paid for them. "Our estimate is for 25 per cent to 35 per cent house price falls from their height...resulting in up to 1.3 million households, or 18 per cent of mortgages by value, in negative equity under our recession scenario," said Bruno Paulson, senior analyst at Sanford Bernstein, the research group.
Mr Paulson said that house price falls would be "far worse" than in the last economic downturn in the 1990s and could have a huge negative knock-on effect for the UK's mortgage lenders. "This should in turn drive 1 per cent peak losses on mortgage books in a serious recession, and an overall mortgage loss bill [for banks] of up to £38 billion," he said.
This week, the Organisation for Economic Co-operation and Development (OECD), an influential think-tank, said that the UK would fall into recession in the second half of the year, marking out Britain as the only country of the G7 economies that will experience a full-blown slowdown in 2008.
Sanford Bernstein gave its forecast after fresh evidence emerged earlier this week that house prices were sliding at double-digit levels year-on-year. Halifax, the country’s biggest mortgage lender, said this week that property prices fell at an annualised 12.7 per cent last month, just days after its rival Nationwide Building Society revealed an annual decline in property prices of 10.5 per cent.
Yesterday, the Bank of England's Monetary Policy Committee failed to provide relief to homeowners looking to cut their mortgage costs by keeping the interest rate at 5 per cent. Moody's Investors Service, the credit rating agency, also reported that mortgage arrears and repossessions had jumped sharply in the second quarter, even among the highest-rated borrowers.
Savills underlined the gloomy picture with new evidence that London's well-paid financial services community has taken a battering during the credit crunch. The estate agent said demand for £1 million to £2 million homes had fallen by 54 per cent, compared with last year.
Prime central London property values fell by 5.5 per cent in the second quarter of 2008, according to Savills, while the prime and country house market fell by 4 per cent during the same period. The estate agency group also pointed out that renting is currently cheaper than owning a house, deterring many potential buyers from entering the market.
By the time the property market reached its peak last year, the costs of ownership were 44 per cent higher than the costs of renting, according to Savills. The company predicts the disparity will diminish during 2009. "By the end of 2009, the cost of buying should be in line with the cost of renting, so making ownership attractive again," Savills said.
Faced with continued evidence that the economy is heading for a technical recession, analysts have begun to adjust their forecasts for the plight of the nation's homeowners. Last month, Standard & Poor's, another credit rating agency, said that one in six homeowners in the UK will fall into negative equity by the end of next year if house prices fall by a further 17 per cent.
Morgan Stanley estimated in April that house price falls of 15 per cent over the subsequent 24 months would put 1.2 million people into the red with their property values. But if price falls of 25 per cent are sustained, that would put 2 million into negative equity, analysts at the investment bank said.
Tighter ECB lending rules seen hitting Spain's savings banks
Spanish savings banks, such as Caja de Ahorros del Mediterraneo, are likely to be hit hard by new European Central Bank (ECB) rules to tighten its lending to banks, market and banking sources said on Thursday.
Spanish savings banks and other financial institutions have rushed to the ECB over the past few months in search of funds, after the credit crunch and a domestic real estate crash decimated investor demand for asset-backed securities.
Savings banks, which are non-profit lenders, accounted for almost 70 percent of the total growth in funds borrowed by Spanish financial institutions from the ECB since last year, according to a research note from Banco Santander.
The ECB on Thursday unveiled tougher rules on the assets banks can submit as collateral after concern the rules were open to misuse. Financial institutions will now have to put up more collateral to borrow the same amount.
"The access to ECB funding is more expensive and this complicates the lives of the savings banks that already had problems," said Olga Cerqueira at Moody's in Madrid. For instance, if 102 euros worth of asset-backed securities were needed to borrow 100 euros in the past, the figure could be now as high as 116 euros.
Spain-based financial institutions borrowed 49 billion euros ($71.14 billion) from the ECB as in July, up from 18 billion over the same time last year, according to Bank of Spain's data. In total, the savings banks accounted for 4.4 percent of the total amount borrowed from the ECB across Europe, up from 0.9 percent last year, according to a Santander research note issued on Thursday. Regular Spanish banks increased their representation to 5.6 percent, from 4.6 percent.
Savings banks -- unlike regular banks -- have not diversified their operations by investing or expanding abroad, meaning they will be harder hit by the new rules. But while the tightening meant higher costs, there was no immediate risk of a collateral shortage, said a source at Spain's central bank. "In economic terms, this is not relevant. No Spanish institution will find itself with insufficient collateral when this new regulation becomes practise."
Spanish savings banks were established in Spain to help develop regional economies and do not have an investor ownership structure like regular banks. Their boards reflect the political forces in the region, and the chairman is usually appointed by the regional party in power.
This lack of accountability to financial shareholders has made them less strict than banks when it comes to lending, banking sources say. "Savings banks have been less diligent than banks in their lending," one banking source said, requesting anonymity. "Banks have owners who oversee the lending, but in the savings banks, it's the regional government that's really in power."
Caja de Ahorros del Mediterraneo, a savings bank in the Valencia region, has been put on a watch list by ratings agency Standard & Poor's, which said it could downgrade the bank by as many as two notches because of the fast deterioration of its asset quality.
Savings banks may suffer more as the Spanish economy heads toward a recession and as rising unemployment is likely to translate into more mortgage defaults. Banks also face further losses as, if turned down by the ECB, they are forced to sell assets in the open market -- at a lower price.
"Everybody knows the problems that Spain faces, so when they go out in the market, they will face tight financing," the banking source said. A typical new Spanish residential mortgage-backed security (RMBS), for example, will price at around Libor plus 30 basis points for Triple-As, whereas Spanish RMBS in the secondary market can trade at levels anywhere between Libor plus 170 to 350 basis points.
Spanish savings banks such as CAM have had to delay planned sales of non-performing loans as the asking prices haven't been low enough to attract investors.
Greenspan: Fed isn’t a ‘magical piggy bank’
Troubled by the Bear Stearns debacle, former Federal Reserve Chairman Alan Greenspan is advocating a new way of dealing with government bailouts of companies whose sudden collapse could wreak havoc on the country's economic and financial stability.
Greenspan says Congress needs to give the government new powers to handle troubled companies to minimize any potential losses to American taxpayers. A self-described libertarian Republican, Greenspan has a reputation for being wary of giving the government extra powers. However, in crisis situations, there needs to be a clear process for handling bailouts, rather than depending on the Fed to do so, he reckons.
A high-level panel of financial officials should be given broad authority to quickly determine whether a failing company poses a sufficient threat to the entire U.S. economy, he recommends. If so, the company would be shut down.
"We need laws that specify and limit the conditions for bailouts — laws that authorize the Treasury to use taxpayer money to counter systemic financial breakdowns transparently and directly rather than circuitously through the central bank as was done during the blowup of Bear Stearns," Greenspan wrote in a new epilogue to the paperback edition of his memoir, "The Age of Turbulence: Adventures in a New World."
Greenspan envisions the formation of a group akin to the Resolution Trust Corp. to step in, take a troubled company into conservatorship, wipe out the equity, impose some charge or "haircut" on its debts before guaranteeing them and then selling its assets.
The RTC was created in 1989 to deal with the aftermath of the savings and loan crisis. It disposed of the assets of failed savings and loans and then went out of business. Costs to taxpayers would still be a concern, he acknowledges. As with the RTC, however, the public cost could be minimized, he says.
Critics in Congress, in academia and elsewhere worry that the Fed's unprecedented actions — including financial backing in March for JPMorgan Chase & Co.'s takeover of Bear Stearns Cos. — are putting taxpayers on the hook for billions of dollars of potential losses. They also say it encourages "moral hazard," that is, allowing financial companies to gamble more recklessly in the future.
Fed Chairman Ben Bernanke, who took the helm after Greenspan, has repeatedly defended the Fed's actions, saying they were necessary to avert a meltdown of the entire financial system, which would have devastated the U.S. economy.
Bernanke's Fed also has taken a number of unconventional — and some controversial — actions to shore up the shaky financial system and to get credit, the economy's lifeblood, flowing more freely. It agreed in March to let investment houses draw emergency loans directly from the central bank. And, in July, the Fed said Fannie Mae and Freddie Mac also could tap the program.
For years, such lending privileges were extended only to commercial banks, which are subject to stricter regulatory supervision. Greenspan, 82, who ran the Fed for 18 1/2 years and was the second-longest serving chief, says he is concerned that Capitol Hill will look to the Fed's actions "as a wondrous new font of seemingly costless federal funding — a magical piggy bank."
The United States has long "abandoned the notion that we should leave crises to be resolved solely by the marketplace," Greenspan says in making the case for new powers in this area.
The ex-Fed chief says he is skeptical of a sweeping plan, put forward by Treasury Secretary Henry Paulson, that would turn the Fed into a uber cop of sorts — responsible for policing financial market stability.
"Much as we might wish otherwise, policymakers cannot reliably anticipate financial or economic shocks or the consequences of economic imbalances," Greenspan says. Greenspan calls the current crisis "one of those rare, once in a century or half-century events." The full closure on this crisis is "a way off," he says.
The U.S. economy, he observes, appears to be "on the brink of recession." And, worldwide inflation, he warns, is creeping, which will pose a challenge to central bankers, he says. Looking back, Greenspan says governments and central banks probably could not have altered the course of the once high-flying housing market and broken through investors' fevered euphoria.
He believes that the government should have gone after fraudulent mortgage practices, however. "Bank regulators, who are expert in accounting, banking law and risk management, are not equipped for this job," he says. "It requires law-enforcement professionals."
Dow plunges after warning of 'financial tsunami'
Weary investors in the United States received a further pummelling yesterday as data showed new unemployment claims at a near-five-year high last week, a leading fund manager gave warning that America faced a “financial tsunami” and key retailers released disappointing sales figures.
The mounting nervousness about America’s economy dragged down shares. The Dow Jones industrial average fell 344.60 points, or 3 per cent, to 11,188.20, and the S&P 500 closed down by 38.20 points, or 3.3 per cent, at 1,236.80 points.
The Labour Department reported that the number of Americans claiming unemployment benefits for the first time rose by 15,000 to 444,000 in the week to August 30. The disappointing figures came after companies cut staff in the face of a weakening global economy and contrasted with a consensus forecast that new jobless claims would fall to 420,000.
The data, combined with a call by the manager of the world’s biggest bond fund for the Government to inject more money into the banking system, spooked US investors already jittery about the outlook for the global economy. Bill Gross, co-chief investment officer of Pimco, said that the US was confronted by “systematic debt liquidation”. He added: “Unchecked, it can turn a campfire into a forest fire, a mild asset bear market into a destructive financial tsunami.”
Mr Gross said: “If we are to prevent a continuing asset and debt liquidation of near-historic proportions, we will require policies that open up the balance sheet of the US Treasury.”
Hugh Johnson, head of Johnson Illington Advisors, the US fund manager, said: “The stock market declines are more than just the jobless figures. Although they are not good, it is more that they tap into growing concerns that the global economy is weaker than expected and that the problems facing financial institutions are not going away.”
Furthermore, Gap and Abercrombie & Fitch, the clothing retailers, and Target, the discount retailer, all reported a decline in same-store sales for August. Gap said that its sales fell by 8 per cent in August. Saks, the luxury department store chain, and Limited Brands, the owner of the Victoria’s Secret lingerie chain, also reported weaker sales.
A separate Labour Department report provided a glimmer of hope, announcing that productivity – the amount of output for every hour of work – rose to an annualised rate of 4.3 per cent in the second quarter, one percentage point above consensus forecasts. Analysts said that the higher productivity was encouraging because it helps to keep a lid on inflation.
Morgan Stanley downgrades AIG
Morgan Stanley downgraded American International Group Inc to "equal-weight" from "overweight," citing escalating liquidity concerns for the world's largest insurer.
"We believe a sizable capital raise is likely, probably in the range of $10 billion to 15 billion, the majority of which is likely to be common equity," analyst Nigel Dally said in a note to clients. He cut his price target on the stock to $25.
The uncertainty being driven by AIG's financial products group and investment portfolio exposures leads us to believe that its debt ratings are highly vulnerable, Dally said. The analyst also said refinancing $39.95 billion of debt and interest due within the next 12 months could hurt pretax earnings by $1.0 billion annually.
He expects $2 billion to $4 billion in deferred acquisition costs and goodwill charges by year-end, which, given the current share count, would hit book value by roughly $1.00 per share. AIG shares were trading up 27 cents at $21.49 Friday morning on the New York Stock Exchange. They had fallen 4 percent to $20.29 earlier in the session.
Goldman tells clients to sell Merrill shares
Goldman Sachs analysts Friday suggested clients sell Merrill Lynch shares, and predicted the firm still has more charges to take as the credit crisis continues.
"Merrill currently trades at the highest price-to-book multiple in our large-cap brokerage universe, despite having some of the most significant exposures to troubled assets such as collateralized debt obligations, mortgages and leveraged loans," said the Goldman note.
Goldman also added Merrill to its "conviction sell" list and lowered its third-quarter forecast, saying it now expects Merrill to report a loss of $5.75 a share compared to its previous forecast of a loss of $4.75 a share. As of 10 a.m., Merrill's stock was down 3.3%, to $25.35. It fell by as much as 5.6% Friday morning. The stock, which fell 7.48% Thursday, slipped another 3.7% Friday, to $25.25.
Goldman said that weak third-quarter results from investment banks will pressure the entire sector. It also sees "a meaningful slowdown" in corporate and institutional activity due in part to deleveraging. Merrill is one of the biggest losers of the credit crunch, having suffered more than $46 billion in write-downs since June 2007. In July, it agreed to sell just over $30 billion in mortgage-related assets for 22 cents on the dollar.
Also in July, Merrill raised $8.5 billion by selling new stock and sold its 20% stake in Bloomberg LP. At the same time, it said it expects to take a $5.7 billion pre-tax write-down in the third quarter. The Goldman research note did not suggest that matters will improve for Merrill, as it revised its six-month price target to $22 from $28.50.
"With these markets still under pressure, we believe additional write-downs and book value deterioration will continue to plague the stock," said Goldman. "As a result, we see no reason why the stock should be trading at such a premium."
The Broker Downgrade Merry-Go-Round Spins On
Shares of Merrill Lynch & Co. dropped in premarket trading Friday as an analyst at Goldman Sachs recommended investors sell the stock due to its heavy exposure to risky assets.
Merrill Lynch has “some of the most significant exposures to troubled assets such as CDOs, mortgages and leveraged loans,” Goldman analyst William Tanona said in a note to clients. Merrill shares look overvalued, he said, in the face of further write-downs of those assets.
Tanona’s downgrade comes as Merrill shares already lie at the bottom of a steep trough, having lost nearly three-quarters of their value since June of last year. Merrill has written down more than $46 billion in assets since then.
But by adding Merrill to his firm’s “conviction sell list,” Tanona clearly indicated his certainty that its shares haven’t reached a bottom yet. He cut his price target on the stock to $22, and estimated that shares could fall 16% over a six-month time-frame. His report spurred a selloff of Merrill shares in premarket trading Friday, where shares had fallen 5% to $24.90 in recent trading.
Tanona also widened his loss estimate for Merrill’s third quarter by $1, to a loss of $5.75 a share. That was the deepest loss estimate among Wall Street analysts so far, with the consensus estimate at a loss of $3.75 a share. His wider loss forecast is due to the higher expectation of write-downs, higher compensation expenses and the $125 million fine that Merrill agreed to pay to settle auction-rate securities lawsuits
Lehman Weighs Split to Rid Itself of Troubling Loans
Lehman Brothers, the ailing Wall Street bank, is working toward a radical solution in its fight for survival: Splitting itself into a “good” bank and a “bad” one.
Lehman, which has been searching for a financial lifeline from outside investors, is contemplating placing about $30 billion of troublesome commercial mortgages and real estate that it owns into a new publicly traded company — the “bad” bank. The rest of Lehman — the “good” one — would then be able to carry on with the help of a cash infusion from one or more investors.
The move is one of several under consideration as Lehman prepares to report what could be grim third-quarter results this month. But the good bank/bad bank idea is hardly new. Several troubled financial institutions took similar steps in the late 1980s and early 1990s.
If Lehman goes through with the plan, the firm itself would probably inject $6 billion to $8 billion in equity into the new company, people briefed on the matter said Thursday. Lehman would also provide debt financing for the company and could raise additional money from outside investors, who would benefit from any recovery in the market for commercial and residential real estate assets.
The fate of Lehman is one of the biggest questions hanging over Wall Street, where concern about the health of the financial industry and the broader economy sent the Dow Jones industrial average into a 345-point tailspin on Thursday.
Lehman, among the largest underwriters of mortgage-backed securities, has been brought to its knees by the running credit crisis. The firm’s hard-charging leader, Richard S. Fuld Jr., has been trying to sell some of the bank’s troubled commercial mortgage holdings, but has failed to find enough buyers.
Lehman’s next results are likely to underscore its precarious position. Analysts expect the firm to write-down as much as $5 billion of commercial real estate holdings and to post a loss of $2.49 a share. Splitting off troubled assets would help Lehman attract new investors, many of whom have been reluctant to put money into the troubled financial industry.
Lehman has been negotiating to sell part of itself to the government-owned Korea Development Bank or other investors in Asia. While no deal has been reached, many analysts think one will materialize soon. Lehman is also considering selling its prized investment management arm, which includes Neuberger Berman, for about $7 billion, possibly to a private equity group like Apollo or Kohlberg Kravis Roberts.
If Lehman were to create a good/bad bank structure it would probably need to raise fresh capital to replace the money it would inject into the bad bank. In June, Lehman tapped a group of American institutional investors for $6 billion when it announced second-quarter results. But its shares have dropped 44 percent since then, making another similar capital-raising unlikely. Shares of Lehman fell $1.77, or 10.5 percent, to close at $15.17 on Thursday.
In 1988, Mellon Bank, weighed down by bad real estate loans, created Grant Street National Bank to offload troubled loans. Mellon sold 191 loans, once worth about $1.4 billion, for $640 million to the new entity and took a one-time, pretax charge of about $200 million.
Every Mellon shareholder was given one share in the new entity. To finance the entity, Mellon put in about $125 million and Grant Street tapped the markets for an additional $513 million in junk bonds. The notes were paid off before they matured and the entity was shut down in 1995.
“Everybody got paid back and there was money left over for shareholders,” said Michael Bleier, a lawyer with Reed Smith in Pittsburgh, and former general counsel at Mellon Bank. “Mellon got the assets off its balance sheet and that improved the quality of the portfolio over all and the quality of the good bank,” he said.
David Trone, an analyst with Fox-Pitt Kelton, endorsed the idea of Lehman spinning off its commercial real estate for shareholders. In a research note on Thursday, Mr. Trone said the issue for Lehman management was not so much one of troubled assets, but rather the fact that uncertainty surrounding the portfolio was weighing down Lehman’s stock.
“Management is in a quandary — the commercial mortgage is performing too well to be dumped in a fire sale but, yet on the other hand, the equity market appears to want it gone,” he wrote. Creating the separate company, the thinking goes, would strengthen the confidence of people who do business with Lehman every day — other banks, hedge funds and institutions like pension funds — thereby encouraging them to continue doing business with the firm.
Shareholders, who would own shares of both the real estate portfolio and the new unencumbered Lehman, could bet on whether the commercial real estate market recovers or gets worse and sell its “bad bank” shares. Mr. Trone estimated that if Lehman spun off a separate entity, it would invest about $3.6 billion in equity.
It would then have to raise a significant amount of debt — a problem, Mr. Trone said, as corporate debt holders might not be comfortable assessing a commercial mortgage portfolio and commercial mortgage holders might not want corporate debt.
Lehman will have to decide how much it wants to capitalize the new company, but it will most likely seek to overcapitalize it to give the new entity enough of an equity cushion to absorb more market punches and have the flexibility to sell the assets when the markets are in better shape.
Lehman May Shift $32 Billion of Mortgage Assets to 'Bad Bank'
Lehman Brothers Holdings Inc. may shift about $32 billion of commercial mortgages and real estate to a new company that will be spun off in a move similar to the good-bank-bad-bank model used in the 1980s banking crisis, two people briefed on the discussions said.
The bad bank, nicknamed Spinco for now, would have about $8 billion of equity coming from Lehman, the people said, speaking on condition of anonymity because the plan is one of several under consideration. Spinco would borrow the remaining $24 billion from Lehman or outside investors. The New York-based bank would replace capital put into Spinco, whose shares would be owned by current Lehman shareholders.
Lehman Chief Executive Officer Richard Fuld, 62, is under pressure to strip the firm's balance sheet of hard-to-sell assets. To raise cash needed to cope with losses from a wholesale disposal, Lehman has been talking with Korea Development Bank about a capital infusion and with private equity firms interested in buying its asset-management unit.
"The model helps banks get on with their real business, focus on their strengths, after they put the bad assets aside," said Michael Bleier, an attorney at Reed Smith LLP who was the senior counsel to Bank Mellon during its spinoff of bad assets in 1988. "We'll see it being used again during this crisis."
The Spinco proposal would enable Lehman to dispose of 80 percent of its commercial mortgages, the people said. Under another plan, the firm would establish a company capitalized and managed by outside investors to buy some of its mortgage assets. The Spinco plan would enable Lehman's shareholders to benefit from a turnaround in the mortgage market.
Korea Development Bank has been in discussions to buy a 25 percent stake in Lehman for $6 billion, according to the people familiar with the talks. That would replace most of the capital Lehman would put into the bad bank. The deal must be structured to guarantee enough cash flow from the mortgages being put into the spun-off entity to repay outside lenders, Reed Smith's Bleier said. That would force Lehman or another bank using the model to disclose much more detail about the mortgages and the securities, he said.
Lehman's $65 billion mortgage-related portfolio has spooked shareholders, driving the stock price down 77 percent this year on concern that the $2.8 billion loss in the second quarter wouldn't end the bleeding. The bigger portion of the portfolio, or $40 billion, is tied to commercial real estate.
Even though defaults of commercial mortgages are still below 1 percent, speculation that delinquencies will jump in that market has pushed down the prices of the bonds backed by commercial real estate loans. By spinning off the mortgages to its own shareholders, Lehman can allow them to benefit from a possible recovery in asset prices when investors realize commercial mortgages aren't going the way of subprime.
"Management's challenge is not that of discarding a troubled portfolio," said David Trone, an analyst at Fox-Pitt Kelton Cochran Caronia Waller. "Instead, management must find a way to relieve pressure on the stock without destroying shareholder value by succumbing to an unwarranted fire sale of commercial mortgages."
Lehman, the largest underwriter of mortgage bonds last year, has been trying to reduce assets linked to that market as demand dried up and prices plummeted, generating more than $8 billion in writedowns and credit losses. BlackRock Inc., the largest publicly traded U.S. money manager, was considering a purchase of some of Lehman's commercial mortgages, people familiar with those discussions said last month.
If talks with the Korean bank fail, Lehman will turn to the other option for raising capital, the people familiar with the firm's plans said. Private-equity firms including Kohlberg Kravis Roberts & Co. and Carlyle Group have been negotiating to buy a stake in Lehman's asset-management business, which includes Neuberger Berman Inc.
Fuld removed his associate of 30 years, President Joseph Gregory, 56, in June and replaced him with Herbert "Bart" McDade, 49, who had run fixed income and equities. Fuld, McDade and other members of the management team are racing to conclude a deal with potential investors before the firm reports earnings this month, people familiar with the situation have said. The company typically announces earnings in mid-September, although last quarter it released preliminary figures a week before schedule.
The mortgage-bond crisis that spread to Lehman escalated in June 2007, when Bear Stearns Cos. began liquidating holdings from one of its hedge funds after losing bets on securities tied to subprime mortgages. Bear Stearns, then the fifth-largest U.S. securities firm, sold itself to JPMorgan Chase & Co. for $10 a share.
Bank of America Seeks to Settle Auction-Rate Accords
Bank of America Corp., the nation's second-largest bank, said it wants to settle state and federal regulatory probes into how it marketed auction-rate securities on terms similar to agreements with other major banks.
"We understood that we had reached such an agreement in principle nearly two weeks ago," spokeswoman Shirley Norton said in statement yesterday. The bank negotiated for almost a month with the U.S. Securities and Exchange Commission and regulators in New York and Massachusetts for a deal that would provide liquidity relief to customers, the statement said.
Citigroup Inc., UBS AG and Goldman Sachs Group Inc. and five other banks settled claims in recent weeks stemming from a nationwide probe into firms that allegedly marketed the securities as about as safe as cash. The brokerages that managed the auctions abandoned the $330 billion market, stranding thousands of investors who could no longer sell the securities at weekly and monthly biddings held to set interest rates.
Bank of America, based in Charlotte, North Carolina, must strike an accord with regulators in Massachusetts or face legal action, Secretary of State William Galvin said Sept. 3. New York Attorney General Andrew Cuomo subpoenaed eight Bank of America executives this week, a person familiar with negotiations said yesterday. The bank fell 7.2 percent yesterday in New York trading.
"I think the underwriters have all recognized they have to settle these cases," John Coffee, a securities law professor at Columbia Law School in New York, said in a telephone interview yesterday. "I don't see many people holding out." Coffee said it was unclear whether high-level executives or brokers were targeted by Cuomo's subpoenas.
"It is possible regulators think some individuals should be responsible," he said, noting the two Credit Suisse Group AG brokers who were criminally charged Sept. 3. "That may ratchet up the pressure." Alex Detrick, a spokesman for Cuomo, said yesterday the Bank of America investigation was continuing. State and federal regulators have investigated the auction-rate market since it fell apart in February.
"We are still seeking answers to certain questions that have arisen as a result of our initial inquiries," Detrick said in an e-mail after Bank of America's statement yesterday that an agreement was worked out in principle. "Hopefully, a settlement will be in reach once we have obtained all the relevant information we are seeking, but we do have an obligation to follow all the evidentiary trails."
Galvin, the 57-year-old Boston-based securities regulator who is leading a 12-state task force investigating Bank of America, said progress has been made. "Getting everyone into a final agreement is a problem," he said in an interview Sept. 3. "I'm not sure it's all Bank of America's fault."
The eight banks that settled agreed to buy back a total of at least $44 billion of the securities from individuals, nonprofits and small businesses and to help their institutional clients find markets for the debt. They also agreed to pay fines totaling more than $520 million to state and federal regulators.
Aside from UBS, Citigroup and Goldman Sachs, settlements were reached with Morgan Stanley, Wachovia Corp., Merrill Lynch & Co., JPMorgan Chase & Co. and Deutsche Bank AG. Cuomo said last month that the settlements with the banks didn't cover conduct by individual executives.
Two former Credit Suisse Group AG brokers were charged Sept. 3 with violating securities laws by fraudulently selling corporate clients subprime mortgages linked to auction-rate securities. Julian Tzolov, 35, and Eric Butler, 36, falsely told clients the products were backed by federally guaranteed student loans and were a safe alternative to bank deposits or money market funds, according to their indictment.
Butler pleaded not guilty to the charges, while Tzolov was said by U.S. Attorney Benton Campbell to be out of the country, though not a fugitive. Tzolov's lawyer declined to comment. Coffee said he didn't think major underwriters would "live or die" on whether one of their brokers gets indicted. "If it's the chief financial officer," he said, "there's certainly pressure there."
Japan Bond Sale to Deepen World's Largest Public Debt
Japan may sell bonds to help pay for a budget overrun for the first time in six years, two Finance Ministry officials said, a sign that the government is failing to contain the world's largest public debt.
The government may issue as much as 500 billion yen ($4.7 billion) of so-called construction bonds to fund some of the extra spending for an economic stimulus package announced last week, the officials told Bloomberg News today on the condition of anonymity.
Selling the bonds will expand a debt burden that the Organization for Economic Cooperation and Development estimates will total 182 percent of gross domestic product in 2008. The ruling Liberal Democratic Party, which needs to pick a new leader after Prime Minister Yasuo Fukuda announced his resignation on Sept. 1, may want to increase spending further to appeal to voters ahead of elections due within a year.
"Construction bonds, deficit-covering bonds, whatever you call it, debt is debt," said Yasunori Kuroda, who helps oversee about $46 billion of assets at Sompo Japan Insurance Inc., the nation's third-largest casualty insurer. "More bond sales will worsen Japan's fiscal health. Toward the election, politicians may call for more spending, loosening Japan's fiscal grip."
LDP Secretary General Taro Aso and Economic and Fiscal Policy Minister Kaoru Yosano are among the candidates to replace Fukuda in what is becoming a battle over Japan's economic future. Aso said last month that the government should consider postponing its goal of balancing the budget by 2011 because the economy is probably in a recession. Yosano, who favors doubling the sales tax to pay for swelling welfare costs, said Aug. 29 the government is "still on track" to meet the budget goal.
Japan has 778 trillion yen of outstanding borrowings, according to the Finance Ministry. Expanding the debt may prompt investors in Japanese government bonds to demand a higher risk premium, said John Richards, head of Asia-Pacific debt-market strategy at RBS Securities Japan Ltd. in Tokyo. "Uncertainty surrounding the fiscal situation is expected to add to the upward pressures to the yields going forward," Richards wrote in a note published Sept. 3.
Japan's economic slowdown has increased demand for government bonds. The government plans to compile a 1.8 trillion yen supplementary budget to help pay for the stimulus package. A second extra budget may be required later this year to pay for possible tax cuts for low-income earners, Finance Minister Bunmei Ibuki said when the measures were announced on Aug. 29.
The government may need to sell more bonds to fund the tax cut later this year should tax revenue fall short of expectations. Revenue was 51 trillion yen in the year ended March 31, less than the government had projected, the Finance Ministry said in July.
"Corporate tax revenue is falling because of worsening corporate profits and household income is slowing," said Susumu Kato, chief economist at Calyon Securities. "Japan has entered a cycle of fiscal expansion." Construction bonds are used to finance public works projects and would cover such measures in the stimulus package as projects to make school buildings more earthquake resistant.
Fukuda said last week that the government won't issue deficit-covering bonds to fund the extra budget. Deficit- covering bonds are used to cover revenue shortfalls.
Market turmoil adds hurdle to KDB-Lehman deal
A wave of financial market turmoil that crashed into South Korea this week has made any deal between Korea Development Bank (KDB) and Lehman Brothers all the more difficult to pull off. Waning confidence in the country's worsening balance of payments has triggered concern about a potential flight of capital from Asia's fourth-largest economy.
The won currency sank as much as 6 percent this week before rising sharply on Friday on suspected intervention; the stock market has dropped 12 percent in five weeks and a Merrill Lynch research report said the central bank may raise interest rates by 0.75 percent over the next three months.
All this comes as state-run KDB pores over a deal with Lehman, a 158-year-old New York brokerage that's seen its shares plunge 75 percent this year, hit by exposure to subprime mortgage securities. With Lehman's market capitalization at $11.7 billion, any big investment by KDB would likely cost several billion dollars and involve loans and other banks. The timing does not look good.
"If you look at the Korea specific context in the current economic environment, there are uncertainties over Korea's external position," said Takahira Ogawa, director of sovereign ratings at Standard & Poor's. "If KDB needs funding, the cost of the funding would be very significant."
Wall Street has proved it can get deals done in good times, and bad. And, given that KDB's CEO is Lehman's former Korea head, a deal between the two cannot be ruled out. But the economic backdrop, and other negative factors lurking, make a link-up look increasingly difficult.
The aversion to risk, of course, is not just a South Korean issue, but a global problem, fed by the credit crisis that sprang from Lehman's hometown just over a year ago. "KDB will have to think real hard about whether Lehman is worth taking the risk," said Choi Doo-nam, an analyst at Prudential Investment & Securities, adding that the market's impact on the deal depends on price.
"If KDB is talking about 6 trillion won ($5.3 billion) for a 25 percent stake," he said, referring to media reports, "I'm not so sure it's worth taking such tremendous market and financial risks."
Government intervention is also a factor. Although KDB is in the process of privatizing, state officials can still weigh in. Like China, South Korea has seen its investments in Wall Street fall fast. Shares of Merrill Lynch have more than halved in value since Korea Investment Corp, a sovereign fund, agreed in January to buy $2 billion worth of new preferred shares in the subprime-hit bank.
"In the middle of privatizing, KDB proposes a major stake in a bank and the subject of the investment is having trouble?" S&P's Ogawa pondered. "I don't think the government will be happy with this stake."
The chances of a deal have not been helped by several Korean banks denying reports they may join KDB in its investment.
Sources told Reuters on Wednesday that HSBC, Europe's biggest bank, isn't likely to make a move either. And neither is China, sources say, given a deal it almost struck with Bear Stearns just before the U.S. bank collapsed. That said, Lehman looks cheap.
"Will KDB have another opportunity to buy a significant stake in such a reputable global investment bank like Lehman?" Prudential's Choi asked. And, some argue, the overall fundamentals of South Korea's economy are sound at the moment.
"Generally, the Korean economy is reasonably resilient, the fundamentals are still pretty strong," said Brayan Lai, a Calyon credit analyst. "A Korean deal is feasible. Obviously price will be the question here." Lai said that while South Korea does face a mini currency crisis, its reserves should provide an adequate buffer.
A veteran banker based in Hong Kong, who did not want to be named due to the sensitivity of the issue, said KDB has eyed buying an investment bank with a global network. While Lehman's roots are in broking, it has a large investment banking franchise that has expanded rapidly in Asia in recent years. Taken overall, however, a possible KDB-Lehman deal has fallen on brutally tough timing.
Just last week, South Korea's Doosan Infracore said it and an affiliate would pump a combined $1 billion into companies set up to buy the Ingersoll-Rand units it agreed to buy in the United States last year. When Doosan announced that $4.9 billion Bobcat deal, the buzz was that Korea was poised for more outbound acquisitions. The $1 billion Doosan just coughed up likely spooked Korean bankers and buyers looking abroad -- KDB included.
China’s Central Bank Is in Need of Capital
China’s central bank is in a bind. It has been on a buying binge in the United States over the last seven years, snapping up roughly $1 trillion worth of Treasury bonds and mortgage-backed debt issued by Fannie Mae and Freddie Mac.
Those investments have been declining sharply in value when converted from dollars into the strong yuan, casting a spotlight on the central bank’s tiny capital base. The bank’s capital, just $3.2 billion, has not grown during the buying spree, despite private warnings from the International Monetary Fund.
Now the central bank needs an infusion of capital. Central banks can, of course, print more money, but that would stoke inflation. Instead, the People’s Bank of China has begun discussions with the finance ministry on ways to shore up its capital, said three people familiar with the discussions who insisted on anonymity because the subject is delicate in China.
The central bank’s predicament has several repercussions. For one, it makes it less likely that China will allow the yuan to continue rising against the dollar, say central banking experts. This could heighten trade tensions with the United States. The Bush administration and many Democrats in Congress have sought a stronger yuan to reduce the competitiveness of Chinese exports and trim the American trade deficit.
The central bank has been the main advocate within China for a stronger yuan. But it now finds itself increasingly beholden to the finance ministry, which has tended to oppose a stronger yuan. As the yuan slips in value, China’s exports gain an edge over the goods of other countries.
The two bureaucracies have been ferocious rivals. Accepting an injection of capital from the finance ministry could reduce the independence of the central bank, said Eswar S. Prasad, the former division chief for China at the International Monetary Fund. “Central banks hate doing that because it puts them more under the thumb of the finance ministry,” he said.
Mr. Prasad said that during his trips to Beijing on behalf of the I.M.F., he had repeatedly cautioned China over the enormous scale of its holdings of American bonds, emphasizing that it left China vulnerable to losses from either a strengthening of the yuan or from a rise in American interest rates. When interest rates rise, the prices of bonds fall.
Officials at the central bank declined to comment, while finance ministry officials did not respond to calls or questions via fax seeking comment. Data in a study by the Bank of International Settlements based in Basel, Switzerland, sometimes called the central bank for central banks, shows that many central banks had small capital bases relative to foreign reserves at the end of 2002, though few were as low as the People’s Bank of China.
Given the poor performance of foreign bonds, the Chinese government could decide to shift some of its foreign exchange reserves into global stock markets. The central bank started making modest purchases of foreign stocks last winter, but has kept almost all of its reserves in bonds, like other central banks.
The finance ministry, however, has pushed for investments in overseas stocks. Last year, it wrested control of the $200 billion China Investment Corporation, which had been bankrolled by the central bank. That corporation’s most publicized move, a $3 billion investment in the Blackstone Group in May of last year, has lost more than 43 percent of its value.
The central bank’s difficulties do not, by themselves, pose a threat to the economy, economists agree. The government has ample resources and is running a budget surplus. Most likely, the finance ministry would simply transfer bonds of other Chinese government agencies to the bank to increase its capital. But even in a country that strongly discourages criticism of its economic policies, hints of dissatisfaction are appearing over China’s foreign investments.
For instance, a Chinese blogger complained last month, “It is as if China has made a gift to the United States Navy of 200 brand new aircraft carriers.” Bankers estimate that $1 trillion of China’s total foreign exchange reserves of $1.8 trillion are in American securities. With aircraft carriers costing up to $5 billion apiece, $1 trillion would, in theory, buy 200 of them.
By buying United States bonds, the Chinese government has been investing a large chunk of the country’s savings in assets earning just 3 percent annually in dollars. And those low returns turn into real declines of about 10 percent a year after factoring in inflation and the yuan’s appreciation against the dollar.
The yuan has risen 21 percent against the dollar since China stopped pegging its currency to the dollar in July 2005. The actual declines in value of the central bank’s various investments are a carefully guarded state secret.
Still China finds itself hemmed in. If it were to curtail its purchases of dollar-denominated securities drastically, the dollar would likely fall and American interest rates could soar.
China spent more than one-eighth of its entire economic output last year on foreign bonds, and then picked up the pace during the first half of this year. Chinese officials have suggested in recent comments that they are increasingly interested in stopping the yuan’s rise, and thus are willing to continue buying foreign securities to support the dollar.
In fact, the yuan weakened slightly against the dollar last month after 26 consecutive months of gains. Along with Treasuries, China has invested heavily in mortgage-backed bonds from Fannie Mae and Freddie Mac, the struggling mortgage finance giants that are sponsored by the United States government. Standard & Poor’s estimates China’s holdings at $340 billion.
Some bond traders suspect that the central bank has scaled back its purchases of these securities, as have China’s commercial banks. But the central bank trades this debt through many third parties in many countries, making its activity opaque to outside analysts.
The central bank has gone to great lengths to maintain its foreign purchases. The money to buy foreign bonds has come from the reserves required that commercial banks must deposit with the central bank. In effect, China’s commercial banks have been lending the central bank more than $1 trillion at an interest rate of less than 2 percent.
To keep the banks strong when they were getting such little interest on their reserves, the central bank has kept deposit rates low. The gap between what banks are paying on deposits and the rates they are charging ordinary customers to borrow is several percentage points. This amounts to a transfer of wealth from ordinary Chinese savers to the central bank and on to Americans who are selling their debt to the Chinese.
The central bank is now under considerable pressure to reduce the commercial banks’ reserve requirements to encourage growth as the Chinese economy shows signs of slowing. Victor Shih, a specialist in Chinese central banking at Northwestern University, said that when he visited the People’s Bank of China for a series of meetings this summer, he was surprised by how many officials resented the institution’s losses.
He said the officials blamed the United States and believed the controversial assertions set forth in the book “Currency War,” a Chinese best seller published a year ago. The book suggests that the United States deliberately lured China into buying its securities knowing that they would later plunge in value. “A lot of policy makers in China, at least midlevel policy makers, believe this,” Mr. Shih said.
Brazil, Russia, India and China Bubble On Verge Of Collapse
After a dizzying expansion, the BRIC bubble appears ready to burst. Share prices in Brazil, Russia, India and China -- the so-called BRICs -- have been declining sharply because of the global credit crunch and military tensions, likely forcing Japanese retail investors to change their investment strategies.
In the past year, the Shanghai A-Share index has plunged 60%, India's Sensex index 33%, Russia's RTS index 32% and Brazil's Bovespa Index 25%. These falls were triggered by the global credit crunch that stems from the subprime loan problem in the U.S. Investment funds that have suffered losses have been withdrawing their money from these emerging economies.
These nations also face the risk of inflation due to high growth, abundance of money flows and higher prices of natural resources. As a result, their central banks have tightened their monetary policies, spurring a decline in asset prices. However, there are greater issues than these economic problems. The BRICs now face increasing country risks that existed long before their recent economic ascendency.
India, for example, has seen a wave of terrorist attacks since the beginning of this year. Bombings occurred in Jaipur in May and in Bangalore and Ahmedabad in July. They stem from Hindu-Islamic religious conflicts, and the situation shows no signs of improvement.
On top of this, Pervez Musharraf resigned as president in neighboring Pakistan. The upshot of this is that hard-line Islamists are likely to gain more power there, and it remains to be seen whether the nation can maintain a pro-American government. There is a possibility that Pakistan, a nuclear power, may be governed by an anti-American Islamic administration for the first time.
This is relevant to neighboring India because in wooing investors, it has stressed that its conflict with Pakistan did not influence its economy. Yet the current situation has forced investors to take a harder look at the risk that this basic framework may erode.
Russia has lost much of its attraction as an investment destination because of its ongoing conflict with Georgia. If Russia were only plagued with the issue of Chechen independence, the nation's economy would probably remain largely untouched. However, if an all-out confrontation with Georgia and ensuing cold war with the U.S. becomes a possibility, then an optimistic forecast for Russia's economic growth will be out of the question.
China faces a major obstacle because of the eruption of ethnic problems, which have been brought to the world's attention because of the Beijing Olympics. Riots in Lhasa have thrust a spotlight on the issue of greater autonomy in Tibet, and terrorist bombings in the Xinjiang Uighur Autonomous Region of Western China coincided with the Olympics.
As China's economy has grown, economic disparities have widened between the coastal and inland areas. Anti-government movements in the poverty-stricken Tibet and Xinjiang Uighur regions have intensified because the issues of economic disparity and ethnicity have become intertwined.
Whether Beijing adapts conciliatory measures or suppresses the anti-government movements, China's economic growth will not immediately stop. However, China has about 100 million people who do not belong to the dominant Han ethnic group, and the independence movements may gain more momentum, depending on the situation.
Brazil is comparatively stable among the BRICs. There are now no major conflicts or independence movements that may change the course of the nation. The BRIC boom started around 2004 in Japan. Asset management firms have established mutual funds investing in BRIC nations one after the other and sold them through banks and securities firms.
India-related funds were particularly popular. At their peak, mutual funds from Japan accounted for more than 30% of inward investment in India in terms of value. Japan money supported India's growth, and this growth has in turn further fueled interest in India among individual investors. Repercussions from the declines in share prices in the BRICs are thus no small matter.
These economies still have a large potential for growth when considering only economic factors. Funds investing in them aim at long-term growth. Some argue that investors should not be moved between hope and despair by short-term fluctuations in share prices. Optimistic security firms recommend buying BRIC-related products that have seen price declines.
Nonetheless, can one dismiss recent military, religious and ethnic conflicts as temporary issues? Is there any guarantee that no major conflicts will erupt? For those who have invested without considering country risks stemming from the above-mentioned issues, the declines in BRIC-related shares provide good a opportunity to reconsider their investments.
UK power breakdowns spark National Grid crisis
The crumbling state of Britain’s electricity network was exposed yesterday when power station breakdowns caused the first energy shortage of the autumn.
National Grid was forced to call for more power from electricity generators after a series of unexpected breakdowns left the company with an insufficient safety cushion. The company, which operates the electricity lines across Britain, requires a safety cushion of between 2,000 and 4,000 megawatts above peak demand. When it fell short yesterday, power suppliers were asked to bring all their available generating capacity online, including expensive oil-fired units.
The move came as Gordon Brown vowed to end the “dictatorship of oil” with a billion-pound plan to boost renewable energy supplies and make Britain more energy-efficient. In a speech to the Scottish CBI, the Prime Minister renewed his call for greater energy independence, saying that the fluctuating cost of oil — which hit $147 a barrel in July — is harming the economy.
“Today I set a new ambition, to free Britain from the dictatorship of oil,” he declared, announcing a new wind farm off Barrow-in-Furness, Cumbria, and a pilot scheme for electric cars. His statement echoed a pledge last week by Barack Obama, the American Democratic presidential candidate, who said that he wanted to end America’s dependence on Middle Eastern oil within ten years.
Mr Brown said: “A low-carbon society will not emerge from business as usual. It will require new thinking and new technologies, new forms of economic activity and social organisation, new forms of consumer behaviour and lifestyles and your creativity, innovation and entrepreneurship to unlock the talents and skills of UK companies.” The statement came as the Government confirmed that it had been forced to abandon plans for families to receive a £50-£100 payment to help them with fuel bills this winter.
The Times revealed yesterday that plans to fund the £500 million scheme — to raise money from the energy companies by auctioning more carbon permits — had been scuppered by the European Union. The revelation underscores the difficulty that ministers have faced with their attempts to help families through the economic downturn.
Other measures to alleviate fuel poverty, which form part of the Prime Minister’s economic recovery package, have been delayed twice and are expected at the end of next week. However, Mr Brown did promise “targeted support” for families when the package is published.
Analysts yesterday expressed concern about the state of the electricity generating infrastructure. It has been described as “crumbling” and “inadequate” for 21st-century use and the industry estimates that it will need to spend £100 billion building a new generation of power stations. David Porter, chief executive of the Association of Electricity Producers, said: “We are reaching a point where we will have to spend more on infrastructure than has ever been done before in this country.”
The problems were caused by a loss of power because of breakdowns over the past two days. Some of the plants that experienced problems included British Energy’s Eggborough power station, Drax and E.ON’s Kingsnorth and Killinghome stations. Britain’s power capacity is generally reduced during the summer for maintenance, which exacerbated yesterday’s problems.
Most companies do not return to full generating capacity until after the clocks are turned back an hour in the autumn.
— A radical plan for hospitals, councils and other public sector bodies to purchase bulk oil collectively on the futures market is being proposed by one of England’s largest local authorities. In an attempt to cope with rising energy costs, Kent County Council has written to ask if they would be willing to join forces to buy fuel. A meeting of local authorities will take place next month to discuss the plan.