Nashville, Tennessee. Battle of Nashville.
Spectators watching the fight between generals Hood and Thomas
Ilargi: With the Dow Jones safely tucked in back down below 9000, and European exchanges losing 7% on average, the positive overall global effect of an unprecedented transfer of public funds to the private sector, to the tune of some $4.5 trillion, has lasted about a day and a half.
The $4.5 trillion could have been used to the benefit of the people it rightfully belongs to, the same people who will soon desperately need every singly penny of it. Instead, it has been given away, and is now no longer available to help in what is cynically called "the real economy".
And that is where the reason for today’s plunging stocks lies: the real economy, in the real world, where the real people live. Unfortunately for them, financial decisions are all taken by those who live in other universes, for whom the real world has no meaning without the world of finance, who are under the illusion that their multi-million bonuses exist for the good of the people.
A nice way of putting it is this: “If you spent $1 million per day from the day Jesus was born until Christmas 2008, you would have spent $733 billion”. In other words, you could have spent a million a day for 12.000 years, and still not get to the amount spent in the past 5 days.
Did anyone notice that the cost of the hotly contested US rescue bail-out just tripled? "In addition to the capital infusions, which will be made this week, the government said it would temporarily guarantee $1.5 trillion in new senior debt issued by banks, as well as insure $500 billion in deposits in noninterest-bearing accounts .. All told, the potential cost to the government of the latest bailout package comes to $2.25 trillion"
There are no limits anymore to the spending of your money, and don't you forget it. There are a lot of stories today about how Paulson and Bernanke forced the first $250 billion in bail-outs on the banks, and about how Paulson cannot force those same banks to use the funds to increase lending.
I think by now it should be obvious that Paulson never meant to increase lending. After all, who’s left to lend it to? The entire US population is overstretched, overdrawn and underwater, and that while home prices are falling like bricks, retail spending plunges, and unemployment rises. Why would any bank want to lend out money to these people, and why would they want to borrow even more? That game is long over.
The same picture, by the way, can be seen in the UK, and soon the rest of Europe. Trillions of dollars are pumped into banks, and no, believe me, they will never come out again. None of the countries, and their plans, that I have read about to date, have any provisions to address the core of the problem: extremely leveraged positions, of the institutions that receive the trillions, in paper that is worth zero or less, as well as extremely out-of-whack housing prices.
The value of the paper is carefully hidden, and simultaneously the delusion persists that home values will stop going down. Forgive me for not believing that Paulson, Bernanke et al are under that delusion. Nor the one that claims that the banking crisis will soon calm down. They just want power, and planting these delusions helps them get it.
David Blanchflower, a highly respected British government economist, and a lone voice in a dry desert, today corrects his earlier prediction of 2 million unemployed in the UK by Christmas: he now says the number will be much higher. Look for similar developments on a global level: welcome to the real economy, and the real people.
The US Treasury and Fed are considering lending to companies directly, and no doubt EU governments will follow the lead. But none of this has any chance of success. Companies need customers. And the customers are broke. Even if banks could somehow be forced to lend to customers, these would either refuse to borrow even more, or get even deeper in debt.
In the US, more parties are showing up at the trough every day. The carmakers want to be part of the Paulson plan, the FDIC will soon need massive infusions now it covers all new bank debt, and the separate states, California first, need billions to douse the flames of going broke, while the precipitous drop in tax revenues hasn’t even started in earnest.
They will all try to do what Iceland and Ireland announced: raise tax levels. I said as early as two years ago that this would happen, and added that raising taxes on people who are getting poorer and losing their jobs, is a very bad idea, especially if they know where you live. There will be a lot of pink slips for government workers under the Christmas trees this year.
Also in the real world, trade itself is increasingly in danger. "The Baltic Dry shipping index, a proxy for world trade flows, suffered its second biggest-ever fall yesterday, to 11%, which took it down under the $2,000 mark and it fell another 8% today to $1,809. The drop means it has fallen more than 80% since July's peak of around $12,000 and is now at a three-year low." Translation: there will be a lot less goods on the shelves in your neighborhood stores, and a lot less raw materials to process in your factories.
The last weapons left are central bank rate cuts, and of course, more trillions in rescues. At this pace, we’ll see them this week. Somebody may yet be rescued, but it won't be you. You’ll be the one paying for it.
Update 4.30 PM EDT
The Dow Jones today lost 7.87%,
the BIGGEST PERCENTUAL LOSS SINCE 1987
Two days after a euphoria induced by $4.5 trillion wealth transfer from you to "them". What will be the cost of the next euphoria?
Am I getting through to people by now? Or do you think it will all be all right tomorrow?
The Dow has gone from 14.000 to 8700, in one year. Have you thought about what would have to happen to bring it back up? People are prone to "magical thinking". But the Dow is lower than it has been in ages, while you, the people, have just spent trillions of dollars to keep it up. For one day.
Think about what you think the next step will be. Think about what you think it will take to stop the bleeding, about how much you think you have left in your wallet to try and prop up the banks, instead of taking care yourself and your family.
ECB Leads Push to Flood Banks With Unlimited Dollars
The European Central Bank, Bank of England and Swiss National Bank loaned financial institutions a combined $254 billion in their first tenders of unlimited dollar funds, stepping up efforts to ease strains in markets. The Frankfurt-based ECB lent banks $170.9 billion for seven days at a fixed rate of 2.277 percent. The Bank of England allotted $76.3 billion and the Swiss central bank $7.1 billion at the same rate, also for a week.
Policy makers are trying to unfreeze credit markets and get banks lending to each other again after a crisis of confidence culminated last week in the biggest stock-market sell-off since 1933, threatening to tip the world into a recession. Money-market rates have started to decline, suggesting the measures may be working.
The London interbank offered rate, or Libor, that banks charge each other for three-month loans in dollars fell 9 basis points to 4.55 percent today, according to the British Bankers' Association. It was its third consecutive decline. Asian money-market rates fell earlier today after the Bank of Japan said it will also offer unlimited dollar funds, with its first tender to be held on Oct. 21, and Hong Kong agreed to guarantee all bank deposits.
In the U.S., the government has earmarked $250 billion to purchase stakes in the nation's largest financial companies including Goldman Sachs Group Inc. to prevent a banking collapse. The U.K. is spending 50 billion pounds ($87 billion) on bank stakes, while France, Germany, Spain, the Netherlands and Austria have pledged 1.3 trillion euros to shore up their banking systems.
"There is no quick fix, confidence is gone and it will take quite a while for it to return," said Thorsten Polleit, an economist at Barclays Capital in Frankfurt. "I doubt that things will get back to where they were before the crisis." The bankruptcy of New York-based Lehman Brothers Holdings Inc. last month precipitated the latest chapter of the 14-month crisis, causing banks to stop lending to each other out of concern they may not get their money back.
The world's largest financial companies have posted more than $635 billion in writedowns and credit losses since the start of last year after the U.S. housing market slumped. The ECB, Bank of England and SNB on Oct. 8 joined the U.S. Federal Reserve in a global round of coordinated interest-rate cuts as the economic outlook deteriorated. The Fed announced on Oct. 13 that the world's largest central banks would offer unlimited dollar loans with maturities of seven days, 28 days and 84 days. All of the previous dollar swap arrangements between the Fed and other central banks were capped.
European leaders meet today in Brussels to discuss the next steps in responding to the market meltdown. "When a fire's burning in the global financial markets, it has to be put out, even if it's a case of arson," German Finance Minister Peer Steinbrueck said in Brussels today. "But then the arsonists have to be held responsible and spreading the flames must be outlawed."
Roubini Sees Worst Recession in 40 Years
Nouriel Roubini, the professor who predicted the financial crisis in 2006, said the U.S. will suffer its worst recession in 40 years, driving the stock market lower after it rallied the most in seven decades yesterday.
"There are significant downside risks still to the market and the economy," Roubini, 50, a New York University professor of economics, said in an interview with Bloomberg Television. "We're going to be surprised by the severity of the recession and the severity of the financial losses."
The economist said the recession will last 18 to 24 months, pushing unemployment to 9 percent, and already depressed home prices will fall another 15 percent. The U.S. government will need to double its purchase of bank stakes and force lenders to eliminate dividends to save them from bankruptcy, Roubini added.
Treasury Secretary Henry Paulson said today he plans to use $250 billion of taxpayer funds to purchase equity in thousands of financial firms to halt a credit freeze that threatened to drive companies into bankruptcy and eliminate jobs. "This will be the first round of recapitalization of the banks," Roubini said. "The government has to decide to intervene much more directly in the provision of credit and the management of these companies."
The Standard & Poor's 500 Index rallied the most since 1933 yesterday, rising 12 percent, on the government plan to buy stakes in banks and a Federal Reserve-led push to flood the global financial system with dollars. The S&P 500, which has fallen 36 percent since its October 2007 record, dropped 0.5 percent today. "The stock market is going to stop rallying soon enough when they see the economy is really tanking," Roubini added.
The U.S. unemployment rate stood at a five-year high of 6.1 percent last month. Home prices in 20 U.S. metropolitan areas fell 16 percent in July from a year earlier, the most since records began in 2001, according to the S&P/Case-Shiller home- price index. Bank seizures may push home prices down further, scaring away buyers in coming months, after U.S. foreclosures rose at the fastest rate in almost three decades in the second quarter, according to the Mortgage Bankers Association.
Roubini said total credit losses resulting from the meltdown of the subprime mortgage market will be "closer to $3 trillion," up from his previous estimate of $1 trillion to $2 trillion. The International Monetary Fund estimated $1.4 trillion on Oct. 7. Financial firms have so far reported $637 billion in losses, according to data compiled by Bloomberg.
Paulson Lacks Leverage to Compel Banks to Put New Cash to Work
Treasury Secretary Henry Paulson persuaded nine major U.S. banks to accept $125 billion in government investment. Getting them to lend it out may prove a tougher sell.
The equity stakes the government is purchasing in Citigroup Inc., Morgan Stanley and seven other big institutions come with no guarantee that the investments will spur lending and unfreeze credit markets. Nor do they give the government board seats or any other leverage to demand that that the firms actually use the money to help the economy.
"The truth of the matter is, they can't put a gun to their head and say you have to lend this money," said Charles Horn, a former official at the Office of the Comptroller of the Currency, part of the Treasury Department, and now a partner at the Mayer Brown law firm in Washington.
Treasury officials acknowledge they can't force banks to get the taxpayer money into the hands of their customers. Instead, officials are betting that the government's investment will create conditions where banks have a greater incentive to earn profits from lending than to hoard money to shore up their balance sheets.
"It's in their economic interest," said David Nason, the Treasury's assistant secretary for financial institutions, in an interview with Bloomberg Television. "When you give them a stronger capital position and you also provide a certain amount of government backstop to their funding sources, it's incumbent upon them to go out and continue to lend."
Tim Ryan, head of the Securities Industry and Financial Markets Association and a former bank regulator, said the sheer scale of the capital infusion banks are receiving is in itself a powerful incentive to put the funds to work in the economy. "The bully pulpit doesn't really work with banks, but capital does," said Ryan, who directed the U.S. Office of Thrift Supervision in 1990-1992. The government is providing banks with "quite a war chest that they were not expecting," Ryan said. "They need to put it to work. The only way you put it to work is to lend."
The Bush administration's rescue, part of a $700 billion bailout passed by Congress this month, is raising questions about what role the federal government will play as it becomes a leading investor in the financial sector. Already, companies that accept the taxpayer money are required to submit to restrictions on their top executives' pay.
"Obviously there is a danger" of increased government involvement in banks' corporate affairs, said Martin Baily, a senior fellow at the Brookings Institution in Washington and former chairman of the Council of Economic Advisers under President Bill Clinton. Still, Baily said that the equity purchases are set up to minimize government intervention. Treasury has "been telling these institutions what to do in the last couple months, so they've exercised a good bit of control," Baily added. "I think they'd like to get out of that business."
The Bush administration is counting on agencies that already regulate the banks, such as the Federal Reserve, to keep an eye on daily operations. Those agencies can encourage firms to keep credit flowing to businesses and households. "The regulators can do a lot to give the signals to the bank," said finance professor Len Rushfield of Pepperdine University in Los Angeles.
Even so, subtle government pressure on banks may not make much difference. Unlike with the recent federal takeovers of Fannie Mae, Freddie Mac and insurer American International Group Inc., the U.S. won't take a major share of the banks they invest in. Also, the Treasury has said it won't seek voting rights when it buys stakes. The Treasury said it would dedicate $250 billion to boost bank capital through preferred stock purchases. Bank regulators estimated yesterday that "thousands" of financial companies would participate, although the program will begin with the nine big banks.
"What you'll see most large institutions saying is, `We will certainly listen to the government but our decisions are what's in the best interest of our shareholders,"' said John Coffee, a securities law professor at Columbia University. Financial companies that accept government investments also are counting on Paulson's pro-market philosophy to keep the government out of their boardrooms. The secretary, announcing the capital injections yesterday, said that he regretted having to make such a move.
"Government owning a stake in any private U.S. company is objectionable to most Americans -- me included," he said. "Yet the alternative of leaving businesses and consumers without access to financing is totally unacceptable." Bank executives know that the Treasury and members of Congress are going to monitor the situation, said Scott Talbott, chief lobbyist for the Financial Services Roundtable. "Policy makers will watch closely to insure that the money is used for credit," he said.
The one unknown that makes Wall Street nervous, several industry executives said, is what the next Treasury secretary will do. The U.S. presidential election is less than a month away. "You'd probably want to have Hank Paulson, more than a lot of other people" overseeing the bailout, said Edward Fleischman, a Republican Securities and Exchange Commissioner from 1986 to 1992, and now a senior counsel at the Linklaters law firm in New York. "But you're not going to have any choice who takes his job."
Drama Behind a $250 Billion Banking Deal
The chief executives of the nine largest banks in the United States trooped into a gilded conference room at the Treasury Department at 3 p.m. Monday. To their astonishment, they were each handed a one-page document that said they agreed to sell shares to the government, then Treasury Secretary Henry M. Paulson Jr. said they must sign it before they left.
The chairman of JPMorgan Chase, Jamie Dimon, was receptive, saying he thought the deal looked pretty good once he ran the numbers through his head. The chairman of Wells Fargo, Richard M. Kovacevich, protested strongly that, unlike his New York rivals, his bank was not in trouble because of investments in exotic mortgages, and did not need a bailout, according to people briefed on the meeting.
But by 6:30, all nine chief executives had signed — setting in motion the largest government intervention in the American banking system since the Depression and retreating from the rescue plan Mr. Paulson had fought so hard to get through Congress only two weeks earlier. What happened during those three and a half hours is a story of high drama and brief conflict, followed by acquiescence by the bankers, who felt they had little choice but to go along with the Treasury plan to inject $250 billion of capital into thousands of banks — starting with theirs.
Mr. Paulson announced the plan Tuesday, saying “we regret having to take these actions.” Pouring billions in public money into the banks, he said, was “objectionable,” but unavoidable to restore confidence in the markets and persuade the banks to start lending again. In addition to the capital infusions, which will be made this week, the government said it would temporarily guarantee $1.5 trillion in new senior debt issued by banks, as well as insure $500 billion in deposits in noninterest-bearing accounts, mainly used by businesses.
All told, the potential cost to the government of the latest bailout package comes to $2.25 trillion, triple the size of the original $700 billion rescue package, which centered on buying distressed assets from banks. The latest show of government firepower is an abrupt about-face for Mr. Paulson, who just days earlier was discouraging the idea of capital injections for banks.
Analysts say the United States was forced to shift policy in part because Britain and other European countries announced plans to recapitalize their banks and backstop bank lending. But unlike in Britain, the Treasury secretary presented his plan as an offer the banks could not refuse. “It was a take it or take it offer,” said one person who was briefed on the meeting, speaking on condition of anonymity because the discussions were private. “Everyone knew there was only one answer.”
Getting to that point, however, necessitated sometimes tense exchanges between Mr. Paulson, a onetime chairman of Goldman Sachs, and his former colleagues and competitors, who sat across a dark wood table from him, sipping coffee and Cokes under a soaring rose and sage green ceiling. This account is based on interviews with government officials and bank executives who attended the meeting or were briefed on it.
Mr. Paulson began calling the bankers personally Sunday afternoon. Some were already in Washington for a meeting of the International Monetary Fund. The executives did not have an inkling of Mr. Paulson’s plans. Some speculated that he would brief them about the government’s latest bailout program, or perhaps sound them out about a voluntary initiative. No one expected him to present his plan as an ultimatum.
Mr. Paulson, according to his own account, presented his case in blunt terms. The nation’s largest banks needed to begin lending to each other for the good of the financial system, he said in a telephone interview, recalling his remarks. To do that, they needed to be better capitalized. “I don’t think there was any banker in that room who was going to look us in the eye and say they had too much capital,” Mr. Paulson said. “In a relatively short period of time, people came on board.”
Indeed, several of the banks represented in the room are in need of capital. And analysts said the terms of the government’s investment are attractive for the banks, certainly compared with the terms that Warren E. Buffett extracted from Goldman Sachs for his $5 billion investment. The Treasury will receive preferred shares that pay a 5 percent dividend, rising to 9 percent after five years. It will get warrants to purchase common shares, equivalent to 15 percent of its initial investment. But the Treasury said it would not exercise its right to vote those common shares.
The terms, officials said, were devised so as not to be punitive. The rising dividend and the warrants are meant to give banks an incentive to raise private capital and buy out the government after a few years. Still, it took some cajoling. Mr. Kovacevich of Wells Fargo objected that his bank, based in San Francisco, had avoided the mortgage-related woes of its Wall Street rivals. He said the investment could come at the expense of his shareholders.
Mr. Kovacevich is also said to have expressed concern about restrictions on executive compensation at banks that receive capital injections. If he steps down from Wells Fargo after completing a planned takeover of Wachovia, he would be entitled to retirement benefits worth about $43 million, and $140 million in accumulated stock and options, according to James F. Reda & Associates, a executive pay consulting firm. Pay experts say the new Treasury limits would probably not affect his exit package.
Kenneth D. Lewis, the chairman of Bank of America, also pushed back, saying his bank had just raised $10 billion on its own. Later, Mr. Lewis urged his colleagues not to quibble with the plan’s restrictions on executive compensation for the top executives. These include a ban on the payment of golden parachutes, repayment of any bonus based on earnings that prove to be inaccurate, and a limit of $500,000 on the tax deductibility of salaries. If we let executive compensation block this, “we are out of our minds,” he said, according to a person briefed on the meeting.
In an interview on Monday, before the meeting, John J. Mack said his bank, Morgan Stanley, did not need capital from the Treasury. It had just sealed a $9 billion deal with a large Japanese bank. During the meeting, Mr. Mack, Morgan Stanley’s chief executive, said little, according to participants. Mr. Paulson, however, was peppered with questions about the terms of the investment by other chief executives with experience in deal-making: Lloyd C. Blankfein of Goldman Sachs, Vikram S. Pandit of Citigroup, John A. Thain of Merrill Lynch and Mr. Dimon.
Among their concerns were: How would the government’s stake affect other preferred shareholders? Would the Treasury Department demand some control over management in return for the capital? How would the warrants work? With the discussion becoming heated, the chairman of the Federal Reserve, Ben S. Bernanke, who was seated next to Mr. Paulson, interceded. He told the bankers that the session need not be combative, since both the banks and the broader economy stood to benefit from the program. Without such measures, he added, the situation of even healthy banks could deteriorate.
The president of the Federal Reserve Bank of New York, Timothy F. Geithner, then proceeded to outline the details of the investment program. When the bankers heard the amount of money the government planned to invest, they were stunned by its size, according to several people. As they heard more of the details, some of the bankers began to realize how attractive the program was for them.
Even as they insisted that they did not need the money, bankers recognized that the extra capital could be helpful if the economy became shakier. Besides, many of these banks’ biggest businesses are tied to the stock and credit markets; the quicker they improve, the better their results. Later, Mr. Pandit told colleagues that the investment would give Citigroup more flexibility to borrow and lend. Mr. Dimon told colleagues he believed the relatively cheap capital was a fair deal for his bank. Mr. Lewis said he recognized the prospects of his bank were closely aligned with the American economy.
Mr. Thain was intrigued by the terms of the guarantee by the Federal Deposit Insurance Corporation on new senior debt issued by banks, participants said. He mentally calculated the maturities on debt issued by Merrill Lynch, to determine how the program could benefit his bank. For Mr. Paulson, selling the bankers on capital injections may not have been as difficult as overhauling a rescue program that had originally focused on asset purchases from banks. In the interview, Mr. Paulson said the worsening conditions made a change in focus imperative.
“I’ve always said to everyone that ever worked for me, if you get too dug in on a position, the facts change, and you don’t change to adapt to the facts, you will never be successful,” he said in the interview. Mr. Paulson insisted that purchases of distressed assets would remain a big part of the program. But having allocated $250 billion to direct investments, the Treasury has only $100 billion left from its initial allotment of $350 billion from Congress to spend on those purchases.
As the meeting wound down, participants said, the bankers focused more on contacting their boards before signing the agreement with the Treasury Department. With time running short and private space limited, some of the bankers left the Treasury building, heading for their limousines while speaking urgently into cellphones. “I don’t think we need to be talking about this a whole lot more,” Mr. Lewis said, according to a person briefed on the meeting. “We all know that we are going to sign.”
US Auto Lenders Aim To Be Part Of Federal Reserve Plan
Automobile-finance companies pushed hard to get in on the government's $700 billion financial rescue plan. Now, with the industry's troubles expected to deepen, they are exploring further moves, including help from the Federal Reserve. The plan outlined by the U.S. central bank Tuesday to effectively lend to companies to fund day-to-day operations will likely not include most auto lenders.
That's because the plan, which would involve Fed purchases of short- term debt known as commercial paper, calls for lending to companies with higher credit ratings. A lobbyist for U.S. auto-finance companies said industry officials are discussing whether to approach the central bank about expanding the program, titled the Commercial Paper Funding Facility, to include auto lenders, whose access to credit has become further restricted amid upheaval in the markets.
"We're hopeful that the Fed will consider purchases of other levels of commercial paper as well," said Chris Stinebert, president and chief executive officer of the American Financial Services Association. "There's a real lack of liquidity." A Federal Reserve spokesman declined to comment on any efforts by the auto industry to seek help from the central bank.
In a sign of the auto-finance industry's troubles, GMAC, partly owned by General Motors Corp) said on Monday it would restrict car loans to U.S. consumers with credit scores of 700 and above. Auto lenders play a critical role because they finance the purchase of cars by both dealers and consumers. But they are facing a growing crisis from many sides, including the freezing of credit markets and the broader economic downturn.
They are becoming increasingly leveraged because of their inability to sell securities backed by auto loans. One factor is that many of these loans are for SUVs and trucks, whose values have declined as consumers turn to smaller vehicles amid high gas prices. But auto lenders say they are suffering more from a general tightening of credit markets than bad assets. "They're just caught in this cycle they didn't create," Stinebert said. He maintained that qualified consumers will still have no problems purchasing cars, but that the markets "continue to tighten."
Congressional leaders have said in recent weeks that auto companies and their lending arms will be eligible for the $700 billion Wall Street rescue plan, which will involve the government's purchasing troubled assets. The plan originally targeted bad home loans but auto-finance companies were among other liquidity-starved businesses who successfully lobbied to be included in the plan. Last month, House Financial Services Chairman Barney Frank D-Mass., responding to a question from Rep. John Dingell, D-Mich., said he would support action from the Federal Reserve to help the auto-finance industry in unusual and exigent circumstances.
The Fed has authority to lend to nonfinancial companies and recently used that authority for American International Group Inc. (AIG) and certain parts of the commercial paper market. Both cases, however, involved broader systemic concerns about the financial system and overall economy.
Blankfein's $70 Million Payday Would Survive Paulson's Limits
Goldman Sachs Group Inc.'s Lloyd Blankfein, whose $70.3 million paycheck made him Wall Street's most highly compensated chief executive officer last year, could still earn tens of millions annually under the bank-rescue plan run by his former boss, Treasury Secretary Henry Paulson.
Executive-pay packages will be restricted for the nine banks receiving a $125 billion infusion of U.S. funds to restart lending, said Paulson, who earned $37.8 million in 2005, his last full year as Goldman's CEO. The investment is part of a $700 billion bailout plan approved by Congress this month. Blankfein, 54, was Wall Street's best-paid CEO in 2007, according to data compiled by Bloomberg. He "could still make tens of millions of dollars if he continues to receive stock grants and Goldman's stock rises," said David Schmidt, a senior consultant for New York-based compensation firm James F. Reda & Associates.
Concerns over public reaction will likely prevent the bank from maintaining the CEO's compensation at last year's level, Schmidt said. Goldman Sachs rose 11 percent to $122.90 yesterday in New York Stock Exchange composite trading. The shares have fallen 43 percent this year. Paulson, who now earns $191,300 annually, is limiting corporate-tax deductions on compensation to the CEO, chief financial officer and the next three highest-paid executives of participating banks to $500,000. While performance-related pay over $1 million has been tax- deductible, companies were able to write off only $1 million of salary since 1993.
As a result, bankers' salaries were often set beneath the $1 million cap. Blankfein's was $600,000 last year, with the rest of his package coming in incentive compensation and services, including a car and driver, according to regulatory filings. Goldman Sachs spokesman Michael DuVally declined to comment.
"This is the first time in American history that the federal government has applied restrictions on the compensation that goes to top executives," House Financial Services Committee Chairman Barney Frank said in a statement. "We will be watching how the Treasury implements these important provisions to ensure that the restrictions are binding and enforceable." The Treasury's stock-buying program will begin with nine banks, which the agency didn't name. People briefed on the matter said $125 billion will be disbursed in days.
Excessive executive compensation is a "legitimate complaint" that needs to be addressed, JPMorgan CEO Jamie Dimon said at Harvard Business School in Boston yesterday. "There were people who made a lot of money who didn't deserve it. That's a fact," said Dimon, 52, who was paid a $1 million salary and total compensation of $27.8 million last year, according to a regulatory filing.
"I don't think there's anything in these rules that will affect their pay," said Sarah Anderson, a director at the Institute for Policy Studies, a Washington-based research group backed by Democrats. Companies will likely maintain current compensation levels and "just take the hit on the tax bill," she said.
For banks that are losing money "and not paying any taxes, this will not be an issue," said Dean Baker, co-director for the Center on Economic and Policy Research, a Washington-based research group. Citigroup, the biggest U.S. bank by assets, had a second-quarter net loss of $2.5 billion, or 54 cents a share. It's forecast to lose $1.77 a share for the full year, according to a Bloomberg survey of eight analysts.
Paulson, 62, will bar companies participating in the stock- purchase program and Treasury purchases of toxic bank assets from offering so-called golden parachutes. Severance of more than three times an executive's base pay won't be tax-deductible for the company, and the recipient will be subject to an extra 20 percent tax on the money, according to the Treasury.
Measures such as the golden-parachute provision are meant to protect the government in its role as the banks' business partner, said Nell Minow, editor of Corporate Library, a Portland, Maine-based corporate-governance research firm.
Congress is likely to "revisit the issue as we better understand" what led to the financial crisis, Minow said. The government will be able to retrieve bonuses and incentive pay that executives already received "based on statements of earnings, gains, or other criteria that are later proven to be materially inaccurate," the Treasury said in a statement today.
Such clawback provisions would be more effective if they were "applied to performance of the company in the medium- and long-term, not a material inaccuracy," said David Lewin, a professor at the UCLA Anderson School of Management. U.K. Prime Minister Gordon Brown on Oct. 13 won promises from Royal Bank of Scotland Group Plc, HBOS Plc and Lloyds TSB Group Plc to lend more at lower rates and stop paying dividends in return for a 37 billion-pound ($64 billion) rescue. Chancellor of the Exchequer Alistair Darling said he wants to cut the bonuses of top executives who led their banks into trouble.
German Finance Minister Peer Steinbrueck, whose government will provide as much as 500 billion euros to banks through capital injections and loan guarantees, wants executive pay to be limited to 500,000 euros ($678,300) annually, he said in Berlin yesterday. Managers should receive "no bonuses, no severance pay during this time and no dividends," he said.
EU in hurry to discard mark-to-market accounting
The European commission is set to propose that depositors are refunded within three days if an EU bank fails, senior officials indicated today.
The commission, adopting revisions to deposit guarantee schemes approved by EU finance ministers last week, will also propose raising the minimum payout to €50,000 (£39,000) immediately — and to €100,000 by the end of 2009. EU banks would be allowed to avoid excessive writedowns of troublesome assets and revalue them under a separate EC proposal to change accounting rules due tomorrow.
The proposed changes, part of a self-styled co-ordinated EU approach to the financial turmoil, were set out by the EC president, JosÈ Manuel Barroso, on the eve of a full-scale EU summit on the financial crisis. "We see light at the end of the tunnel but we are not there yet," Barroso said of market responses to the €2tn rescue plan for banks adopted by eurozone countries and other EU states, including Britain.
The accounting changes, due to be rushed through if MEPs and governments approve, would be made retrospective to third quarter 2008 figures and are designed to create a level playing field with US banks. Senior officials said the changes, approved on Monday by the International Accounting Standards Board, would no longer require banks to "mark to market" distressed products held on their trading books.
Instead, banks will be allowed to value them as "held to maturity" or more closely reflecting their intrinsic value over time. European banks have been forced in recent quarters to write down tens of billions of euros under the previous rules. But Barroso admitted there were serious rifts among the EU-27 over issues such as stiffer regulation of cross-border banks, strict controls over budget deficits and state aid/competition rules.
He called for international regulation of hedge funds and private equity groups in a move at complete loggerheads with his internal market commissioner, Charlie McCreevy. The EC president also indicated a desire to revive French-inspired ideas for a single, pan-European banking regulator to replace the current system of committees or McCreevy's preference for a "college" of supervisors. McCreevy wants a lead regulator to be established in a cross-border bank's home country.
Barroso admitted several countries were putting up strong resistance to even McCreevy's plan which was, from Brussels' point of view, "a minimum." It also emerged that France and Germany are embroiled in a ferocious row behind the scenes over moves by Paris to suspend the "Maastricht" criteria setting a 3% budget deficit limit and 60% government debt for the duration of the crisis. Senior diplomats indicated that Berlin "hated" French president Nicolas Sarkozy for initiating the move.
Barroso and his senior officials insisted the stability and growth pact enshrining the Maastricht rules had been made sufficiently flexible in a 2005 revision to cope with exceptional circumstances and current bank rescue/recapitalisation plans may ultimately be of limited cost to taxpayers.
Separately, France and its allies are pressing for competition rules to be relaxed in the wake of the bank bail-outs for other sectors such as cars, but senior EC officials, who have rapidly approved the British bank guarantee and capital injection scheme, ruled this out.
Interbank lending market costs remain high
The costs for banks to borrow money from each other remain at highly elevated levels in spite of the global government action taken to cure the paralysis at the heart of the financial system. Stubbornly high interbank lending rates indicate that tensions remain in the money markets even though the US, UK and various European governments have pledged to inject capital directly into banks and guarantee many types of bank debt.
Analysts said that while stock markets had rallied and the cost of protecting bank debt against default had tumbled by record amounts in the US, it would take time for the reduced costs of what is in effect government-sponsored funding to show through.
Three-month Libor, the most important interbank lending rate that is used to price loans, derivatives and many other kinds of financial products, has barely moved in sterling markets, which have had full details of the UK government guarantee since Monday morning.
Sterling three-month Libor was just 2 basis points lower at about 6.25 per cent, more than 2 percentage points above where markets are pricing UK interest rates and higher than where the rate set before last week’s co-ordinated interest rate cuts by major economies. Similarly, euro three-month Libor, which was down 7.37bp at 5.225 per cent on Tuesday remains high.
“The fact that the boldest banking guarantee in history was not worth more . . . raised some eyebrows,” said Christoph Rieger, analyst at Dresdner Kleinwort. Dollar three-month Libor is reacting better, down 11.75bp at 4.635 per cent, which was accompanied by a 15bp rise in the yield on three-month Treasury bills to 0.4 per cent.
This leaves the so-called Ted spread, which measures the difference between interbank lending rates and risk-free government lending rates, at a hefty 420bp. “These developments suggest that the market is reducing the odds of imminent financial Armageddon, but that significant year-end funding issues remain,” said TJ Marta, strategist at RBC Capital Markets.
Lou Crandall, economist at Wrightson Icap, said: “Heightened concerns about counterparty risk may have been the major reason for the initial pullback from the term money markets last month, but investors’ worries about their own liquidity exposure could make them slow to return.”
Bush Administration Mulls Use Of 2nd Tranche Of TARP Funds
The Bush administration is mulling whether to tap the second installment of its $700 billion authority to rescue the U.S. financial system as it looks set to burn quickly through the first $250 billion with its new bank recapitalization plan. U.S. Treasury Secretary Henry Paulson and other Bush administration officials were in discussions about whether they will need to access the next $100 billion, a Treasury official said Tuesday.
Tapping the next tranche would require "merely a transmittal letter from the president to Congress," the official said. The Bush administration announced Tuesday a plan to inject $250 billion into potentially thousands of U.S. banks in the coming weeks, a historic action to restore confidence in the financial system.
The administration also said the Federal Deposit Insurance Corp. would begin to guarantee temporarily most debt issued by banks. The FDIC will also extend its deposit insurance to all noninterest-bearing transaction accounts, which are widely used by small businesses to cover payroll and other day-to-day operations. Paulson said that banks have until 5 p.m. EST on Nov. 14 to sign up for the program. He said that nine "healthy" financial institutions had already agreed to accept cash from the government.
A U.S. Treasury official said those deals would close "within days, not weeks." However, he declined to confirm the names of the nine banks that will receive the government money or give the size of the injections. The official said there would be a third program announced soon aimed at ailing banks as opposed to the healthy banks the Treasury said it's targeting with its recapitalization plan. The program would involve purchasing assets from or injecting cash into such firms.
Under authority granted by Congress earlier this month, the Treasury has $700 billion on hand to purchase a wide array of assets, including company stock, to stabilize the financial system. While it received $250 billion up front, the administration must notify Congress to access the next $100 billion. The final $350 billion, which also requires such notification, can be blocked by Congress.
U.S. President George W. Bush sent a letter to House Speaker Nancy Pelosi, D- Calif., on Tuesday to certify that it's "necessary" for the Treasury secretary to use his authority to "purchase, or commit to purchase, troubled assets up to the limit of $350 billion outstanding at any one time." House Financial Services Chairman Barney Frank, D-Mass., said Congress might need to give Treasury more money if its multi-pronged approach does not sufficiently quell the financial crisis.
"If it's being well-used and more is needed, then yes," Frank said when asked if the Treasury Department could need more than $700 billion. "If it begins to work then you may not need a lot more money." When Treasury asked for the $700 billion from Congress, it said that it would use the funds to buy toxic assets from Wall Street. However, the sharp deterioration in the global financial crisis has prompted the Treasury to shift gears within days of receiving the authority. Now, the focus has moved toward recapitalizing the banking sector, which Treasury insists it has authority to do under the legislation.
The recapitalization program attempts to walk a delicate line by embedding incentives to spur banks to eventually repurchase the government shares, but not be so punitive as to discourage firms from participating. A Treasury official compared the government stakes as "plain vanilla preferred shares," saying they wouldn't be structured so as to be punitive. Yet he noted several features designed to make the program less appealing for firms compared with the status quo of no government ownership.
"We wanted to encourage participation," the official said. "The terms are not meant to be punitive, but there are incentives built in so companies will buy us out." Participating firms won't need to shut off dividends to existing shareholders. However, they won't be able to increase dividends to common shares or repurchase common stock for three years. In exchange for its investment, the government will receive warrants to purchase common shares with a market price equal to 15% of the cash it has sunk into the firm. It will receive a 5% annual dividend that will rise to 9% after five years.
Firms also will have to submit to tough restrictions on executive pay, including banning so-called "golden parachutes" to departing executives as well as pay awarded for excessive risk-taking. Also, compensation based on results that turn out later to be wrong can be "clawed back" by shareholders under the program. These restrictions, which were attached to the legislation by lawmakers, also apply to firms selling their rotten assets directly to the U.S. government rather than through an auction or other competitive mechanism.
In addition, Treasury has added one other executive pay condition for firms receiving government equity stakes: Companies can't deduct compensation of more than $500,000 per senior executive for tax purposes. Under current law, companies can deduct up to $1 million.
These executive pay restrictions, which will last as long as Treasury owns stock in an institution, give participants reason to work to quickly buy back their shares. Treasury has also sought to spur participating firms to access the capital markets. A condition of the program bars firms from buying back the government's shares for three years unless the firm raises private capital.
U.S. bank bailout comes at steep price
The U.S. government plan to inject $250 billion into the troubled banking industry will repair balance sheets and help restore market confidence, but the banks and investors will pay a hefty price. U.S. officials announced on Tuesday a plan to inject capital by acquiring preferred stock and warrants to purchase significant stakes across a number of banks.
Half that amount will go to nine banks: Citigroup, JPMorgan Chase, Morgan Stanley, Goldman Sachs Group, Bank of America Corp and Merrill Lynch & Co, Wells Fargo & Co, State Street Corp and Bank of New York Mellon. "I think it helps. It helps everyone who is participating," said Benjamin Wallace, a money manager at Grimes & Co. "These banks have to support others. They all have their share of exposures."
U.S. Treasury Secretary Hank Paulson, under pressure to restore order to the financial markets, pushed these top tier banks to participate so that there would be no stigma associated with the plan as it was rolled out throughout the industry. Still the government's support, comes at a cost.
Fox-Pitt, Kelton analyst David Trone estimates that earnings per share for participating banks will be reduced by as much as 22 percent, at Wells Fargo, or as little as 6 percent, at Bank of New York. Some bank executives, notably JPMorgan chief Jamie Dimon, contended they did not need the additional capital. JPMorgan, which recently raised funds for its acquisition of Washington Mutual, faces 11 percent dilution from the plan. "Not everyone was on board, but Paulson realized you needed an industrywide solution," Grimes said.
Certainly stock market investors applauded the plan, which will inject needed capital into some weak banks and help accelerate the end of the current credit crunch. Treasury also will back new bank debt, guarantee certain deposits and support commercial paper. "These steps will have a significant positive impact on the crisis of confidence," Trone said.
Shares of Morgan Stanley surged another 21 percent Tuesday, after nearly doubling the day before, while Citi stock rose 18 percent as investors greeted news of even more capital strength. Goldman shares rose 11 percent. Longer term, analysts said bank and broker stocks will "stall out" as investors shift their focus from survival to the business environment, which remains weak. That will yield rising losses from loans and problem assets as well as lower revenue.
Meanwhile, earnings now will be weighed down by the preferred dividends. For consumer banking giants Citi, BofA and JPMorgan, $25 billion of preferred stock will generate an annual expense of $1.25 billion. JPMorgan shares fell 3 percent Tuesday amid worries the new capital was not needed and would drag on returns.
Goldman last month sold $5 billion of 10-percent preferred stock to Berkshire Hathaway and issued warrants to buy another $5 billion of stock. Goldman, which also issued $5 billion of common stock, will have to pay out a combined $1 billion each year to the government and to Warren Buffett. Morgan Stanley on Monday completed a $9 billion sale of preferred stock -- yielding 10 percent -- to Mitsubishi UFJ Financial Group, a deal Morgan said gave it more than enough capital. Morgan's preferred dividend tab is an even steeper $1.4 billion a year.
That said, some Wall Street observers say the stability that comes from the new capital outweighs any near term dilution or cutbacks in executive pay. Some weaker banks have little grounds to complain, said veteran Wall Street compensation consultant Alan Johnson. "When you got begging, it's hard to complain if you get chicken instead of chateaubriand," Johnson said. "What can you say? If you don't like the terms, you can go broke."
Bank crisis ends as the economic crisis begins
The taxpayer rescue of the entire western financial system is more or less complete. Tuesday's sweeping move by US Treasury Secretary Hank Paulson to guarantee financial debt and inject state capital into America's biggest banks brings the US into line with Britain and Europe, where almost $3,000bn (£1.7 trillion) has been vouched in the biggest bail-out of all time.
If the history of financial crises is any guide, the violent credit shock of 2007-2008 has largely run its course. The sovereign states of the US, Britain, France, Germany, Italy, Spain, and Holland have broad enough shoulders to carry their load of fresh liabilities – even if Iceland does not.
We are now moving to the next phase, a grinding slump across the G7 bloc of leading industrial economies as years of excess debt are slowly purged from the system. This is when people start to lose their jobs in earnest. Professor Nouriel Roubini from New York University, the vindicated prophet of the crisis, says he can at last glimpse light at the end of the tunnel.
"Policy makers peered into the abyss of systemic collapse a few steps in front of them and finally got religion. While the economic damage is already done, and the global economy will not avoid a painful recession, rapid action will prevent a decade-long stagnation like the one in Japan after the bursting of its real estate and equity bubble," he said, predicting a 'U-shaped' slump lasting 18 to 24 months.
World trade has already stalled. The Baltic Dry Index measuring freight rates for shipping has crashed by 82pc since May, touching a five-year low yesterday. Container vessels are leaving Asian ports with 20pc spare capacity. "We're heading into a global recession," said Simon Johnson, the IMF's former chief economist.
The whole OECD bloc of rich economies is crumbling in unison – a rare event. Such is the dark side of globalisation. Asia is deeply linked into the debt bubble through trade effects, which is why Japan and Singapore are contracting as sharply as the West.
Oil-rich Russia had to step in yesterday with a $56bn package to recapitalise banks and cover foreign loans. Brazil has seen a triple rout in its stocks, bonds, and currency. The Gulf states of Qatar and the Emirates have had to support their financial systems. Even Norway needed a $55bn bank rescue over the weekend.
The French economy is officialy shrinking. Germany's exports fell 2.5pc in August, led by the car industry. BMW has begun to idle three plants; Opel has shut a factory in Eisenach for three weeks. "The eurozone is in recession already," said David Owen from Dresdner Kleinwort. "The consumer downturn has begun, but the cuts in business spending that you see late in the cycle have yet to come. This is going to get a lot worse," he said.
Brussels invoked its "exceptional circumstances" clause yesterday, allowing EU states to breach the budget deficit limit of 3pc of GDP. But leeway for fiscal stimulus is already constrained. Ireland had to raise taxes yesterday to stop borrowing spiralling out of control. Its deficit will reach 6.5pc.
Former Federal Reserve chief Paul Volcker, a harsh critic of the debt bubble, says there is no alternative to the Paulson bail-out measures at this late stage, however "distasteful" they may be. "They will turn an inevitable recession into something more manageable," he said.
Be thankful for small mercies.
Home prices may plummet, but property taxes won't
Housing prices have plummeted, but property tax bills probably won't budge. This January, local tax authorities will begin to send out property assessments for 2009, telling homeowners what their property is valued at, and how much their tax bill is.
But many assessments won't reflect any of the steep home price declines that have been making headlines for the last year or so. And even if property assessments do drop, property tax bills won't necessarily be any lower. "I think you're going to see a lot more taxpayer protest this year," said Bruce Hahn, president of the American Homeowners foundation, a non-partisan consumer advocacy group.
Property taxes climbed relentlessly earlier this decade as home prices rose, according to Pete Sepp, spokesman for the National Taxpayers Union. This year Americans will pay more than $400 billion in property taxes, up about 25% from levels in 2004 and double what they paid ten years ago. At best, says Sepp, those steep increases may start to level off. Nevertheless, homeowners are already pressing assessors for lower tax assessments.
"For my first 25 years [as an assessor], nobody ever asked me to lower the assessment based on a home selling for less down the street. There are many such inquiries this year," said Ken Wilkinson, the tax assessor for Lee County Fla., which includes Cape Coral and Ft. Myers. He estimates that 80% of county residents have seen the value of their homes decline.
The median price of existing homes fell more than 25% in the 12 months ending June 30, according to the Housing Opportunity Index compiled by Wells Fargo for the National Association of Home Builders. Home prices in Moreno Valley, Calif. a city of 187,000, have fallen by more than a third over the past two years, according to the same index. And that has many more homeowners clamoring for reassessments, according to Barry Foster, the city's economic development director.
But even if local prices are way down, taxpayers may not win a lower assessment, because there can be a big lag time between when the home sales used to calculate them take place and when the assessment is actually issued. To calculate 2009 assessments, for example, assessors will use home sale prices from 2008 or even earlier, according to Sepp. Usually this works to taxpayers's advantage, since price increases take a while before they are fully reflected in assessments.
That's why it's typical for most homes to be under-valued, according to Bruce Hahn of the American Homeowners foundation. But that's also why many homeowners aren't likely to see their assessments shrink immediately. There's another reason why homeowners are unlikely to see any decrease in property tax bills. In some states, such as California, Washington State, Massachusetts and Idaho, taxes are based on the last resale price of the house. Even a home worth $500,000 in California may be taxed based on the sale price when it was bought 10 years earlier for $200,000.
"Because the assessment is based on acquisition value, it's difficult to get that re-evaluated," said Sepp. That's why the market value of most homes in these states exceeds the assessed tax values. The owners with best case for a reassessment are the ones who bought at the top of the market and have seen their values drop by a third or more, like many of Moreno Valley's residents.
Even if citizens do receive a lower assessment - and this year Wilkinson expects to lower assessments for most taxpayers in Lee county, Fla. by 20% or more - their property tax bill may not shrink at all. Tax collectors often raise tax rates to offset lower assessments to meet their budgets, which will be very strained this year. Assessments go down but rates go up so that the tax collections stay roughly the same. "State and local governments depend very heavily on real estate taxes and they are reeling from a loss of revenues from sales taxes and other sources," said Bruce Hahn.
Once homeowners get their bills, they'll have several weeks to contest their assessments, according to Hahn.
He suggested they go online to real estate evaluation sites such as Trulia or Zillow to determine how far property values have fallen in their communities. They can also cite comparable home sales for similar properties to make their cases. "Some tax assessors have been very reasonable," said Hahn, "but others are under great pressure to keep revenues up."
Growing number of US workers are poor
Even before the collapse of major U.S. banks and the Dow's plunge, the rolls of America's working poor grew as their piece of the U.S. economic pie shrank, according to a study released on Tuesday. The percentage of working families who were poor rose to 28 percent in 2006, from 27 percent in 2002, the Working Poor Families Project said in a report based on government data collected as part of the American Family Survey.
"If we start factoring in what's happened this year, we know the number will increase," said Brandon Roberts, an author of "Working Hard, Still Falling Short." The report found that 9.6 million working families were poor in 2006, up from 9.2 million in 2002, the report said. "One-third of all (U.S.) children reside in low-income working families," said Roberts.
By 2008 standards, the report defined working poor as a family of four living on less than $42,400 in the 48 contiguous states, or slightly more in Alaska and Hawaii. Income inequality grew over the period of the study, as janitors, cashiers, construction workers and nannies saw their portion of U.S. income decrease, compared to the richest workers, the report found.
"The fact that it's (the number of poor families) gone up 350,000 from 2002 to 2006 during what were good economic times, some claim robust economic times, is pretty surprising and it's very revealing about the bifurcation of the economy," said Roberts. Twenty percent of working white families were low-income, while 41 percent of minority families were low-income, figures that were stable compared to 2002, the report said.
Ireland delivers gloomy budget
Irish Government ministers are taking a 10 per cent pay cut in a “patriotic” bid to pull the country out of its vertiginous plunge into recession. The announcement was made by the finance minister, Brian Lenihan, as he delivered his budget two months earlier than originally planned. It was brought forward because of the economy’s dramatic deterioration.
The Fianna Fail-led coalition government slashed spending and raised taxes by 2 per cent for those earning more than €100,000 per year. Even so, Mr Lenihan said he expects the 2009 budget deficit to be more than double the European Union limit. The new "income levy" of 1 to 2 percent (1 per cent for those earning less than €100,000) was the central plank of a budget which also introduced an air travel tax as well as increases in taxes on gambling, cigarettes and alcohol.
However, Ireland’s corporate tax rate of 12.5 per cent was maintained, with Mr Lenihan describing it as “a cornerstone in our industrial development in the last decade”. He said: "I want to emphasise that this rate of tax is not for changing upwards and it will continue to be a central part of Ireland's economic brand." French President Nicolas Sarkozy is known to want a European Union-wide corporate tax rate, removing Ireland’s advantage in attracting international companies to use it as an entry point into Europe.
Mr Lenihan said he expected Ireland's public deficit to hit 6.5 per cent of gross domestic product in 2009, well above the 3 per cent cap set by the EU's Stability and Growth pact, and debt to reach 43 per cent of GDP. "A substantial increase in borrowing is unavoidable if we are to minimise the impact of the tighter fiscal position on the economy," he told the Dail.
An abrupt collapse in the once-thriving property market and global market turmoil has pushed the former 'Celtic Tiger' into its first recession in 25 years, ending more than a decade of economic boom and triggering a steep fall in tax receipts. Government data at the weekend showed that, on a pre-budget basis, the 2008 exchequer deficit was set to rise seven-fold to €11.5 billion from €1.6 billion at the end of 2007, before hitting €14.8 billion in 2009.
"It is my intention to secure a progressive reduction in the deficit as a percentage of GDP in 2010 and 2011," Lenihan said, struggling to be heard over the heckles of opposition deputies, who accused him of making a bad situation worse. "You have made decisions today that will threaten to turn a recession into a depression," said Richard Bruton, deputy leader of the main opposition Fine Gael party.
But the pay cut for ministers will go down well across the country. Some senior civil servants are taking a similar voluntary cut.
"As a small open economy, we are especially vulnerable to economic shocks beyond our shores," said Mr Lenihan. "The international credit crisis has compounded and deepened the downturn in the construction sector and led to a fall off in consumer confidence." A €10 air travel tax, which will come into effect from 30 March, will apply to all Irish airports.
There will be an increase in the standard rate of VAT by half a point to 21.5 per cent from 1 December, but no change in the zero rate which applies to food, children's clothes and footwear. The budget provided an opportunity "for all of us to pull together and play our part according to our means," Lenihan said, describing it as "no less than a call to patriotic action"
Ireland Raises Income Tax, Cuts Spending as Budget Gap Swells
Irish Finance Minister Brian Lenihan said he plans to raise income tax for the first time in a quarter century and slash public spending as the economic slump opens a hole in the public finances. A 1 percent tax will be added to all personal incomes, rising to 2 percent on earnings over 100,000 euros ($136,570), Lenihan, 49, said in his budget speech in the parliament in Dublin today. The levy marks the first increase in Irish income tax since 1984.
"We must take the right decisions now," Lenihan said. "The soft option would have grave consequences for the future of this country." Ireland became the first euro area economy to enter a recession in the second quarter as construction and consumer spending slumped. Today's budget, Lenihan's first, comes against a backdrop of tumbling house prices and a financial crisis that has sent share prices crashing and forced the government to guarantee all the deposits and debts of Irish banks.
The budget was brought forward from its usual date in December as the outlook deteriorated. Since Lenihan took over five months ago, the banking crisis has worsened and Ireland now faces its bleakest prospects in 25 years. The benchmark ISEQ stock index has dropped 55 percent this year, Western Europe's worst performer. Bank of Ireland Plc and Allied Irish Banks Plc, the country's largest lenders, have fallen more than 75 percent.
The economy, as measured by gross national product, will contract at least 1.5 percent this year and 1 percent in 2009, according to the forecasts announced today. The budget deficit will widen to 6.5 percent of gross domestic product in 2009 from around 5.5 percent this year. Lenihan said he plans to conduct a review of the National Pension Reserve Fund before the end of the year. Ireland contributes 1 percent of GNP to the fund every year to meet future pension needs. He also said the government and some senior civil servants will take a 10 percent pay cut.
"There is too much at stake; we all have too much to lose by not taking action now," Lenihan said. "We face the most challenging fiscal and economic position in a generation." While the income tax levy will raise funds for the government, it may further damp an economy where retail sales are tumbling and consumer confidence is close to a record low.
In the U.K., Chancellor of the Exchequer Alistair Darling has ruled out immediate tax rises or spending restraint, saying now is not the time to take money out of the economy, but has hinted measures will ultimately be needed to reduce the deficit.
JP Morgan warns on weak profit after 84% fall
JP Morgan, America's largest bank by market value, today reported an 84 per cent slump in third quarter profits and warned of falling income "over the next few quarters".
The bank, which is one of nine US financial institutions who will receive a share of the Government's ambitious bailout package, saw its third quarter profit reduced from $3.4 billion in the same period last year to $527 million, after writing off $3.6 billion. Since the sub-prime crisis emerged early last year, JP Morgan has written off $18.8 billion on assets and credit costs.
However, the group's running total is lower than Citigroup, the US banking giant, which has so far written off around $50 billion while JP Morgan has been able to rescue struggling rivals and earlier this year saved Bear Stearns from collapse. Overall revenue fell from $16.1 billion to $14.7 billion and Jamie Dimon, JP Morgan's chief executive said today: "Given the uncertainty in the capital markets, housing sector and economy overall, it is reasonable to expect reduced earnings for our firm over the next few quarters."
JPMorgan's investment-banking division made $882 million in the third quarter, compared with profit of $296 million the previous year, and revenue rose $1.1 billion.
Credit Woes Squeeze Wells Fargo
Wells Fargo & Co. posted a 24% drop in third-quarter net income as the bank wrote down its investments in Fannie Mae, Freddie Mac and Lehman Brothers Holdings Inc. and added to credit reserves. But revenue increased amid growth in loans and deposits.
Chief Executive John Stumpf said, "Our strength, security and outstanding financial performance continued to compare favorably with our industry peers." He added that the bank, which last week won the battle against Citigroup Inc. to acquire Wachovia Corp., expects to complete the deal by year-end and that the company's "disciplined" acquisition strategy "will not change."
Wells Fargo reported net income of $1.64 billion, or 49 cents a share, down from $2.17 billion, or 64 cents a share, a year earlier. The latest results include 13 cents a share in write-downs for the Fannie, Freddie and Lehman investments, along with a 10-cents charge from boosting credit reserves by $500 million to $8 billion. The reserve is now double its year-ago size.
Revenue climbed 5.4% to $10.38 billion. Excluding the write-downs, revenue would have climbed 12%.
Analysts polled by Thomson Reuters were expecting earnings of 42 cents a share on an 11% revenue increase to $10.96 billion. Asset quality weakened substantially during the quarter, with net charge-offs rising to 1.96% of average total assets from 1.01% last year and 1.55% in the second quarter. In April, the company made a policy change for only those loans in default for 180 or more to be written off. Previously, those in default 120 days or more were written off.
Nonperforming assets -- those near default -- surged to 1.22% from 0.58% a year earlier and 1.02% in the prior quarter. Loans delinquent 90 days or more as of Sept. 30 totaled $8.44 billion in the latest quarter, up 53% from a year earlier. The company said it continued to see delinquencies "increasing as the negative credit trends impact loan performance."
Net interest margin -- the difference between interest earned on loans and paid on deposits -- increased to 4.79% from 4.55% a year earlier, though it fell from 4.92% in the second quarter. Wells Fargo said the latest margin reflects reduced funding costs and "continued above-market" core deposit growth. Average core deposits increased 4.6%, while loans rose 15%.
After staying in the shadows in recent years by avoiding large acquisitions, Wells Fargo thrust itself onto center stage several weeks ago as it announced a deal to acquire Wachovia for just over $15 billion several days after Citigroup had agreed in a federally backed deal to buy it for $2.1 billion. Wells Fargo's ability to pay so much more, without government help, highlighted its strength.
Wells Fargo has also been listed among nine "healthy" financial firms in which the government is injecting capital. Wells Fargo is still dealing with another contentious battle against Citigroup, which is seeking $60 billion in damages related to the Wachovia transaction. Tuesday, Wells Fargo fired back by filing its own lawsuit against Citigroup, asking a federal court to block Citigroup from pursuing its liability claims.
The legal wrangling makes up just part of the difficulties Wells Fargo must grapple with as a result of the Wachovia deal. The bank also said it will face some $74 billion in losses and write-downs from acquiring Wachovia and its troubled portfolio loans of loans.
GM: Better off bankrupt
GM certainly is keeping a close eye on its cash these days. One supplier reports he is now getting paid 60 days after he presents an invoice - not the 30 days he was used to. Worse, the clock doesn't start ticking until after the bills get approved in Detroit - and then sent to Arizona for processing.
Next thing you know, GM will be inflating its float by cutting supplier checks on banks in Fiji that will take weeks to clear. It is a measure of GM's desperation that it is reported to be considering a linkup with Chrysler to get access to Chrysler's cash so it can remain in business. The idea has provoked nearly universal skepticism among analysts and GM watchers.
With good reason; they have history on their side. The list of unsuccessful auto mergers stretches from the present day - Daimler and Chrysler, BMW and Rover - all the way back to Studebaker-Packard and Nash-Hudson. Buying Chrysler would only get GM more of what it doesn't need: more brands, more models, more factories, more employees, more dealers.
You have to wonder what makes GM think it could run Chrysler's operations more successfully than it has run its own. Like a second marriage, a GM/Chrysler merger would be a triumph of hope over experience. So what's an ailing automotive giant to do? GM has the wrong products to sell into a shrinking market and can offer little or nothing in the way of financing to its customers.
To remain liquid through next year, it needs to raise $10 billion to $15 billion through a combination of internal measures, borrowing and asset sales. That's next to impossible these days. With some of its bonds selling for less than 50 cents on the dollar, the cost of new debt would be prohibitive. Not even vulture investors are clamoring to buy shuttered parts or assembly plants. And Hummer, which GM is trying to shed, does not appear to be the next iconic American brand. Harley-Davidson it isn't.
So how about a government bailout? What's good for GM is good for the country, and vice versa. The federal government has promised more than $1 trillion to keep banks, insurance companies and other financial institutions afloat. Couldn't it find another $100 billion or so to invest in the Detroit Three on top of the $25 billion in loans already approved?
A government loan wouldn't be about protecting well-compensated union jobs or keeping afloat inefficient suppliers in Michigan and Ohio. It could be directed toward advancing Detroit's and the country's strategic interests by speeding development of alternative fuel technologies that reduce our dependence on foreign oil as well as help limit the generation of greenhouse gases.
GM may have a decent shot at that in a Democratic administration. If not, there is bankruptcy. That's a horrible possibility, to be sure, and one that GM claims is not an option because it would destroy consumer confidence in its vehicles. Who is going to accept a three-year warrantee on a new car from a bankrupt company?
But hear me out. Bankruptcy would give GM a chance to negotiate further cost reductions with its union workers, work out its obligations with those suppliers that are still solvent, and help speed the rationalization of its dealer body. Would GM then be stigmatized as the only bankrupt auto company? No way. Ford and Chrysler would immediately find that they have been made uncompetitive by GM's actions and quickly follow it into Chapter 11.
Flying one bankrupt airline felt a little awkward, but by the time half a dozen were in the same condition, it seemed perfectly natural. That would apply to the Detroit Three. There is still an appetite out there in America's heartland for Detroit iron, and in the end bankruptcy may be the best way to continue to satisfy it.
UK unemployment: 'Something horrible' this way comes
No one should be surprised by today's huge rise in unemployment. David Blanchflower, the Bank of England monetary policy committee's labour market expert, has been warning of "something horrible" happening to the jobless numbers for months and months. But few wanted to listen to him.
They should have, because the numbers today are horrible. They show the biggest rise in unemployment - 164,000 - since June 1991, when the economy was tipping into its worst post-war recession. The jobless rate also jumped from 5.2% to 5.75%, the biggest increase since July 1991. Employment suffered its biggest drop since February 1993. These are recession numbers.
Unemployment on the broadest Labour Force Survey measure is now a tad under 1.8 million. Blanchflower has been warning it will go to 2 million by Christmas. Today he admitted to me he was wrong - he now thinks it will be well above 2 million by Christmas. The numbers are bad at many levels. For a start, they apply to the period up to the end of August - well before the current stage of the financial crisis erupted a month ago. So there will be much worse to come.
They are also bad because they show a huge number of young people - 56,000 - became unemployed in the three months to August - the biggest rise since the series began in 1992. This happened because young people were unable to find jobs as they left school or university. Because they are not eligible for benefits, they have not been picked up by the claimant count numbers, which is a key reason why the claimant count did not go up by more than it did last month.
It rose by 31,800, a bit less than the upwardly revised leap of 35,700 in August but still heading up fast. Remember that last month's increase was the worst since December 1992. Blanchflower was ignored by his MPC colleagues all through the summer as he voted for interest rate cuts because he saw the damage the credit crisis was inflicting on the economy way before they did.
Indeed, the Bank's governor, Mervyn King, made a jocular aside to him when both men appeared before the Treasury committee on September 11 that the gods must have given Blanchflower some unemployment figures from the future but had not been so kind to him. Well, it now looks either that the gods had given Blanchflower the data or simply that, as a serious labour market economist, he had been looking at the numbers in greater detail than his colleagues.
It is true that the MPC finally cut interest rates last week for the first time since April in an emergency response to the meltdown in financial markets. They cut half a point to 4.5% and further hefty cuts are expected. But the cuts were already needed. Rates were too high. Inflation, which many of the MPC members had been fretting about, was not the problem. The danger of deflation was, and is, the problem.
Look at another number in the labour market figures. The headline average earnings growth rate fell to 3.4% - its lowest for five years. Not surprising, you might think, since unemployment has been rising for a while and people are too afraid of losing their jobs to ask for a big pay rise. But until very recently MPC members were saying that the spike in inflation caused by the spring surge in oil prices, would feed through into higher wages. It didn't, hasn't, and won't.
All that matters now is that rates are cut further and quickly to prevent the recession we are already in turning into "something horrible".
US Consumers’ Confidence in Banks Plummets to 21%
Who has faith in big banks? Not many consumers these days, and that's driving people into the arms of their local institutions.
Only 21% of consumers polled are confident in U.S. banks, according to a survey taken in late September by Gallup. That marks an unprecedented drop from 40% in mid-July and is the lowest level of consumer confidence in banks in three decades. The 21% low easily beat the previous trough of 30% in October 1991, which occurred amid a major recession, the savings-and-loan crisis and lingering turmoil from the Gulf War.
Rocking that trust further are huge banks getting even bigger -- Bank of America swallowing Merrill Lynch, Chase merging with Washington Mutual and Citibank wrestling with Wells Fargo over Wachovia. "It looks like just another manifestation of greed and protecting themselves," said Alan Siegel, chairman of branding firm Siegel & Gale. But not all banks are equally feeling the heat, and some local institutions are benefiting.
Unity National Bank in Miami County, Ohio, says it's getting new customers every day from Chase branches in town. "People are saying they're just not comfortable there," said Julie Monnin, Unity's marketing director. "We haven't changed anything about the way we do business. ... [But] people who before thought that maybe we were too stringent [with loan requirements] are now saying that they see why we are."
Unity is going out of its way to make sure consumers know it's solid. It has revamped its website to say so, adding a letter from the bank's president and an FAQ section. It even posted the home phone numbers of its president and marketing director. It also plans to put a newspaper insert in the local press. "We want [customers] to know we're doing fine," Ms. Monnin said.
Gallup's findings show that while fewer than 25% of consumers trust U.S. banks, a much healthier 66% said they had confidence in the local banks where they do business. Both numbers are down from mid-July, but while national bank confidence dropped from 40%, local bank confidence dropped from 80%.
"What people were saying is ... 'I don't trust those other bums, [but] I believe in the people at my individual institution,'" said Douglas Berlon, Gallup global practice leader for financial services. "A lot of local banks have positioned themselves as the caregiver -- we take care of you and your money," said Fritz Grutzner, president of branding-strategy firm Brandgarten. "And in times like this, it works to their benefit."
The key is to maintain that trust. "The whole concept of that moment of 'wow' between employees and customers at the local bank level means they have to manage it, believe in it, instill it and train around it. You have to make sure you're living at that local level," Mr. Berlon said.
The American Bankers Association, in which most members hold $125 million or less in assets, said many of its member banks are proactively reaching out to customers through private and public messaging. They're e-mailing customers, taking out ads in local papers and offering services that previously carried fees for free, an ABA spokeswoman said. She said one member bank has even hired an ad agency to create a video called "How Your Money Is Protected."
"Part of the issue has been that the general population doesn't make the distinction between Wall Street investment banks and neighborhood banks or deposit banks," she said, adding that only about 11 of the 8,500 banks in the U.S. have failed in the past year. Local banks' open and direct communication to customers is the right strategy, Mr. Siegel said. "To be silent is a mistake. You have to be honest and transparent and communicate with customers."
That's what Canandaigua Bank has been doing since May, prompted by the housing crisis. Steve Martin, VP-public relations and marketing, said the upstate-New York bank has been proactively communicating a reassuring message to its customers. "Our objective was to be a leader in the market and tell our customers the facts and give them information," he said. "What we have received is an overwhelming response of deposits and loan requests."
Fed lifts cap on currency swap with Bank of Japan
The U.S. Federal Reserve on Tuesday erased the upper limit on its currency swap line with the Bank of Japan, the latest in an extensive series of steps to restore stability in shaky credit markets world-wide. "The size of the swap line between the Federal Reserve and the Bank of Japan will be increased to accommodate whatever quantity of U.S. dollar funding is demanded," the Fed said in a statement.
The Fed has opened swap lines with other major central banks to enable them to lend to their local commercial banks in an effort to get U.S. dollars circulating in overnight and short-term money markets. The Fed on Monday similarly removed the caps on swap lines with the Bank of England, the European Central Bank and the Swiss National Bank.
Are states next in line for federal bailout?
How California fares with a $4 billion short-term bond sale this week will help answer a key question looming over the current US financial crisis: are traditional credit markets so frozen that states won't be able to raise revenues to tide them over their cash crunch? The practice of selling short-term bonds is used regularly by at least a dozen US states, and occasionally by several more, to keep state programs and services running smoothly year round.
Because tax income is not steady throughout the year – far more revenue comes in from September through December than January through March – California and others (including Massachusetts, New Jersey, Nevada, Rhode Island, Arizona, Delaware, New York, Florida, and Alabama) borrow short-term to pay their bills when revenues are temporarily insufficient. Now, with states facing the same problem faced by millions of businesses – tightening credit markets – at the same time that revenues are sinking, many budget officials are worried that they may not be able to borrow when they need to.
Some, including California, have notified US Treasury Secretary Henry Paulson that if the credit markets don't come through, they may be knocking on his door. There is currently no formal mechanism in place for the federal government to provide loans to states unless the need is generated by a natural disaster, say experts. By law, states have to balance their budgets each year. If several go to the federal government and line up all at once, who will decide which states gets the limited – and dwindling – funds?
"This is an unprecedented situation because of the scope of the lending needs," says Alan Rubin, director of federal government relations for Buchanan Ingersoll & Rooney, which has decades of experience in state financing. "If these states can't get their funds the usual way and start asking the federal government, there is no clear-cut way for Washington to respond." The federal government is best prepared to come through with funding after disasters – such as Katrina or 9/11 – says Mr. Rubin and others.
"This could pit states against each other in very uncomfortable ways," says Rubin. "If the federal government has to determine who gets $6 billion and who gets $10 billion, there's likely to be a lot of finger-pointing. People will be very angry if politics becomes the methodology – there are real issues that are critical to determine. We've never been there before."
Scott Pattison, executive director for the National Association of State Budget Officers, says "about 10 to 12 states in the next few months might have to go on market for a RAN [short-term bonds called Revenue Anticipatory Notes]." Most states have rainy day funds they are dipping into during the current revenue crisis. Other states may be forced to raise taxes, cut services, or do both, he says.
California needs to make up a $7 billion shortfall. But state Finance Department spokesman H.D. Palmer says this week's bond sale will attempt to collect only $4 billion. "Given the market conditions, we concluded it was best to go only for $4 billion immediately and try for $3 billion more in a few weeks," he says. Because Massachusetts successfully marketed $700 million in bonds last week, Palmer says Governor Schwarzenegger is "cautiously optimistic."
The state sent a letter to Henry Paulson last week saying that if the bond sale doesn't work, officials hope to borrow from the US Treasury under the recently signed Troubled Asset Relief Program (TARP). "The Treasury hasn't answered yet," says Nick Johnson, director of the state fiscal project for the Center for Budget Planning and Priorities. "There's some discussion on whether or not they have legal authority to do so."
The issue to watch, say several state fiscal analysts, will be whether the credit markets will be able to loan money to California and other states. If not, it sends a dire signal to the rest of the country's businesses. "States are the safest loans out there with the exception of a loan to the US federal government," says Donald Boyd, a state fiscal analyst with the Rockefeller Institute of Government, the public policy research arm of the State University of New York.
"They have very diverse economies, have the power to tax, and cannot go bankrupt. How can General Motors get a loan, if the state of Massachusetts cannot?"
California Selling Short-Term Notes at Higher Yields
California sold almost half of the $4 billion of notes it is offering this week to avert a cash shortage, with tentative yields as much as 1.1 percentage points higher than last year. Notes due May 20, 2009, may offer a yield of 3.75 percent to 4 percent and debt to be paid off June 22 might yield 4.25 percent to 4.50 percent, said Tom Dresslar, spokesman for California Treasurer Bill Lockyer, in an e-mail. The state sold $7 billion of notes last year at 3.37 percent.
California, home of the world's eighth-largest economy, is seeking to raise cash to pay bills until tax revenue arrives later in the year. The state is pressing forward, even as rising costs drive borrowers, including New York City and Ohio, to defer long-term bond sales. Standard & Poor's last week threatened to lower the state's credit rating if the sale falters amid a freeze in the bond market.
"It's about being able to sell it," said Matt Fabian, managing director at Concord, Massachusetts-based research firm Municipal Market Advisors. "Everyone is paying higher yields to get their deals done." The yields are still a quarter-percentage point lower than previous preliminary yields underwriters suggested might be necessary to find buyers for the notes as the credit crisis saps investor demand.
That's "perhaps a good indication that there is interest," said Mark McCray, a managing director and municipal bond fund manager at Newport Beach, California-based Pacific Investment Management Co. The notes may yield as much as 3 percentage points more then the U.S. Federal Reserve's target rate for overnight bank lending; last year, the state paid 1.38 percentage points less.
Bank of America Corp. and Goldman Sachs Group Inc. are leading a group of investment banks taking orders from individuals today and tomorrow, with final pricing set for Oct. 16 when institutions such as funds and insurers place orders. During the first day of the so-called retail order period, individual investors said they wanted to buy more than $327.4 million of the May notes and almost $1.5 billion of the June notes, Dresslar said. The preliminary tally of $1.837 billion represents 45.9 percent of the deal. Last year, California collected $1.65 billion, or 23.5 percent, of the note sale during a three-day retail period.
California Governor Arnold Schwarzenegger, who appeared in radio advertisements pitching the bonds to state residents, said he bought some. He didn't say how much he purchased. "It's clear that the first day of note sales to Californians has gone extremely well and exceeded expectations, Schwarzenegger said. "These are good, safe investments that will help protect vital state services."
California's notes this year carry ratings of MIG1 from Moody's Investors Service, the highest possible. S&P and Fitch Ratings assigned their second-highest short-term ratings of SP1 and F1, down from SP1+ and F1+ last year. S&P placed California's long-term general obligation rating of A+ under review for possible downgrade Oct. 10, citing "concerns over the ability of the state, as a result of recent market conditions, to successfully access the short-term market to meet its pressing cash flow needs."
The state, the biggest borrower in the municipal-bond market, has $51 billion in general-obligation debt outstanding and is rated A+ by Fitch Ratings and a comparable A1 by Moody's Investors Service. Schwarzenegger two weeks ago told the U.S. Treasury his and other states may need emergency federal loans if they aren't able to tap the debt market. Last week, the Republican governor said the need had lessened.
Japan government to freeze its share sales to aid prices
To ease selling pressure on domestic stocks, the government plans to freeze the sales of shares it acquired during past financial turmoil, Finance Minister Shoichi Nakagawa said Tuesday. It also intends to revive legislation to enable public-fund injections into faltering regional banks and extend a mechanism to protect life insurance policyholders with taxpayers' money, he said.
The steps are the cornerstone of a policy package Nakagawa announced to cushion the blow from the global financial crisis. "Japan's financial system remains stable, compared with what's happening in the United States and Europe," said Nakagawa, who doubles as state minister in charge of financial services. "We have put together the measures that we need right now, after taking into account falling share prices and other factors."
On Tuesday, the Nikkei 225 index gained 1,171.14 points to close at 9,447.57, more than recovering the 881.06 points it lost Friday. The government bought shares from large banks between 2002 and 2006 to reduce unrealized losses on their stockholdings and began selling them on open markets in fiscal 2006 after share prices stabilized.
The Bank of Japan, which bought shares in a similar campaign between 2002 and 2004, will also be asked to freeze sales. The government plans to reinstate a law that expired in March, to authorize recapitalization of regional lenders with public funds. It has also slated legal revisions to extend by three years a safety net under which public funds can be used to protect policyholders of failed life insurers.
The government will seek tighter monitoring on the practice of short selling, a factor behind falling share prices.
The Tokyo Stock Exchange will be required to publish the value of shares short-sold every day for each industry sector, up from the current monthly disclosure.
Baltic Dry shipping index warns of tough times on the horizon
The Baltic Dry shipping index, which has been flashing amber signals about the world economy for the past couple of months, is telling us there is something going badly wrong because it is now stuck firmly on red.
The index, a proxy for world trade flows, suffered its second biggest-ever fall yesterday, to 11%, which took it down under the $2,000 mark and it fell another 8% today to $1,809. The drop means it has fallen more than 80% since July's peak of around $12,000 and is now at a three-year low.
The index has long been seen as a good leading indictor of future economic production levels because it charts the cost of freight movements in 26 of the world's biggest shipping lanes of "dry" materials, such as coal, iron ore and grain which feed into the production of finished goods some weeks or months ahead.
Think back to the first part of the year and there was a boom in oil and commodities prices, which pushed up demand for the ships to carry them. Now we seem to be stuck in the bust phase. We know that oil and commodity prices have fallen sharply because demand has faded in the face of high prices and because the world economy is being deflated by the global financial crisis.
There is some hope today that the worst of the financial crisis may be over, thanks to the mass injections of capital into banks by governments in Europe and the US. But the damage to the world economy is already a fact of life and the Baltic Dry is pointing to a further slowdown in both output and inflation in many of the world's economies.
The index may also be telling us something scarier. It may be telling us that the world's great industrial powerhouse, China, could be in trouble and that its imports of raw materials are collapsing at a far greater pace than the slow slide in demand from the West for China's finished goods would imply.
There have been increasing concerns about China this year. It has been booming for years and growing, if the official figures are to be believed, at more than 10% a year. That has, in turn, given rise to a stockmarket and housing market boom which now look to be going pop, as ours have done. The great Asian miracle economy might now be coming apart at the seams, in spite of the official figures suggesting everything is stillfine. But the Chinese authorities cannot control the Baltic Dry.
Wall Street Skid Prompts Calls for Interest-Rate Swap Guarantee
The executives who devised a way to guarantee private energy deals after Enron Corp.'s collapse will use the same approach to soothe concern that traders can't honor bets in the $400 trillion interest-rate swap market.
Clearport, formed a year after Enron went bankrupt in 2001, uses the New York Mercantile Exchange's clearinghouse to guarantee over-the-counter energy trades. Derivative traders said the same model can bolster confidence within the markets for interest-rate swaps, used by almost every buyer or seller of debt to protect against swings in rates. "This is an extraordinary opportunity," said Tim Woodward, European head of exchange-traded derivatives at UBS AG in London. "I can't imagine you will find any investment bank in the space who thinks this is not the right time to examine this."
The failures of Lehman Brothers Holdings Inc. and Bear Stearns Cos., sparked by bad bets on subprime mortgages, fed panic on Wall Street that other big banks wouldn't make good on trades. Lehman was among the top 10 counterparties for trades of credit-default swaps, prompting the Federal Reserve Bank of New York to seek ways to reduce market risks. Supporters of the clearinghouse model say it redistributes risk to a number of institutions, not a single counterparty.
Wachovia Capital Markets estimates that clearinghouse revenue for credit-default swaps, used to hedge against the risk of loan defaults or to speculate on creditworthiness, may reach $100 million within a year. The interest-rate swap market is almost seven times larger, making it the world's biggest over- the-counter market.
Two of Clearport's creators, Vincent Viola and Robert "Bo" Collins, were chairman and president, respectively, of Nymex in 2001. The third, Christopher Edmonds, was chief development officer at ICAP Plc, the world's largest broker of trades between banks. Their venture, International Derivatives Clearing Group LLC, applied to the Commodity Futures Trading Commission in late August for regulatory approval, a process that typically takes 90 days.
Clearport has grown to be the second-largest producer for Nymex, accounting for 28 percent of the exchange's gross clearing revenue in the second quarter. IDCG, like Clearport, will generate revenue by charging a fee to guarantee each swap. So-called clearing members will have to capitalize the venture with a minimum of $5 million each.
Edmonds will serve as chief executive officer of New York- based IDCG, replacing Collins, who has no management role at the company. Viola is a founder of the clearinghouse and remains involved, Edmonds said. Until recently, investment banks and companies such as New York-based insurer American International Group Inc. that traded interest-rate swaps were perceived as solid counterparties. It was much the same in credit-default swaps, where traders relied on the ability of a single counterparty to make good on trades. That's no longer the case, said Craig Pirrong, a finance professor at the University of Houston.
"Some of the major dealers have disappeared and the rest of them are under a cloud, so that really changes the competitive environment," Pirrong said. "There's a very clear parallel in what was going on then in the energy space and what's going on now virtually everywhere." IDCG aims to guarantee existing swaps starting Dec. 1, said people with knowledge of the matter, who declined to be identified because the information is private. The next step would be to offer access by February through third-party trading platforms to execute new swaps backed by the clearinghouse, the people said.
The new swaps might appeal to hedge funds, lightly regulated investment pools generally open only to wealthy investors, and active traders who want access to the contracts without going through a prime broker. It would let hedge funds and brokerages compete for trades in a market dominated by about a dozen dealers. It also would free up capital in an environment where cash is highly sought-after.
Spreads on interest-rate swaps could fall if a clearinghouse were used and public bids and offers were available, reducing trading costs. The price to trade a swap with a bank is now hidden within the overall cost of the transaction and depends on how a bank rates a counterparty's creditworthiness. An inter-dealer broker who reaps revenue of $150 million to $300 million a year "will try to destroy anybody who challenges their model," said Michael Cosgrove, head of North American energy operations for broker GFI Group Inc. in New York.
Nymex forged Clearport at the same time as a similar successful effort by Intercontinental Exchange, its main competitor. Half of Atlanta-based Intercontinental's transaction revenue came from OTC clearing in the first six months of 2008. Several other attempts to clear OTC energy trades failed, including a push by TradeSpark LP. "If the dealers are ever going to get behind something like this, it will be now, and I dare to say that the regulators could in fact insist upon it," said Bill Cline, a former Accenture Ltd. partner.
Fannie, Freddie Debt Spreads Widen to Records on Bank Guarantee
Yields on Fannie Mae and Freddie Mac corporate debt rose to records relative to Treasuries as the government said it would guarantee borrowing by banks, providing bond buyers with competing U.S.-backed investments. The difference between yields on Washington-based Fannie's five-year debt and similar-maturity Treasuries rose 15.8 basis points to 118.2 basis points as of 3:35 p.m. in New York, according to data complied by Bloomberg.
As part of U.S. plans announced today to halt a credit freeze, the Federal Deposit Insurance Corp. will fully guarantee newly issued, senior unsecured debt from some banks. The bank notes initially will probably carry yields greater than those on Fannie and Freddie's $1.7 trillion of debt, reducing demand for so-called agency bonds, said Jim Vogel, an analyst at FTN Financial Group.
"This is a major shift investors will have to digest," Vogel, the head of agency debt research at FTN in Memphis, Tennessee, wrote in an e-mail. The FDIC's coverage applies to all senior unsecured debt issued by certain banks on or before June 30, 2009. The largest seller of U.S. agency debt is the Federal Home Loan Bank system, the series of 12 cooperative lenders owned by U.S. financial companies. A basis point is 0.01 percentage point.
The government is directly helping banks refinance by agreeing to guarantee new securities amounting to 125 percent of the debt they have maturing through June 30. That would enable banks to sell $12.5 billion of debt backed by the U.S. for every $10 billion they have coming due.
Fannie and Freddie, the mortgage-finance companies that own or guarantee almost half of the $12 trillion of U.S. residential debt, were placed into a government-run conservatorship last month following losses that pushed foreign debt buyers to retreat from their securities. The U.S. at the time vowed to inject as much as $200 billion of capital into the firms to support their corporate borrowing and more than $4.2 trillion of home-loan bonds they guarantee.
"It's a not a credit-related issue," Gary Cloud, a senior portfolio manager who helps oversee $500 million at the AFBA Funds in Kansas City, Missouri, said in a telephone interview. "There's nothing that has fundamentally changed." Investors may also be concerned that an increase in supply of Fannie and Freddie debt may hit the market, following reports that the U.S. has directed the companies to buy $40 billion a month of subprime and Alt-A mortgage securities, Cloud said.
"How do they do that? They don't waive their wand," Cloud said. "They sell bonds to raise cash to buy the securities." The difference between yields on McLean, Virginia-based Freddie's five-year debt and similar-maturity Treasuries rose 18.1 basis points to 124.2 basis points.
What keeps the Dow Jones up? Happy thoughts
The cover of today's New York Daily News loudly proclaimed the joy and wonder, the shock and awe of yesterday's Wall Street rally. Right beside the headline, in the middle of a huge red arrow marked "Dow soars to biggest point gain in history," the paper presented a picture of a trader, both thumbs up, sporting a cocky, devil-may-care smile. Inside, the paper carried another shot of its leering cover boy, this time accompanied by another trader sporting a mindless grin.
It was hardly necessary to read the accompanying article, as the pictures told the whole tale: the stock market, after plummeting for a few days, more or less hit bottom. Other countries started pouring money into their banks, calming the panic, and enabling investors to remember that the paper they were passing back and forth sometimes represented actual value. When this happened, the investors proceeded to start buying some of their stock back at ever-increasing rates, causing the Dow Jones index to rapidly rise. Of course, the next few acts in this play are equally obvious: the market will continue to fluctuate as irrational exuberance and irrational caution trade places and seek equilibrium in the Wall Street version of manic depression.
For some people, the wild fluctuations of the market will translate into equally wild emotional rides. In the United States, the land where Calvinism never died, wealth is still considered a sign of rectitude and poverty a mark of weakness. It naturally follows, then, that the relative ebb and flow of our economic fortunes will translate into a similar roller coaster of pride and self-doubt. One need look no further than the cover of the Daily News to see a man who takes responsibility for the strength of the market and, presumably, blames himself for its failings. As stock market players continue to confuse knowledge of the market with the ability to control it, their sense of self will rise and fall with its fluctuations.
The flip side of the unknown trader's BOOYA! grin is a brutal depression, a condition noted by the Reverend Canon Ann Malonee. As the vicar at Trinity Church, the storied house of worship located at the intersection of Broadway and Wall Street, Canon Malonee is something of a spiritual first responder for the financial district. With regard to the recent panic, she stated "I've had a number of people say that this is [...] reminiscent of 9/11," noting that "It's that sense of having the rug pulled out from under them."
Just as the financial crisis has had effects far beyond the environs of Wall Street, the ensuing depression has also spread across the country, leading to a rise in suicides and "mercy killings," as families have realized that they will no longer be able to stay in their homes. In the process, many people facing foreclosure have also turned to suicide hotlines, counseling services, and other community organizations, quickly overwhelming these resources.
According to some experts, this sense of malaise and helplessness is, ironically, having a negative effect on the economy. As a recent CNN poll noted, 60% of Americans think that an economic depression is "likely" to occur in the near future. While economists strongly disagree, many have noted that this widespread perception will actually exacerbate the forthcoming recession. As consumers hoard their money and prepare for the worst, the cuts in expenditures will result in reduced jobs and greater economic hardship. Under the circumstances, it seems like the grin sported by the Daily News' unknown trader may have more power to control the economy than any rational thought he might produce!