Oscar-winning actress Norma Shearer (Mrs. Irving Thalberg) at the White House.
Ilargi: According to Bloomberg, $30 trillion in equity value was lost around the world in the past year. Better open your wallets a bit wider, my crystal ball says there's more bail-outs in your immediate future. It’s getting busy at the trough: FDIC, Detroit, 51 states, and now monolines Ambac and MBIA. It’s a good thing we gave Paulson unlimited funds and powers, don’t you think?
AIG has taken $123 billion of your money, and is using part of it on a lobbying campaign aimed at getting rid of government oversight. How ridiculous did you say you want it? I say lock 'em up and throw away the key. Nobody still knows what will happen on Tuesday October 21st, except that Lehman’s credit default swaps are to be settled on that day. I think there’s a solid chance that AIG, involved in this schpiel as insurer, is on the hook for billions of dollars. And that means your, the taxpayer’s, money will be used to settle gambling debts.
I have argued for a long time that this is the basic underlying theme in all the bail-outs, but in this case it becomes an awfully direct link. And it leaves a gruesome aftertaste in my mouth.
They're not trying to keep the economy going, that’s just a PR line. They're trying to keep the casino going. With trillions of dollars of your children’s funds.
Even if all these guys were sincere in their proclaimed aim of 'saving the economy', even then what they do would still be nothing but a giant double or nothing bet. With your money. Nobody wants to consider putting an end to this gambling addiction. If we would close the casino doors, or so is the word, the world itself would come to an abrupt end.
And this is sort of the best-case scenario, the idea that they are actually trying to save something. But I don’t believe for a minute that the Paulson’s of this planet have faith that it could possibly work. The best shot they would have is a one-in-a-3 trillion double or nothing.
Obviously, no matter if their goals are devious or not, they will have to prepare for that bet to be a losing one. What do you think Tony Soprano would do when facing those odds?
People may think it’s a ludicrous comparison, but really, if you want to figure out why Paulson does what he does, ask yourself: what would Tony Soprano do?
My take is that he would take pre-emptive action, and take out his opponents before they clue in, get together, and come after him.
Soprano takes over all businesses in the hood with offers they don't want but can’t refuse, and all the grannies in the hood have to hand over all their cash.
Paulson forces banks to take multi-billion dollar bail-outs they don't want but can't refuse, and as soon as they do, he takes over. And since he became head of the Treasury 2 years ago, he already had full control over all the cash of all the grannies in the land.
America, the land of opportunity. Crisis equals opportunity.
Next move: cut interest rates. That will make all your savings worthless, and induce you to sign on to new
From where I'm sitting, I’d say the only difference between Hank Paulson and Tony Soprano is that Soprano has a code of honor.
US consumer sentiment plunges at fastest rate ever
In the midst of global efforts to shore up markets and economies, U.S. consumer sentiment plunged in October, according to the University of Michigan/Reuters index released Friday.
In a record single-month drop, the index fell to 57.5 in October, compared with a reading of 70.3 in late September. Economists surveyed by MarketWatch had been expecting an October result of 64.5. "Clearly, this is the response to the market chaos, and it does not look good," wrote Ian Shepherdson, chief U.S. economist with High Frequency Economics. It's unlikely that consumer confidence will reach levels consistent with rising spending until next year, Shepherdson added.
While inflation has eased recently -- gasoline prices have been falling -- it's no wonder that daily headlines on the credit crunch and the volatile stock market have taken a toll on consumer sentiment. The Dow Jones Industrial Average fell 21% during the first two weeks of this month. The UMich expectations index declined to 56.7 from 67.2. And the current conditions index, which also experienced a record single-month drop, declined to an all-time low of 58.9 from 75.
Consumer expectations for inflation over the next 12 months rose to 4.5% from 4.3%. Expectations for annual inflation over five years decreased to 2.8% from 3%. Also this week, the government reported that retail sales fell 1.2% in September, marking the worst drop in three years and the third monthly decline in a row -- a further sign that the nation's economy has sunk into a recession under the weight of an exhausted consumer.
And earlier this month, the government reported that the U.S. economy lost 159,000 jobs in September, the worst since March 2003. Separately Friday, the Commerce Department reported that construction of new homes dwindled to the second-lowest level in 50 years last month, as home builders sought to reduce the number of unsold inventories in an elusive quest to find the bottom of the historic housing collapse.
Single-Family Home Starts in U.S. Fall to 26-Year Low, Building Permits Plunge
Housing starts in the U.S. fell more than forecast in September as construction of single-family homes plunged to the lowest level in a quarter century, indicating the real-estate slump intensified even before the recent credit meltdown. Construction began on 817,000 houses last month, down 6.3 percent from August's 872,000 level that was lower than previously estimated, the Commerce Department said in Washington. Building permits, a sign of future construction, dropped 8.3 percent to 786,000 pace, the lowest level since November 1981.
Builders will find it difficult to lure buyers into the market after stock prices plunged this month and banks made it harder to qualify for a mortgage. Declines in construction are likely to continue to hurt economic growth well into 2009, extending the housing slump into a fourth year. "The full impact from the financial meltdown is yet to come," said David Sloan, a senior economist at 4Cast Inc. in New York, whose estimate matched the lowest in the Bloomberg survey. "Housing will be a drag on growth into the middle of next year. The bottom is now looking further away than it did previously."
Starts were projected to fall to an 872,000 annual pace from a previously estimated 895,000 million in August, according to the median forecast of 74 economists polled by Bloomberg News. Estimates ranged from 840,000 to 935,000. Compared to September 2007, work began on 31 percent fewer homes. Construction of single-family homes dropped 12 percent to a 544,000 rate, the fewest since February 1982. Work on multifamily homes, such as townhouses and apartment buildings, climbed 7.5 percent from the prior month to an annual rate of 273,000.
Starts of single-family houses dropped to record lows in three of four regions in September, led by a 24 percent slump in the Midwest. The biggest housing slump in a generation was showing signs of nearing a bottom when financial markets began to implode in September, leading to the government takeover of mortgage lenders Freddie Mac and Fannie Mae, the failure of banks and a $700 billion government rescue plan this month. Recent events are likely delaying any return to stability.
"These things are putting a new nail" in the housing market's coffin, David Seiders, chief economist at the National Association of Homebuilders, said in an interview on Bloomberg Television yesterday. "this sort of vicious feedback loop is still in play." The National Association of Home Builders/Wells Fargo index of builder confidence decreased in October to its lowest since 1985, the Washington-based association said yesterday.
Combined sales of new and existing homes have fallen 36 percent from their peaks in mid-2005. Home construction has declined 64 percent from a peak in January 2006. The supply of unsold homes on the market remains above 10 months' worth of sales, signaling homebuilding is likely to continue falling.
Home prices in major cities are down an average of 20 percent from mid-2006, after nearly doubling in the prior six years, according to the S&P/Case Shiller index of 20 metropolitan areas. Falling prices are contributing to the jump in foreclosures as Americans, trying to refinance adjustable-rate loans, find out they owe more than their homes are worth. The drop in prices also means owners can't tap home equity for extra cash, one reason behind the slowdown in consumer spending.
Homebuilders are still reeling. Lennar Corp., the second- largest U.S. homebuilder, on Sept. 23 reported its sixth straight quarterly loss as potential buyers struggled to get mortgages and rising foreclosures increased the supply of homes on the market. "The weakness in the market actually accelerated as a result of increased foreclosures, weakened consumer confidence and tightened mortgage lending standards," Chief Executive Officer Stuart Miller said in a statement.
Slowing Inflation Opens the Door For Fed to Cut Interest Rates Further
With U.S. consumer price inflation receding, the Federal Reserve has additional leeway to reduce interest rates further in the weeks ahead, though Fed officials currently don't see more rate cuts as a clear choice.
The U.S. consumer-price index was unchanged in September, the Labor Department said Thursday, after falling in August for the first time in almost two years. Excluding volatile food and energy prices, so-called core consumer prices -- which are believed to give a more stable reading of inflation -- advanced just 0.1% last month. And the year-over-year rate of inflation, at 4.9%, is coming down from high levels reached this summer.
There was widespread softness in pricing. Transportation prices fell 0.6% as airline fares and new-car prices dropped. Housing, which accounts for 40% of the consumer-price index, fell 0.1% for a second straight month, the first back-to-back declines since 2001. Clothing prices fell 0.1% for the month. Other signs of economic weakness are building, including a report by the Fed on Thursday that U.S. industrial production dropped sharply in September.
The inflation readings underscore a growing belief inside the Fed that inflation pressures are easing, as many senior officials expected earlier this year. Indeed, financial shocks like the one the U.S. is experiencing could eventually lead to the opposite of inflation -- deflation, or a broad decline in prices -- though that doesn't look like a serious risk, given the amount of stimulus going into the U.S. economy.
The Fed next meets on Oct. 28-29. U.S. futures markets put high odds of at least a quarter-point interest-rate cut by the Fed at its next meeting. With inflation a diminishing concern, Fed officials are weighing other questions, including whether additional rate cuts will help much as a stimulus. As long as investors remain fearful of holding risky assets such as junk bonds or mortgage-backed securities, a reduction in the Fed's target federal-funds rate is likely to have a muted impact on other borrowing rates that are important to businesses and consumers.
In speeches Wednesday, Fed Chairman Ben Bernanke and Vice Chairman Donald Kohn highlighted the intense risk aversion plaguing financial markets as the primary drag on economic growth, and thus their main concern. "The path of the economy will depend critically on how quickly the current stresses in financial markets abate," Mr. Kohn said in a speech in New York. "But these events have few, if any, precedents, and thus we can have even less confidence than usual in our economic forecasts."
Mr. Kohn noted that the low level of the fed-funds rate -- now at 1.5% -- will eventually help to stimulate growth. And officials believe their rate cuts have provided an important cushion to markets -- without them, interest rates on consumer and business loans would be much higher today. Fed officials also must weigh the impact of further rate cuts on market confidence. When the Fed, the European Central Bank, the Bank of England and several other central banks cut rates last week, they expected the move to help boost market confidence.
Instead, the Dow Jones Industrial Average fell 2% that day and investors continued to flee from risky assets, driving U.S. officials to the broader bank-rescue program announced earlier this week. Within the ECB's 21-member Governing Council, there was some surprise that the coordinated cuts didn't impress the market. Unlike the Fed, the ECB had kept its key rate steady throughout much of the crisis, and raised it to a seven-year high of 4.25% in July. Euro-zone interest rates have room to fall from their current 3.75% if ECB policy makers feel that economic and inflation threats warrant steeper cuts.
On the inflation front, Fed officials have noted that expectations for future inflation -- as measured by consumer surveys and financial markets -- are receding. Prices of key commodities such as oil and copper have been falling since September. Crude futures Thursday fell to below $70 per barrel for the first time since August 2007.
"If sustained, the recent declines in commodity prices should soon lead to a sharp reduction in headline inflation," Mr. Kohn said. "In addition, I expect core inflation to slow from current levels as lower commodity prices and greater economic slack moderate upward pressures on costs." The Fed's industrial production report showed that industrial output decreased 2.8% in September, the worst drop in almost 34 years. One-time events, including hurricanes Gustav and Ike and the Boeing Co. machinists' strike, contributed to the decline.
Fears of Lehman's CDS derivatives haunt markets
It is a full week after bankers gathered in New York to start sorting out the derivatives mess left by the bankruptcy of Lehman Brothers. We still do not know who is on the hook for some $360bn of default insurance, or how much they will have to pay.
Ominous talk of big names and big sums continues to haunt global markets, thwarting efforts by the US and European authorities to unlock inter-bank lending. Traders have noted with acute interest that insurer AIG - now nationalised - says it will need another $38bn from the US government, on top of the $85bn bail-out it has already received. AIG is the world's biggest underwriter of credit protection.
Those on the wrong side of these Lehman debt contracts - known as credit default swaps (CDS) - must come up with the money by Tuesday, the next D-Day in the ever-fraught calendar of the credit markets. There has been a deafening silence so far. There is no easy way of finding out who they are, so every bank and insurer is suspect. The $55,000bn CDS market is "completely lacking in transparency and completely unregulated" in the words of Chris Cox, the chairman of the US Securities and Exchange Commission.
The settlement auction on Lehman CDS contracts last week was in itself a bombshell. Creditors retrieved just nine cents on the dollar from the Lehman wreckage. As Naked Capitalism put it, the bank had "vaporised". The biggest players at the auction were Goldman Sachs and Deutsche Bank but they were almost certainly transacting for clients. The insurers of the debt -- a third are hedge funds -- will have to pay 91pc of the $400bn in contracts.
The Depository Trust and Clearing Corporation says the risks have been exaggerated in headline scare stories, insisting that the total sum to be paid will be closer to $6bn. It says most positions are "netted out". "That's not credible," says Andrea Cicione, credit chief at BNP Paribas. "They keep coming up with these number by 'netting' but we think the amount is going to anywhere from $220bn to $270bn. The chain broke in the CDS market when Lehman Brothers went down. We may now see other counter-parties defaulting," he said.
With hindsight, it is now clear the decision to let Lehman Brothers go bankrupt set off a melt-down of the world financial system, forcing North America, Britain, Europe, Australia, and now parts of Asia to rescue their banks. "A dramatic error," said Christine Lagarde, France's finance minister. US Federal Reserve chair Ben Bernanke said this week that Washington lacked the legal power to take on the vast liabilties stemming from a Lehman rescue.
"A public-sector solution for Lehman proved infeasible, as the firm could not post sufficient collateral to provide reasonable assurance that a loan from the Federal Reserve would be repaid, and the Treasury did not have the authority to absorb billions of dollars of expected losses to facilitate Lehman's acquisition by another firm. Consequently, little could be done," he said. The new legislation passed by Congress "will give us better choices."
In truth, both Congress and the US public wanted a scalp. Treasury Secretary Hank Paulson had to bide his time until it was clear to almost everybody that a domino collapse of the US banking system would lead to catastrophe. The Lehman collapse did the trick. The list of companies admitting to losses on Lehman investments reveals the global extent of the damage. Dexia held €500m of bonds, which may have caused its own need for a Franco-Belgian rescue days later.
Among the others with declared exposure: Swedbank $1.2bn; Freddie Mac $1.2bn; State Street $1bn; Allianz €400m; BNP Paribas €400m; AXA €300m; Intesa Sanpaolo €260m; Raffeissen Bank €252m; Unicredit €120m; ING €100m; Danske Bank $100m; Aviva £270m; Australia and New Zealand Bank $120m; Mistubishi $235m; China Citic Bank $76m; China Construction Bank $191m, Industrial Commercial Bank of China $152m and Bank of China $76m. Ultimately, some money may be recovered.
These losses are out in the open, but the CDS shoe has yet to drop. Perversely the insured volume is greater than the $150bn total of Lehman debt. Some $400bn of CDS contracts were sold. Many were used by hedge funds to take "short" bets on the fate of the bank. The contracts nevertheless have to be honoured. Chris Whalen, head of Institutional Risk Analytics, says this creates a huge moral dilemna. Why should taxpayers now responsible for AIG foot the bill for huge windfall transfers to hedge funds?
"We need to shut this whole thing down. The people who don't own the underlying collateral and were just betting should be flushed away. It would be grotesque if the US authorities were now to subsidize speculators. The US political class is waking up to this," he said. If so, the winners may have more trouble than they realize collecting their prize.
Lehman Is Focus of Three U.S. Grand Jury Probes, 12 Subpoenas
Lehman Brothers Holdings Inc., which last month filed the largest bankruptcy in history, is the subject of three federal criminal probes and at least 12 subpoenas, according to a lawyer for the failed bank.
"We are facing three grand jury investigations," said lead Lehman bankruptcy lawyer Harvey Miller yesterday in Manhattan federal court. The probes, launched by the New York U.S. attorneys in Brooklyn and Manhattan as well as in Newark, New Jersey, are focusing in part on Lehman's role in the $330 billion auction rate securities market and possible crimes associated with the New York-based bank's $6 billion June stock issue, according to a person familiar with the case.
The New York Post reported today that Lehman Chief Executive Officer Richard Fuld is among the 12 subpoenaed, without saying where it got the information. Miller declined to immediately comment on whether Fuld was among those subpoenaed. Investigators have subpoenaed Ernst & Young LLP, Lehman's auditor; U.K.-based bank Barclays Plc, which bought Lehman's North American brokerage; and the New Jersey Division of Investments, which runs a pension fund that lost $115.6 million on a $180 million investment in the June stock sale, according to people familiar with the case. It's not clear whether these subpoenas are part of the 12 noted by Miller.
Lehman sought bankruptcy protection on Sept. 15 with debt of $613 billion. Its demise helped accelerate a global credit crisis that wiped out $30 trillion of equity value in the past year. Triggered by bankruptcies or stock losses linked to the financial collapse, the U.S. has begun investigations of mortgage lending, securitization and failed banks including Lehman. Nationally, the FBI is looking into 26 firms, including American International Group Inc., a senior law-enforcement official said.
Garcia, along with Brooklyn U.S. Attorney Benton Campbell, and Newark, New Jersey U.S. Attorney Christopher Christie, have increased their resources to prepare for possible prosecutions associated with the credit crisis and subsequent bank failures. Christie has subpoenaed documents to determine whether Lehman failed to fully disclose its eroding financial condition at the time of the $6 billion stock offering, according to people familiar with the matter. Campbell has opened inquiries into whether Lehman executives misled investors about the firm's financial health and whether Zurich-based UBS AG lied to investors about securities backed by subprime mortgages, according to a person familiar with the case.
Also subpoenaed by federal prosecutors were Putnam Investments LLC, the Boston-based mutual fund firm that oversees about $163 billion and bought Lehman bonds and shares; New York- based fund manager BlackRock Inc., a Lehman creditor; AIG, once the world's largest insurer; and C.V. Starr & Co., which is run by ex-AIG CEO Maurice Greenberg, according to the people. The grand jury probes follow not only the implosion of Lehman, but the collapse of Bear Stearns Cos. earlier this year, the U.S. government takeover of Fannie Mae and Freddie Mac and the rescue of New York-based AIG.
On the issue of auction rate securities, the grand juries may be exploring whether Lehman misled investors about the viability of the securities. The market collapsed in February after demand for the debt dried up. Banks paid to manage bidding on the debt abandoned the market and stopped acting as buyers of last resort. That caused rates to rise to as high as 20 percent.
Last month, Brooklyn prosecutors charged two former Credit Suisse Group Inc. traders with fraudulently selling corporate clients more than $1 billion of auction-rate securities linked to subprime mortgages, which they claimed were backed by U.S. guaranteed student loans. Interest rates on auction-rate debt are set through periodic bidding. When there aren't enough prospective purchasers, the securities reset based on a formula or revert to a rate specified at the time the securities were initially sold.
Fed's Discount Window Loans Rise to $101.9 Billion
The Federal Reserve's direct loans to commercial banks rose to a record $101.9 billion yesterday versus $98.1 billion a week earlier as still-high money market rates encouraged more borrowing from the lender of last resort. Borrowing by securities firms through the Fed's Primary Dealer Credit Facility totaled $133.9 billion, up from $123 billion, the central bank said today in its weekly report.
"The ability to borrow 90-day funds at 1.75 percent is a good deal for a lot of banks," said Michael Feroli, economist at JPMorgan Chase & Co. "The stigma of borrowing from the Fed is declining." The Federal Reserve, the European Central Bank and four other central banks lowered interest rates in an unprecedented coordinated effort to head off the economic impact of a worldwide panic in credit markets on Oct. 8. Central bankers are also flooding banks with temporary loans in an effort to overcome cash hoarding by banks. Outstanding loans under the Fed's term auction facility rose to $263 billion yesterday from $149 billion last week.
Money market rates are starting to ease. The London interbank offered rate, or Libor, that banks charge each other for three-month loans in dollars declined for a fourth day to 4.5 percent, down from 4.75 percent a week ago, the British Bankers' Association said. The federal funds rate stands at 1.5 percent, and the discount rate is set at 1.75 percent. Average daily discount window borrowing was $99.7 billion during the week ended Oct. 15, up $24.6 billion.
In an effort to restore confidence, the U.S. Treasury plans to inject $250 billion into banks, and the Federal Deposit Insurance Corp. announced a temporary guarantee of senior unsecured debt of banks. Under an emergency lending program to help money-market funds, banks borrowed $122.8 billion as of yesterday to buy asset-backed commercial paper, down from $139.5 billion a week ago.
Fed loans to American International Group Inc., the largest U.S. insurer, rose to $82.9 billion from $70.3 billion. The Fed agreed Sept. 16 to rescue AIG with an $85 billion loan in return for an 80 percent stake for the U.S. government. The Fed also will provide as much as $37.8 billion in additional liquidity to AIG. The Fed also reported that the M2 money supply fell by $31.9 billion in the week ended Oct. 6. That left M2 growing at an annual rate of 5.9 percent for the past 52 weeks, above the target of 5 percent the Fed once set for maximum growth. The Fed no longer has a formal target.
The Fed reports two measures of the money supply each week. M1 includes all currency held by consumers and companies for spending, money held in checking accounts and travelers checks. M2, the more widely followed, adds savings and private holdings in money market mutual funds. During the latest reporting week, M1 fell by $44.8 billion. Over the past 52 weeks, M1 increased 3.8 percent. The Fed no longer publishes figures for M3.
A month or so ago, when asked by Rep. Barney Frank (D-Mass) whether he had the $85 billion necessary to rescue AIG, Fed Chief Ben Bernanke reportedly replied, "I have $800 billion". According to a recent report and as shown quite graphically below, he might need a lot more than that in short order.
According to a report by Merrill Lynch's David Rosenberg, the Fed's balance sheet might reach as high as $3 trillion by the end of the year.Given the announced increase in the TAF program, unlimited swap lines and modest growth in other segments of the asset side of the Fed’s balance sheet we could see it hit $3 trillion over year end. This would represent an 84% increase on top of the growth in assets we have already seen in 2008.
He goes on to talk about "excess reserves" and their relationship to assets held by the central bank but, to be honest, my brain just kind of shut down when I saw that chart.
UK interest rates to hit lowest level since 1694
The Bank of England faces cutting borrowing costs to beneath two per cent - or even as low as one per cent - within months as it battles to protect Britain from the financial crisis and the worst recession in decades, economists said. Such a drastic move would bring rates, currently 4.5 per cent, to their lowest level since the Bank was founded in 1694.
The rate cut would be good news for borrowers, who have faced sharp increases in their mortgage rates as embattled banks have raised the cost of borrowing in recent months. However, it would be a blow for Britain's savers, who have seen their almost £1 trillion worth of deposits eroded by 16-year high inflation. The forecast came on a turbulent day for world markets, as leading shares in London dropped to their lowest level since the time of the Iraq War in early 2003, amid growing fears that the financial crisis has not been overcome.
There is growing consternation that, in the wake of the financial turmoil, the Western world is slipping into a serious economic slump. In the US the Dow Jones Industrial Average veered sharply after it emerged that American manufacturing output plunged at the fastest rate in 34 years. Shares in Britain's biggest insurers including Prudential, Legal & General and Aviva fell by as much as a fifth as concerns grew that they could prove the next victims of the crisis.
Meanwhile, worries mounted that the £2 trillion international bail-out of the banking system had been ineffective, as banks are still unwilling to lend money to each other. Despite Gordon Brown's £500 billion bail-out of high street banks the cost of wholesale borrowing has failed to drop back to more reasonable levels. Such is the scale of the crisis that economists said that the Bank may now be forced into dramatic cuts in its key interest rate in order to prevent the probable recession from escalating into a longer-lasting depression.
Roger Bootle, managing director of Capital Economics and a former Treasury adviser, said the Bank's Monetary Policy Committee may have to cut rates to below two per cent. "It is critical to get rates lower - if the medicine is not working you have to use a stronger dose," he said. "[The Bank] needs to get rates down far and fast. "They need to be pretty bold. The lowest rates have ever gone is two per cent. They could easily go lower than that now - why not? After all the Federal Reserve [in the US] dropped rates to one per cent."
He said that even such a dramatic move, alongside the recent part-nationalisation of UK banks, would not guarantee solving the financial crisis, although it would increase the chances of recovery afterwards. The Government was warned this week that unemployment could rise to three million in the coming years after the jobless total jumped by the fastest rate since the 1991 recession. Homeowners were also warned that, even if they are among the third of households with a tracker mortgage which follows the Bank's rate, they may not benefit if rates fall to such a low level.
Most mortgage lenders, including Halifax and Nationwide, tend to prevent their tracker mortgage rates from being cut further once the Bank's base rate drops below 3 per cent or 2.75 per cent. The Bank surprised the City with an emergency half percentage point rate cut last Wednesday, and is widely expected to reduce rates again at its next meeting early next month.
Alan Clarke of BNP Paribas said it may have to cut rates by even more than half a percentage point. He added that although he expects rates to be cut to 2.5 per cent by May, there is a chance that they could have to drop to two per cent or below in the same timeframe. "One per cent or lower is not impossible," he added. "The important trigger is the labour market: unemployment over say eight per cent would be a disaster."
Tim Congdon, the prominent economist who was one of the few to warn last year that inflation could rise towards five per cent, agreed that borrowing costs could have to drop to around two per cent. The threat posed by high inflation has receded in recent months, as food and oil prices have dropped sharply. At below $70 a barrel, the crude price is now less than half the level it hit at its peak earlier this year, while wheat prices are a third of their peak price.
Many economists now expect inflation to drop to beneath the Bank's two per cent target by next year. Five years ago, as share prices hit the trough of the dot-com slump, the Bank cut borrowing costs to 3.5 per cent. The lowest they hit before then was for the 25 years following the Great Depression, when they were kept fixed at two per cent.
Paulson plan drives up US mortgage rates
US mortgage rates have soared this week in an unexpected reaction to the latest Treasury financial rescue plan, which has prompted investors to buy bank debt and sell bonds backed by home loans. Interest rates on 30-year fixed-rate mortgages, as measured by Bankrate.com, rose to 6.38 per cent on Thursday from 5.87 per cent last week - before the Treasury said on Tuesday that it would take equity stakes in banks and guarantee new bank debt.
Investors responded to the new guarantee by buying existing bank debt, reckoning it could be refinanced with the new government-supported bonds. As they did so, they sold lower-yielding paper issued by Fannie Mae and Freddie Mac, the mortgage companies put into government conservatorship last month. The sales of Fannie and Freddie paper pushed up yields on their debt, which is backed by mortgages. This, in turn, pushed mortgage rates to levels not seen since the government took over Fannie and Freddie on September 7.
Fannie and Freddie had been taken into conservatorship by their regulator to help keep mortgage rates low and – it was hoped – revive the housing market. However, the opposite is now happening, making it more difficult for struggling homeowners to refinance their mortgages and for prospective homebuyers to get financing. As a result, house prices may fall further before they find a bottom.
“Agencies (debt issued by Fannie and Freddie) have been under huge liquidation pressure in recent days,” said Bill O’Donnell, strategist at UBS. “The 30-year mortgage rate leapt higher by almost 50 basis points in the latest week – likely pressuring home prices even lower in the weeks ahead, at least.” Some analysts believe that further government intervention in the housing sector could be forthcoming to push down the cost of borrowing and help prices recover.
“Weak housing remains at the heart of the economic and financial turmoil, and the policy imperative will remain improving housing affordability,” said Janaki Rao, analyst at Morgan Stanley. “The possibility of a policy response to what is obviously an unacceptable outcome for policymakers has increased, in our opinion.”
The conservatorship brought down the cost of funding for Fannie and Freddie by making explicit a previously implicit government guarantee of their debt, allowing them to buy more mortgages. Before they were taken over, the fragile state of their finances had limited Fannie and Freddie’s participation in the mortgage market.
Ambac, Bond Insurers Seek Government Bail-Out
Ambac Financial Group Inc. and other bond insurers are working on a plan to send to the U.S. Treasury that would enable them to sell troubled assets to the government, Chief Executive Officer Michael Callen said. The companies also may present a proposal next week that would allow the insurers to guarantee some assets with government backing, Callen said in an interview today.
"We're working hard to put together a proposal and it's got to be an industry proposal," Callen said. "We don't have a lot of time." The Treasury's $700 billion program to buy troubled assets may allow the two guarantors to dispose of bonds backing collateralized debt obligations that they guaranteed, Royal Bank of Scotland Plc analyst Michael Cox said in a research report. Banks also may be more willing to cancel credit-default swap contracts they bought from bond insurers if the banks can sell the underlying CDOs to the government, Cox wrote.
Callen said he isn't asking Treasury to take a stake in Ambac. "We're not going to be asking the government to give us a big gift," Callen said. The Treasury yesterday said it isn't considering buying equity holdings in bond insurers. "That's not an idea we're focused on or pursuing." Treasury spokeswoman Jennifer Zuccarelli said in an e-mail to Bloomberg News.
Bond insurers also may participate in the government's program to stabilize financial markets by guaranteeing securities on bank balance sheets, Callen said. Bond insurers would guarantee securities, agreeing to take the first losses in a default, with the government acting as a backstop, Callen said. Such a plan would allow the securities to trade at their full face value, unlocking "the liquidity trap that these assets find themselves in."
Bond insurers' participation in the government's program to stabilize the financial system is important because of their role in the $2.66 trillion municipal bond market, he said. "We need a municipal market that works better than it does," Callen said. By one estimate, the cost of funding for cities and states has risen by $5 billion since the bond insurers suffered a collapse of confidence, he said.
Five of seven bond insurers, including MBIA Inc. and Ambac, lost their top AAA ratings this year as losses surged on securities linked to subprime mortgages. As the insurers' ratings collapsed, cities and states saw the value of their bonds drop and banks that had purchased protection against a decline in the securities they held were forced to take writedowns. "Even a significant capital injection would likely not be enough to restore confidence" in bond insurers, Royal Bank of Scotland's Cox wrote. It's also not clear that bond insurance on bank assets will be needed now that governments have agreed to add capital to banks, Cox wrote.
Treasury Has No Authority to Coerce the Banks: Fed’s Bill Poole
Last week, the Treasury's Troubled Assets Relief Program was itself in deep trouble, with observers harping on the administrative nightmare it would entail. On Tuesday, Treasury announced its program of direct purchases of bank stock. The capital-infusion program would be voluntary for the banks wanting to raise new capital this way. This approach was the right way to go. It promised to use federal resources in an effective and relatively market-friendly way.
But we've since learned from press reports, including in this newspaper, that the program was not quite so voluntary for nine of the nation's largest banks. The day before the government announced its new program, the heads of these banks apparently "volunteered" to sign up the way a soldier is "volunteered" for latrine duty. "Yes sir, sergeant, right away, sir."
To my knowledge, there is no statute that permits the U.S. government to require that a corporation sell stock to the government. Is Treasury so panicked by the financial crisis that it is willing to abandon normal democratic processes, such as acting under statutory powers?
The sad thing is that there is no need to strong-arm large banks; indeed, this tactic adds risk to the financial stabilization effort. Treasury's argument, as I understand it, is that it needs to require some participation in the capital-infusion program to avoid stigma. Because participation carries terms objectionable to banks, such as limits on executive compensation, only weak banks will want to participate willingly. If some banks participated and others did not, those who did would be in effect declaring they were weak and scaring away depositors and investors.
The stigma argument does carry some weight. But the way to deal with it is for participating banks to raise private capital as well as Treasury capital -- so that they can demonstrate that they are unquestionably solvent and strong. One way to demonstrate strength would be to hold capital clearly in excess of the regulatory minimum.
One risk posed by Treasury's less-than-voluntary approach: What if a courageous board of directors of one of the nine large banks doesn't agree to sell stock to the Treasury, despite the CEO's promise? After all, a board should be more than a rubber stamp for the CEO. What if a stockholder suit blocks a bank's participation? Then what? Would Treasury apply further turns of the extralegal screw to the recalcitrant bank?
If a bank hangs tough, we have some very rough times immediately ahead. If no bank resists, we have some tough times ahead for the longer run, because, large bank or small, the federal government is now beginning to walk down the path of credit allocation.
Treasury Secretary Hank Paulson was quoted by Bloomberg on Tuesday as saying that "leaving businesses and consumers without access to financing is totally unacceptable." Actually, it is perfectly acceptable to leave certain businesses and consumers without access to credit. Everyone understands that we would be a lot better off today if the market had denied mortgage credit to many subprime borrowers. Can federal direction as to which businesses and which consumers banks must serve be far behind -- even if not from this Treasury Secretary, then from his successor, or from elsewhere in the federal government?
Some banks need more capital not to expand lending, but to shore up the existing balance sheet. It would be a terrible mistake for Treasury to direct banks participating in its capital-infusion program to expand credit in particular directions, or in the aggregate. Exhibit A: Fannie Mae and Freddie Mac, both now wards of the state. Do we need further exhibits? Federal credit allocation will be an unmitigated disaster.
Banks will not want to play this game. Treasury's new program provides that a bank can exit by repurchasing Treasury shares with newly raised private capital. Given the program's distasteful features and future dangers, banks may want to exit as soon as they can to escape potential federal intrusion into their lending practices. Only weak banks, after all, may remain in the program -- a direct consequence of Treasury's strong-arm tactics. Such an outcome would be unfortunate, as many banks do need more capital.
Some will dismiss my comments as reflecting exaggerated concerns. I well remember, though, how those advocating wage-price guideposts in the 1960s dismissed fears of full-blown wage-price controls. But when comprehensive controls became politically convenient for President Richard Nixon, he imposed them in 1971.
We face the same issue with credit controls. Consider the temptation: Congress may now be able to force off-budget assistance to struggling homeowners and others through Treasury's capital-infusion program. Isn't it logical, members could argue, that participating banks, benefiting from taxpayer-provided capital, do their "fair share" of mortgage relief?
In managing the financial crisis, the worst may not happen -- and I hope it does not. But the arm-twisting applied to the nine large banks is a terrible precedent. The danger is that the financial mess will be turned into a larger, even more critical governmental mess as well.
William Poole was president and CEO of the Federal Reserve Bank of St. Louis from 1998 to March 2008.
Paulson's demand that all banks take cash doesn't hold water
Imagine that a person falls out of a boat. He is drowning, so someone throws him a life preserver. If he grabs the ring, he'll be safe; slightly embarrassed, but alive. If he does not grab it, he drowns. Ask 100 people what they would do, and 100 will say they would take the help. Unless, of course, some of them are bankers. Bankers would not take the help, because then everyone would know they can't swim.
At least, that's what Treasury Secretary Henry Paulson seems to think. When it came time to dole out $250 billion to help save the banking system this week, Paulson did not simply lend money to banks that needed it. Rather, he forced banks that did not need any help to take money, so as not to embarrass the banks that did need the money. JPMorgan Chase didn't want the money. Wells Fargo, neither. But both banks ultimately agreed to sign up for the Paulson plan.
We are in confusing times, and some fundamental economic beliefs are under attack. One of them is the notion that in any economy, the more freely information flows, the better. And yet, Paulson has launched the bank bailout program with a reverse kind of logic. In lending billions of dollars merely so some banks can try to keep up appearances, he has miscalculated on a number of fronts.
For starters, a bank truly at risk of failure would readily accept federal cash. When Warren Buffett showed up with $5 billion, nobody at Goldman Sachs refused help for fear of damaging the firm's reputation. Why would federal funds be any different? The "Scarlet letter" problem—the stigma banks would suffer because they took Uncle Sam's largesse—is way overstated. After all, the feds shouldn't lend the funds unless it makes the bank healthy. So any bank that gets federal cash would, by definition, be strong. Reputation problem solved.
There is a scarcity issue too. Even with $700 billion at its disposal, the government needs to act prudently. Foisting money on banks that don't need it is a waste of limited resources. Listen to the banks that were pressured into this program, and it's clear they have misgivings. "We really saw this as doing something that is very good for the system," JPMorgan Chief Executive Jamie Dimon said in a conference call with analysts Wednesday. "It is equally true if you said there are asymmetric benefits, that this could be negative for JPMorgan versus our competitors."
It could be a negative for Paulson too. Because he attached strings to the money he lent, Paulson will be distracted monitoring healthy banks when he should be focused on the vital challenge of deciding which of the industry's giants can survive and which cannot. "To the extent the government is involved in the industry, it should be to facilitate helping strong banks acquire weak banks and putting the weak ones out of business," said banking consultant Bert Ely. By lending to all the banks, "Paulson is making an effort to try to convey an illusion of solvency that is no longer there." Banks that are under water may well need the government's life preserver. The strong ones should swim for themselves.
AIG Still Lobbies to Relax Oversight Rules
Even after receiving an emergency loan that gave the government an 80% ownership stake, American International Group Inc. is spending money to lobby states to soften new controls on the mortgage industry. When the U.S. took control of failing mortgage titans Fannie Mae and Freddie Mac, it prohibited them from lobbying. But it hasn't banned the practice at AIG, a huge insurer that is still 20%-owned by public shareholders.
AIG is currently working to ease some provisions in a new federal law establishing strict oversight of mortgage originators, according to state regulators. The law requires that originators be licensed by the states, and that they supply comprehensive information so state regulators can track their activities. The goal of the new rules is to hold originators accountable if they engage in the sorts of improper or fraudulent lending that ultimately contributed to AIG's downfall. The law was passed by Congress in July as part of a sweeping housing-industry rescue package.
On Sept. 16, the day of the federal takeover of AIG, company lobbyist Brett J. Ashton was meeting with Indiana banking regulators about the law, said Judith Ripley, director of the Indiana Department of Financial Institutions. Two weeks later, Mr. Ashton spent three days at a Hilton hotel in Beverly Hills, Calif., where he briefed other financial-services industry representatives on "key legislative and regulatory concerns."
Mr. Ashton referred questions about his activities to an AIG spokesman. "We are maintaining government-affairs activities," said Nick Ashooh, an AIG spokesman. "We're not the only financial-services company that has expressed concerns" about the new mortgage-lending oversight rules. "We're rebuilding value in AIG to pay back the Federal Reserve loan and to restore AIG as a vital, ongoing concern."
Separately, New York Attorney General Andrew Cuomo on Wednesday asked AIG to recover millions of dollars worth of "unreasonable" and "outrageous" payments it made to executives as the big insurer neared collapse -- or face legal action for violating state law. Mr. Cuomo is conducting a probe into allegedly "unwarranted and outrageous expenditures" at AIG.
Peter Tulupman, an AIG spokesman, said the attorney general's concerns "are immediately being brought to the attention of the board." He said the company last Friday issued a directive ending all activities "not absolutely essential to the conduct of our business." AIG owes its continued existence in its present form to more than $120 billion loaned to it by U.S. taxpayers. The government received its 80% equity stake in exchange for loaning AIG as much as $85 billion last month. Last week, the Fed extended another $38 billion in credit, believing the money is needed to prevent an AIG failure, which would reverberate through economies world-wide.
Some regulators are troubled that despite the injection of federal cash into AIG and other financial institutions, the industry is continuing its longstanding efforts to combat stronger control of its activities. "I find it disconcerting that there's still efforts to weaken our regulatory system, and that those efforts would be in any way subsidized by taxpayer dollars," said John W. Ryan, executive vice president of the Conference of State Bank Supervisors, one of the entities charged with implementing the federal law on mortgage-broker oversight, known as the SAFE Act.
Some state banking regulators have long pushed for the consumer protections afforded by the SAFE Act, short for the Secure and Fair Enforcement for Mortgage Licensing Act of 2008. AIG and its subsidiaries hold membership in several industry lobbying groups, where dues for companies its size total millions of dollars annually. The company spent more than $3 million on federal-government lobbying in the second quarter alone, and more at the state level. Members of Congress expressed outrage two weeks ago at a different AIG expenditure: more than $440,000 for a California spa outing for top business producers just days after AIG's government-funded rescue.
Before the federal takeover, AIG had contracts with a half-dozen outside lobby firms. One such firm, Ogilvy Government Relations, now represents a group of shareholders of the company. Those include former Chief Executive Maurice R. "Hank" Greenberg, who this week proposed more-favorable terms on the federal loan in a letter filed with the Securities and Exchange Commission.
Some financial institutions contend the SAFE Act's licensing fees and requirements are too expensive, and the extensive background information required about loan originators could violate their privacy. They further worry that the state-based system will prove too costly and cumbersome to be effective, and want more transparency over how licensing fees paid by the industry are spent by the states.
Regulators say they are working with the institutions to address those issues. But some of them say that AIG and other financial-services companies keep raising new objections to slow down the implementation, which, if not completed by the end of 2009, reverts to the federal government. "They're trying to reintroduce things that really are superfluous and get in the way of implementing the act," said Thomas Gronstal, Iowa's superintendent of banking. "Basically, they're just objecting to having to be regulated. ... I frankly think that takes a lot of gall, given what the industry has done and what we're trying to do."
Mr. Ashton is one of a half-dozen officials from AIG's American General Finance unit who sit on the mortgage-lending advisory board for the American Financial Services Association, which has lobbied heavily on the SAFE Act in Washington. Others on the advisory board include lobbyists for Citigroup Inc., Merrill Lynch & Co. and other companies battered by the mortgage-related crisis. Mr. Ashton has frequently briefed the AFSA and other Washington trade groups on the effort.
During the second quarter of 2008 -- the last full quarter before its takeover -- AIG spent at least double on federal lobbying by outside firms than most other financial-services conglomerates, including Merrill Lynch, Citigroup, Goldman Sachs Group Inc. and Lehman Brothers Holdings, according to congressional filings. "I would think it would be difficult to justify a sustained lobby budget of that magnitude in bailout mode," said Kenneth Gross, an attorney at Skadden, Arps, Slate, Meagher & Flom in Washington who advises lobbyists and their clients.
The $3 million AIG spent on outside federal lobbyists in the second quarter "is a lot for an entity under any circumstance," Mr. Gross said. "The industry norm is about half that."
Hungary signs €5 billion deal with ECB to keep euros flowing
The Hungarian government struck a deal Thursday to borrow up to €5 billion from the European Central Bank in a bid to avoid becoming - like Iceland - a national victim of the financial crisis. Hungary is feeling the effects of the credit crisis not because its banks invested in bad mortgages, but because the markets have dried up, depriving it of the ability to service debts denominated in currencies other than the Hungarian forint.
Because interest rates in Hungary are relatively high at 8.5 percent, the majority of borrowers have taken loans in Swiss francs, euros or other currencies with lower interest rates. Roughly 30 percent of Hungary's public debt and about 60 percent of loans to businesses and individuals are denominated in foreign currencies, making the country acutely vulnerable to a sinking forint. Hungary also suffers from high public debt and anemic economic growth, scaring risk-averse investors and leading them to take their money out of the country. That puts the forint under even more pressure.
Sandor Jobbagy, a financial analyst at CIB Bank in Budapest, said that by borrowing the equivalent of up to $6.7 billion from the ECB, and talking earlier to the International Monetary Fund, policy makers were trying to scare off "those speculating on weaker Hungarian currency, to show that we have strong external support." After a steep slide the previous day, the forint recovered some of its value Thursday, and was little changed against the euro and the dollar.
Andras Simor, governor of Central Bank of Hungary said the fundamentals of Hungarian economy have improved in the last two years. "That doesn't mean we should sit back and say 'Let's wait until the international environment gets better again,"' Simor said. "We have to adjust ourselves to the new environment, and that is exactly what we are doing." Though Hungary has solicited the advice of the IMF, it has resisted seeking money there, hoping to arrest the slide itself. "We maintain that this is a last resort," Janos Veres, the finance minister, said.
The ECB loan gives Hungary the means to meet its obligations directly even though harder currencies are flowing out, while tight credit markets mean that few banks want to put money into the country. But the loan comes at a price. The Hungarian central bank had to deposit collateral, denominated in euros, with the ECB. Addressing the underlying problems will be more difficult than taking a loan, analysts said.
Standard & Poor's, the ratings agency, put Hungary on review for a possible downgrade of its credit rating on Wednesday. Slower growth takes a bite out of government revenues, and any hint that they are allowing deficits to grow again would put pressure on the currency. The government has said it will withdraw planned tax cuts and look for cuts in government spending. The details of the new budget will be announced as soon as Saturday.
Hungary is in trouble because of overspending in the past. In 2006, the annual budget deficit reached 9.3 percent of the gross domestic product. While that is expected to fall to just 3.4 percent for 2008, the overall public debt is around 65 percent of gross domestic product. Because the country has a strongly export-driven economy, the worldwide slowdown will hit hard. The government revised its expectation for growth this year to 1.8 percent, from 2.4 percent.
A spokesman for the Hungarian Financial Supervisory Authority said they conducted a comprehensive survey of the financial sector and found extremely low exposure to the mortgage crisis. The agency said it was monitoring the Hungarian banks closely. "Figures show us day-to-day that the banks are stable, with more money paid in than they need to pay out," said Istvan Binder, the agency's spokesman. "The whole banking sector is in very good condition at the moment."
CDOs Imperiled by Collapse of Iceland Banks, S&P Says
Iceland's collapsed banks pose a "substantial" risk to collateralized debt obligations that made bets on corporate debt, according to Standard & Poor's.
Kaupthing Bank hf, Landsbanki Islands hf and Glitnir Bank hf were included in 376 CDOs worldwide, S&P said. Another 297 made bets on two of the three banks. The CDOs packaged credit-default swaps that pay investors if there is a default, and the government's placement of the banks into receivership triggered a settlement of the contracts.
Because the so-called synthetic CDOs also bet on Lehman Brothers Holdings Inc., which filed for bankruptcy on Sept. 15, and Washington Mutual Inc., the bankrupt holding company of the largest U.S. lender to fail, the "impact of these exposures is likely to be significant," S&P said in the statement yesterday.
KBC Group NV, Belgium's biggest financial-services company by market value, yesterday wrote down 1.6 billion euros ($2.15 billion) on its CDOs. Moody's Investors Service said Oct. 14 that it's reviewing 2.88 billion euros of the Brussels-based lenders' five CDOs linked to Icelandic banks.
Iceland's bank regulator took control of the country's three biggest lenders last week when they couldn't secure short-term funding on their about $61 billion of debt. The nation's benchmark stock index plunged 77 percent on Oct. 14, the biggest decline on record, after trading resumed following a three-day suspension.
The cost of hedging against default by the Icelandic government has soared to 948 basis points, according to CMA Datavision prices for credit-default swaps. That means it costs 948,000 euros a year to insure 10 million euros of debt for five years. It compares with 118 basis points for the Czech Republic and 238 basis points for Morocco.
Sellers of credit-default swap protection must pay the buyer face value in exchange for the underlying securities or the cash equivalent after a bankruptcy filing. Many of the deals also will lose payments and loss cushions from contracts linked to Fannie Mae and Freddie Mac, the mortgage-finance companies seized by the U.S. government last month. The takeovers caused a technical default on the credit swaps.
The CDOs sell notes to investors that are repaid using the proceeds of credit-default swap premiums. Credit-default swaps are financial instruments based on bonds and loans that are used to speculate on a company's ability to repay debt. The cost of protecting corporate bonds from default rose today on investor concern a global recession will sap earnings and companies' ability to repay their debt.
The benchmark Markit iTraxx Crossover Index of 50 European companies with mostly high-risk, high-yield credit ratings jumped 23 basis points to 737, according to JPMorgan Chase & Co. prices at 9:32 a.m. in London. In Tokyo, the iTraxx Japan climbed 23 basis points to 208, Morgan Stanley prices show.
Hedge fund squeeze wreaks havoc in equity markets
The move has pushed some funds closer to the brink and triggered yet more havoc in global stock markets. The bankers say that the wild swings in stock prices across the globe has radically increased their risk, forcing them to demand as much as five times more collateral from the hedge funds.
The extra demand has left funds scrambling to find the extra cash or collateral, forcing many to sell other positions to fund their more important ones. One hedge fund said: "One of our positions is a blue chip firm for which we have normally put up just 5pc cash [while the bank funds the remaining position]. Yesterday we got a call saying we had to put up 50pc margin. We're already tight on the line and had to quickly sell stock to fund it. And this was just one position."
A prime broker said: "The volatility in the market over the past few days has been extraordinary. Huge stocks have been swinging by 40pc a day – Morgan Stanley went down 85pc in one day. We can't handle this sort of risk without passing it on, even though we know it's causing more volatility." Another prime broker said: "We've had to hike the margins in times of stress before so this shouldn't have come as a surprise.
The clever ones are already in cash so it hasn't affected them. The problem has been caused by those holding illiquid assets that they can't sell. This means their having to sell their better positions to get the cash together." The expense had added to the mounting squeeze being felt across the high-rolling hedge fund sector. Over the past month many hundreds of hedge funds have been caught up in the collapse of Lehman Brothers, one of the biggest prime brokers. The freezing of the assets and failure of trades at Lehman has forced many funds to cover their exposures elsewhere.
A group of the largest US hedge funds has called on the Bank of England to intervene to free an estimated $65bn (£38bn) of Lehman's assets that are frozen in London. The funds, through the Managed Funds Association, said the scale of the problem was so great that it could undermine bank rescue plans as tens of billions of dollars would be kept out of the market and other funds would fail.
The warnings come as hedge funds have been quietly shifting billions of dollars of assets out of London to the US, claiming that the US legal system provides greater protection.
Caisse d'Epargne Reports $800 Million Derivatives Loss
Groupe Caisse d'Epargne, the French customer-owned bank in merger talks with Groupe Banque Populaire, reported a 600 million-euro ($807 million) loss on equity derivatives after stock markets plunged last week. The loss occurred at the proprietary-trading unit of Caisse Nationale des Caisses d'Epargne, the lender's holding company, the Paris-based bank said today.
The team of about half a dozen people exceeded trading limits in terms of size and risk, said an official at Caisse d'Epargne. European stocks last week slid 22 percent, driving the Dow Jones Stoxx 600 Index to its worst week on record, on concern the deepening credit crisis will push the economy into a recession. The equity derivatives losses don't affect the "financial solidity" of Caisse d'Epargne, which has more than 20 billion euros of shareholders' equity, the company said. The stock market plunge may have led to losses at other banks.
"Everyone will have incurred big losses because of market volatility," said Bahadour Moussa, a consultant specializing in derivatives recruitment at London-based Pelham International. "A lot of the banks will have positions they can't unwind or shift and that are losing money, and when the time's up, they'll have to publish losses."
Banks in Europe and the U.S. are also grappling with the impact of the global credit crisis. The French government this week announced plans to loan as much as 320 billion euros to banks to unlock lending and to spend as much as 40 billion euros on equity stakes in financial companies, if needed.
Caisse d'Epargne and Banque Populaire started merger talks last week, with the encouragement of the French state, as the financial crisis put pressure on banks to combine. The banks are the main shareholders of Natixis SA, the Paris-based investment bank that piled up about 3.9 billion of writedowns tied to the U.S. subprime mortgage market collapse by June 30.
The loss doesn't affect the merger plan between the holding companies of Caisse d'Epargne and Banque Populaire, the official said. A deputy of Julien Carmona, Caisse d'Epargne's head of finance and risk management, has been suspended because of the loss and the bank is pursuing "sanctions" against the members of the proprietary-trading desk, he said.
French Finance Minister Christine Lagarde, in a statement, said the losses don't threaten the financial strength of Caisse d'Epargne. She asked the French banking commission to carry out an inquiry into the trades, and to ensure that French banks are complying with market controls. The announcement comes about nine months after Societe Generale SA, France's second-largest bank by market value, reported a 4.9 billion-euro trading loss because of unauthorized bets by Jerome Kerviel.
Caisse d'Epargne and Banque Populaire formed Paris-based Natixis in 2006 by merging their investment-banking and asset- management businesses. They own about 34.5 percent each in Natixis and agreed on Sept. 29 that they may raise their holdings by as much as 2 percent each. Natixis said in July that it plans a "strong reduction" of its proprietary-trading business as it cuts 850 jobs and trims costs by 400 million euros in 2009 to restore profitability.
French banks had at least 18 billion euros of writedowns and provisions so far stemming from the collapse of U.S. mortgages. Natixis fell 6 cents, or 2.9 percent, to 2 euros by 1:47 p.m. in Paris trading, bringing this year's decline to 77 percent. Caisse d'Epargne, formed by 21 member banks, is France's third-largest consumer banking network by branches, with 4,770 agencies. Caisse d'Epargne had 358 billion euros of savings and deposits at the end of 2007. Derivatives are financial instruments derived from stocks, bonds, loans, currencies and commodities, or linked to specific events like changes in the weather or interest rates.
UBS Seeks to Stem Outflows After Shedding Toxic Debt
UBS AG, the European bank with the biggest losses from the global credit crisis, is getting rid of its toxic assets. The next challenge will be to stem an exodus of wealthy clients. UBS said yesterday that the Swiss government and central bank will provide a $59.2 billion aid package to take risky debt securities off its balance sheet. Zurich-based UBS also reported that wealthy clients withdrew about 66 billion francs ($58 billion) in the third quarter.
"The big question is whether high net worth individuals are willing to stay with an institution incapable of surviving on its own," said Bernhard Bauhofer, founder of Swiss consulting firm Sparring Partners GmbH and author of "Reputation Management." Asset outflows mean bankers leave, "customer service declines and it becomes a vicious circle that no one wants to be associated with."
While customers at UBS, the world's biggest manager of money for the rich, are pulling funds, smaller rival Credit Suisse Group AG attracted about 14 billion francs from private clients during the third quarter. In Switzerland, UBS clients withdrew 12.6 billion francs in the three months through September. By contrast, state-owned Zuercher Kantonalbank reported inflows of about 1 billion francs per month this year. "It is indeed obviously the one key concern we have," UBS Chief Executive Officer Marcel Rohner said of client withdrawals on a conference call yesterday. "We've laid the foundation to turn it around."
The bank, which managed 1.93 trillion francs of assets for wealthy clients at the end of September, saw outflows in all regions in the third quarter, with the U.S. business losing about 10 billion francs. In total, the wealth management and business banking unit's clients withdrew 49.3 billion francs, and affluent customers accounted for about half of 34.4 billion francs in outflows in asset management, Rohner said.
By comparison, Merrill Lynch & Co., the third-biggest manager of money for the rich, said yesterday that clients pulled a net $3 billion from its global wealth management unit, primarily because of "persistent volatility and negative market movements during the quarter."
Javier Lodeiro, an analyst at Bank Sal Oppenheim in Zurich, described the client redemptions at UBS as "a cold shower." "They thought wealth management could lose even more if they didn't do something, and having a healthy balance sheet may help retain talent in the business," he said. Still, Lodeiro doesn't expect UBS to attract new money next year.
UBS has lost client advisers at its wealth unit. Seven of 33 advisers and three assistants at its St. Moritz office left to competitors including Julius Baer Holding AG. In the U.K, 18 advisers and 32 supporting employees joined London-based Vestra Wealth LLP. Such departures may lead to more client redemptions in the fourth quarter and beyond as private bankers become free under severance contracts to join other firms and take clients with them, Bank Sarasin Chief Executive Officer Joachim Straehle said in an interview last month.
UBS said Sept. 30 it hired Philippe Tschannen as head of executive recruitment, a new position, to find more wealth managers and help stem withdrawals by rich clients. The bank also hired 26 Lehman Brothers Holdings Inc. investment advisers to manage about $10.9 billion for clients from offices in New York, Los Angeles and San Francisco.
Swiss clients have increasingly turned to state-owned institutions, such as Zuercher Kantonalbank, which added 8.5 billion francs in new assets in the first eight months of this year, compared with 2 billion francs for all of 2007. Clients seeking to open an account last week at ZKB's central branch on Bahnhofstrasse in Zurich, a block from UBS's headquarters, had to wait as long as an hour. "We don't know what to do with all the money right now," ZKB spokesman Urs Ackermann said.
At UBS, wrong-way bets at its investment-banking unit led to $48.6 billion of credit losses and writedowns since the start of last year, the most by any bank in Europe. It had to raise fresh capital three times in a less than a year. "The next six months will be critical for UBS," Derek De Vries, a London-based analyst at Merrill Lynch & Co., said in a note to clients, adding that he had expected 5 billion francs of outflows. "Having gotten rid of its legacy assets, UBS has to show that it can stop the outflows."
China to help Pakistan out of economic crisis
China has assured Pakistan of help to get out of its economic crisis, the Pakistani ambassador to Beijing said on Friday, but he gave no details and did not say if China had agreed to urgently needed new loans. Pakistan, a nuclear-armed U.S. ally, is struggling to come to grips with a financial crisis. Islamabad's rapidly dwindling foreign reserves are at their lowest level since 2002.
It needs $3 billion to $4 billion or it risks defaulting on a $500 million bond due to mature in February, economists say.
President Asif Ali Zardari, the widower of former prime minister Benazir Bhutto, ended a four-day visit to China on Friday during which Premier Wen Jiabao pledged cooperation.
"There will be a negative impact on Pakistan of the world financial crisis. We have to make efforts ourselves but China has assured us, and they will help us to come out of this crisis," said Masood Khan, Pakistan's ambassador to China. The Washington Post said on Thursday Pakistan was seeking up to $3 billion from China. The Financial Times reported earlier that Zardari hoped to secure concessional loans of $500 million to $1.5 billion.
"There has always been cooperation between Pakistan and China in a specific framework, and this time too we have made efforts to increase bilateral cooperation through various existing mechanisms," Khan said. He did not elaborate. Pakistan is facing a balance of payments crisis, inflation running at close to 25 percent and heavy government borrowing from the central bank to cover a budget deficit.
The rupee weakened 2.78 percent to a record low of 84.40 rupees to the dollar on Friday after reserves fell by $570 million and on pressure from import payments, dealers said. The rupee has lost 27 percent against the dollar since the beginning of the year. Shaukat Tarin, a respected banker appointed last week as economic troubleshooter, said he would hold a news conference on Saturday. He was travelling back from China with Zardari.
Tarin said on Monday he was sure Pakistan would fulfil upcoming debt obligations of $3 billion. Zardari and Chinese President Hu Jintao signed 11 agreements on trade and economic cooperation on Wednesday. Pakistani officials have also been to Washington and the Gulf to drum up support but there have been no firm commitments. China agreed to provide $500 million in a concessional loan to help Pakistan meet balance of payment needs in April and the Asian Development Bank has also lent Pakistan $500 million.
Saving Pakistan comes cheap
Pakistan has timed its request for international help to perfection. In this era of multi-billion pound bailouts - with the rich world devoting perhaps £2 trillion to rescuing its devastated banks - the cost of helping out Pakistan is remarkably modest.
President Asif Ali Zardari needs a mere £6 billion to avoid defaulting on his debts and stave off the immediate threat of bankruptcy. This sum is only 0.3 per cent of the amount now devoted to saving the global financial system. For the amount that Britain is prepared to spend to salvage its banks - £500 billion - Pakistan could be rescued no less than 83 times over.
Since the terrorist attacks on September 11, America has given Pakistan £5 billion of aid. This is barely one per cent of the £458 billion that Washington may be forced to spend on saving Wall Street. Bereft of oil and possessing little natural wealth, Pakistan has suffered decades of economic failure and stagnation. Ten years ago, it came within a whisker of formally defaulting on its debts and declaring itself bankrupt. So the country's leaders have become perennial seekers of bailouts.
Yet for once, the stigma attached to being an international beggar has entirely disappeared. Today, almost every government is besieged by formerly well-heeled beggars - and most are seeking far larger sums than Pakistan with its 165 million people. In this time of crisis, saving a valued ally has never seemed so cheap.
Ilargi: Wait a sec. How many billions did Buffett lose so far this year?
Buffett: Buy American. I Am.
The financial world is a mess, both in the United States and abroad. Its problems, moreover, have been leaking into the general economy, and the leaks are now turning into a gusher. In the near term, unemployment will rise, business activity will falter and headlines will continue to be scary.
So ... I’ve been buying American stocks. This is my personal account I’m talking about, in which I previously owned nothing but United States government bonds. (This description leaves aside my Berkshire Hathaway holdings, which are all committed to philanthropy.) If prices keep looking attractive, my non-Berkshire net worth will soon be 100 percent in United States equities. Why?
A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful. And most certainly, fear is now widespread, gripping even seasoned investors. To be sure, investors are right to be wary of highly leveraged entities or businesses in weak competitive positions. But fears regarding the long-term prosperity of the nation’s many sound companies make no sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records 5, 10 and 20 years from now.
Let me be clear on one point: I can’t predict the short-term movements of the stock market. I haven’t the faintest idea as to whether stocks will be higher or lower a month — or a year — from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up. So if you wait for the robins, spring will be over.
A little history here: During the Depression, the Dow hit its low, 41, on July 8, 1932. Economic conditions, though, kept deteriorating until Franklin D. Roosevelt took office in March 1933. By that time, the market had already advanced 30 percent. Or think back to the early days of World War II, when things were going badly for the United States in Europe and the Pacific. The market hit bottom in April 1942, well before Allied fortunes turned. Again, in the early 1980s, the time to buy stocks was when inflation raged and the economy was in the tank. In short, bad news is an investor’s best friend. It lets you buy a slice of America’s future at a marked-down price.
Over the long term, the stock market news will be good. In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497.
You might think it would have been impossible for an investor to lose money during a century marked by such an extraordinary gain. But some investors did. The hapless ones bought stocks only when they felt comfort in doing so and then proceeded to sell when the headlines made them queasy.
Today people who hold cash equivalents feel comfortable. They shouldn’t. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value. Indeed, the policies that government will follow in its efforts to alleviate the current crisis will probably prove inflationary and therefore accelerate declines in the real value of cash accounts.
Equities will almost certainly outperform cash over the next decade, probably by a substantial degree. Those investors who cling now to cash are betting they can efficiently time their move away from it later. In waiting for the comfort of good news, they are ignoring Wayne Gretzky’s advice: “I skate to where the puck is going to be, not to where it has been.”
I don’t like to opine on the stock market, and again I emphasize that I have no idea what the market will do in the short term. Nevertheless, I’ll follow the lead of a restaurant that opened in an empty bank building and then advertised: “Put your mouth where your money was.” Today my money and my mouth both say equities.
Illinois bars Countrywide from mortgage lending
Illinois’ top banking regulator is barring Countrywide Home Loans Inc. from making any new mortgages in the state until his agency is convinced the lender is complying with terms of a new settlement requiring workouts of existing mortgages that otherwise would be headed for foreclosure.
The Illinois Department of Financial and Professional Regulation on Thursday granted renewal of Countrywide’s license to operate in the state but made it conditional on making no new home loans until the department gives the go-ahead. The order affects more than 100 loan offices around the state and requires them to focus on working out existing loans that are in trouble.
It’s questionable, though, how big an effect the department’s restriction will have because Countrywide originates some of its loans through its thrift subsidiary, Countrywide Bank, which the federal government regulates, not the state. It’s unclear how many new loans are now made by Countrywide Home Loans, the unit regulated by the state, which used to originate the bulk of Countrywide’s mortgages.
Illinois department Secretary Dean Martinez emphasized that his order applies only to Countrywide Home Loans and not to Countrywide Bank. A spokeswoman for the department said, “We don’t know what their business model is right now. … All we can do is control what we license.”
Countrywide’s license comes up for renewal again on April 30. Countrywide, once the biggest mortgage lender in the country, as well as in Illinois, was purchased in July by Bank of America Corp. B of A entered into a legal settlement with several state attorneys general, including Illinois Attorney General Lisa Madigan, requiring it to modify about 400,000 home loans nationwide at a cost of $8.4 billion. In Illinois, Ms. Madigan’s office estimates the settlement will assist 10,750 borrowers at a cost of $185 million.
Dean Martinez, secretary of the Department of Financial and Professional Regulation, said the restrictive license renewal was appropriate in light of Countrywide’s past lending practices, which saddled borrowers with loans they couldn’t afford.
He allowed, though, that barring a lender as large as Countrywide from making new loans could exacerbate the tight mortgage market that’s making it hard for would-be home buyers to qualify for loans. “Is there a trade-off? Possibly,” he said. “I think it’s a good trade-off to make sure people don’t wind up in foreclosure.”
Hedge-Fund Assets Fell 11% in Quarter on Record Withdrawals
Assets managed by hedge funds fell 11 percent in the third quarter as investors pulled a record $31 billion from their accounts, according to data compiled by Hedge Fund Research Inc.
The decline reduced industry assets to $1.72 trillion from $1.93 trillion as of June 30, the Chicago-based research firm said today in a statement. Fund returns fell an average of 8.85 percent in the quarter, compared with the 16 percent decline by the MSCI World stock index.
Investor withdrawals wiped out all deposits made in the first half of the year, leaving funds with year-to-date outflows of $2.5 billion, the firm said. Redemptions and market losses cut industry assets by $210 billion in the quarter, more than investors put into funds in 2007.
"With losses continuing through October, it appears that 2008 will be the worst year on record for both hedge-fund performance and industry asset flows," Kenneth Heinz, president of Hedge Fund Research, said in the statement.
Hedge funds, largely unregulated private pools of capital, have lost an average of 17 percent this year, according to the firm, as the U.S. subprime-mortgage meltdown ignited a global financial crisis. Assets managed by fund of funds, which allocate money to hedge funds, fell by $78 billion to $747 billion in the quarter as clients withdrew $13.3 billion, the firm said. The redemptions reduced year-to-date inflows to less than $10 billion, the firm said.
President Sarkozy Calls for Revamping of Capitalist System
European leaders on Thursday urged that a pending international summit carry out an urgent overhaul of the world's financial architecture and impose new controls on freewheeling bankers and traders. U.S. officials pledged that all good ideas would get an airing but hinted of opposition to giving new authority to international regulators.
French President Nicolas Sarkozy, who holds the European Union's rotating presidency, said here that he will meet President Bush on Saturday in Washington to lay the groundwork for the conference, which the Group of Eight industrialized countries is convening. It should "re-found the capitalist system" that has governed international financial exchanges since World War II, Sarkozy said.
E.U. leaders, who on Thursday completed a two-day meeting in Brussels, have called for globally coordinated regulation of the financial industry, elimination of tax havens and a compensation system in which traders are not rewarded for dangerous risk-taking.
The current international financial system grew out of a U.S.-dominated meeting of 44 allied nations in 1944 at a genteel resort in Bretton Woods, N.H., as victory in World War II was coming into sight. In addition to establishing the World Bank and International Monetary Fund, the conference laid down a philosophy of lowering trade barriers and easing the movement of money across borders.
Launching a remake of this old model -- particularly in such a short time, with so many new participants -- would represent a daunting challenge at any time, but particularly during the twilight of the Bush presidency and the crisis that is still jolting banks and stock markets around the world.
Japan's Nikkei stock index fell by more than 11 percent Thursday, and European markets sank across the board on fears that the financial crisis was leading to a sharp economic slowdown despite efforts by government leaders to shore up the system with massive injections of funds. London's FTSE 100 was down 2.9 percent, Frankfurt's DAX dropped by 2.3 percent, and the CAC 40 in Paris was off by 3.6 percent.
Sarkozy said Thursday that continued nervousness in the markets showed all the more clearly that speed and audacity by the world's leaders are precisely what is required. "We do not have the right to let the luck and the opportunity to create the financial system of the 21st century get away from us," he told reporters after the conference. The bloc's decision to advocate new financial rules and dispatch Sarkozy to carry the torch to Washington was seen here as an affirmation of European confidence and aspiration to leadership at a moment of reduced U.S. influence in world affairs. "Europe wants the summit before the end of the year," he declared. "Europe wants it. Europe demands it. Europe will get it."
White House deputy spokesman Tony Fratto said Thursday that "every good idea" would be considered at the still unscheduled meeting, which was called by the G-8 countries -- the United States, Canada, Britain, France, Germany, Italy, Russia and Japan. G-8 leaders have urged that leaders from nonmember countries be included as well.
Earlier, Fratto said that anything the gathering did must not restrict the flow of trade and investment. President Bush appeared to echo that concern Thursday when he said at a bill-signing ceremony that "in the long run, one of the best ways to restore confidence in the global economy is by keeping markets open to trade and investment." José Manuel Barroso, head of the European Union's executive body here in Brussels, cautioned that the United States must be brought aboard for the conference to succeed: "There can't be a solution to the international financial crisis without the active participation of the United States."
Where the summit will take place is also unsettled. Sarkozy has proposed New York. Prime Minister Taro Aso of Japan, which chairs the G-8 this year, wants it to be in his country. He told parliament Thursday that he would prefer that no summit were necessary: "Holding such a meeting would mean we are just one step away from a worst-case scenario," Aso said.
After weeks of prodding, the Bush administration announced Wednesday that it was ready for an international financial conference. But it was unclear whether U.S. officials are as enthusiastic as their European counterparts about moving quickly in new directions.
Although the atmosphere has changed markedly in Washington in recent weeks, with government funds being freely poured into shaky banks, the United States traditionally has been a free-market champion, stripping away controls in its own banking system and demanding that other nations do the same. In contrast, since the financial disruption broke out on Wall Street last month, many European leaders have been calling for a return to more regulation.
British Prime Minister Gordon Brown called for increased supervision of international financial exchanges and suggested the Washington-based IMF should be reorganized to play this role. "The IMF has got to be rebuilt as fit for purpose in the modern world," he told reporters here Wednesday. "We need an early warning system for the world economy that can involve the supervisors in different countries. Where international or multinational companies work in a whole series of different countries, they themselves are agreeing that instead of having 15 different supervisors meeting separately, that you have a college of supervisors to deal with this issues.
"And there is no doubt," Brown added, "that round the world there is insufficient transparency, too much opacity, too little information about what are the problems that if known about early on can be dealt with." In an e-mail, U.S. Treasury spokesman Robert Saliterman said that "our top priority right now is restoring stability to our financial system so lending flows again to the consumers and businesses that are the engines of our economy, and we also need to take steps -- working with our colleagues abroad -- to prevent a future recurrence of the current turmoil."
". . . The international community has a very active agenda underway through the Financial Stability Forum and other international bodies," he noted in the e-mail. "We are working together to strengthen practices on -- valuation and disclosure; credit rating agencies, risk management and prudential oversight." He declined to comment on most of the ideas being floated but did appear to respond directly to Brown's proposal for a college of supervisors, writing that "ultimately regulation is undertaken at a national level, though it must take the global context into account. In this respect, a global regulator is not a realistic approach."
Asked about the conference agenda, Sarkozy threw out a list of ideas similar to Brown's. He also said that some international supervisory body should be set up, associated with the IMF, and that tax havens should be ended. Highly speculative hedge funds should be more closely regulated, he suggested, rating agencies should be made more independent of the financial institutions they monitor, and traders' compensation schemes should no longer encourage risk-taking.
Albrecht Ritschl, an economic history professor at the London School of Economics and Political Science, said that despite talk of a new Bretton Woods, no one yet knows what a new financial exchange framework might look like. "One thing is clear," he added. "Everyone feels a need for regulation of the financial markets." Sarkozy, Brown and German Chancellor Angela Merkel will be in close touch in coming days to push the conference to fruition, Sarkozy said. But it should also include some others in the 27-nation European Union and countries whose economies have recently grown to international proportions, such as China and India, he added.
"A new, acceptable architecture of the financial markets can only be drafted together," Merkel told reporters. She said China, India, Brazil, Mexico and South Africa should be included. Mark Duckenfield, a lecturer at the London School of Economics, said China and rich Middle East countries in particular would have a natural place in such a gathering because the enormous amount of money they have in reserves makes them players in the international system. "They are the only ones with any money left," he added. "They certainly have the dollars, but what they want in exchange . . . could be the problem."
Christian Dreger, chief economist at the German Institute for Economic Research in Berlin, cautioned that there will be no quick changes. "Different countries will have different interests," he said. "Their banks are affected differently by this. It will be a long-run process." The E.U. summit that ended Thursday also pledged to proceed with costly anti-global-warming programs despite the crisis, and to extend a bank bailout plan to all of the bloc's 27 member countries.
Billion go hungry as rich countries fail to pay up, Oxfam says
Five months after countries pledged to give more than $12bn (£6.9bn) to address the global food emergency, less than $1bn has been given, according to Oxfam. In a report to coincide with World Food Day today, the international aid charity berates rich countries for failing to respond speedily or adequately to soaring food and fuel prices.
"Rich countries are directing their attention to high fuel prices and turmoil in the financial sector, but the number of malnourished people in the world rose by 44 million in 2008," Oxfam said. "Nearly one billion people are now going hungry. When you consider the speed of the world's response to the credit crisis, the delay in acting is shocking."
In a separate report, Care International said that at least 6.4 million people in Ethiopia need emergency food aid and that Somalia is facing a food crisis "unseen since the famine of the early 1990s". "Drought, conflict, and rising food prices have left more than 17 million people in the Horn of Africa sliding into a full-blown humanitarian crisis," said Jonathan Mitchell, Care's emergency director. "These countries are heading into the peak hunger season when cereal prices are at their highest, and families have no stocks left from the previous harvest."
The Oxfam report says that while staple food prices have come down since their peak in July, they remain stuck at levels far higher than the long term average. Barbara Stocking, director of Oxfam GB, said: "It is shocking that the international community has failed to organise itself to respond adequately to this. The UN task force produced a good plan - the Comprehensive Framework for Action - but there is still not clear leadership to implement it."
She added: "Developing countries are being bombarded with different initiatives and asked to produce multiple plans for different donors. We need to see one coordinated international response, led by the UN, which channels funds urgently to those in need." The Oxfam report contrasts the global food crisis with the record profits being made by the world's largest agribusiness and seed companies.
"[US food company] Bunge saw its profits increase by $583m between April and July; Thailand's Charoen Pokphand Foods is forecasting a 237% increase in sales; Nestlé's global sales rose 8.9% from January to June, and Tesco has reported profits up 10% on last year," the report says. However, poor countries have also failed to come up with adequate answers to food price rises, says the report. Many countries responded by banning rice exports. But this, says the report, resulted in only limited curbs on inflation and has contributed to a shortage of supplies on the world market.
Make Them Pay
Richard Kovacevich had a point. Why should his company, Wells Fargo, sign its freedom (and his compensation) away to the U.S. Treasury when, unlike many other banks, it hadn't overloaded itself with risky mortgage-backed securities? The Wells Fargo chairman eventually agreed Monday to Treasury Secretary Hank Paulson's capital injection plan—it was, frankly, an offer he couldn't refuse—but Kovacevich's objections still resonate. Amid the continuing market turmoil, there is a sense that all of us are being asked to assume collective guilt for the large, but still identifiable, group of rogues and villains who got us into this mess. And then we're supposed to just forget about it.
Even the Justice Department seems to have slowed down its probe of mortgage and securities fraud, or at least it has adopted a much lower profile. Last spring FBI Director Robert Mueller was eager to trot out big numbers in the probe—35 task forces were at work, and 19 Wall Street firms were being investigated, the FBI declared. "We're going after people right at the top," a spokesman said. Now there is silence. "We've declined all interview requests with regard to this issue," FBI spokesman Bill Carter said earlier this week. Why? One reason, no doubt, is that the Bush administration is deeply concerned about causing more giant firms and hedge funds to collapse. Their principals have become, in a sense, too big to jail.
This is more than just an academic quibble over justice. Federal Reserve chairman Ben Bernanke alluded to the issue in remarks he made Wednesday to the New York Economic Club. "We have a very big 'too big to fail' problem" now, Bernanke said, involving " too many firms that are systemically critical" to the nation's financial health. And unless we solve that problem, and hold some of the villains of this sordid affair accountable, something like the subprime bubble is more likely to happen again some day, even with a new regulatory regime in place.
To a far greater extent than the public realizes, fraudulently inflated home values, wholly invented incomes and other illegal schemes figured in a huge percentage of subprime loans that were turned into securities during the boom—possibly at least 50 percent nationwide, according to county and state officials as well as real-estate experts interviewed around the country. Some experts, like Anthony Accetta, a former federal prosecutor in New York, contend that many big Wall Street players know far more than they are admitting about the extent of this fraud.
For years before the subprime market collapsed, he says, they got in the habit of quietly "swapping" defaulted loans for good ones, for favored investors—and selling securities that are not as good as you say they are is, on its face, securities fraud. "The criminality lies in the fact that the investment bank now knows that a substantial portion of mortgages are going to go south. Putting them into securities without disclosing the high probability of default is aiding and abetting mortgage fraud," says Accetta.
Even so, the Wall Street giants have been so confident of escaping serious liability that even some of the most predatory and seamiest lenders, like Countrywide Mortgage, were quickly bought up by respectable banks like Bank of America. Among those puzzled by that trend was Rep. Barney Frank, head of the House Financial Services Committee, who told me he was stunned that Bank of America would want to venture into such a liability minefield. "I'd be more in favor of Syria buying Countrywide," Frank joked.
And now, with the exception of Lehman Brothers, most of these banks feel pretty close to invulnerable with a $250 billion government investment in their preferred stock in the offing. So much so, that some economists, like Brad DeLong of Berkeley, suggest that Wall Street could become like Japan's complacent banking sector. "The worry is that Paulson is in the process of creating a bunch of zombie banks," DeLong says.
Bernanke, on Wednesday, favorably compared the current government response to the failures of intervention in the late '20s and early '30s that led to the Great Depression. As the Fed chairman said, the Hoover administration simply allowed half of the nation's banks to fail, turning a serious recession into the Great Depression (which is the main thrust of Bernanke's scholarly work). In addition, "inappropriate monetary policy [high rates] led to a deflation" that drove up the value of debt. "
We didn't make either of those mistakes," Bernanke said. True enough, and we may have saved ourselves from a devastating downturn because of these moves. But at least the market crash of '29 and the subsequent fallout rooted out the frauds and shysters of that era—men like Richard Whitney, the Boston Brahmin who headed the New York Stock Exchange and was exposed and disgraced as an embezzler. With the exception of a couple of mid-level indictments over at Bear Stearns, it seems doubtful that all that muck will get cleaned out now.
Worse still, now that all the big financial firms are getting lumped-in together—by Paulson's capital injection plan, as well as other rescue schemes—the innocent have lost some of their innocence. Paulson wanted all the top nine banks to take the capital injection, so that investors and other bankers making loans, wouldn't retaliate against the ones that took the government funds, viewing them as weak sisters. But the relative health of Wells Fargo reminds us that, in fact, some banks did resist getting burned by these toxic securities.
Many of these institutions are little-known state or local banks. One of them, Third Federal Bank of Cleveland, has even built itself a brand new headquarters, with fine trim lawns and red sandstone walls, in a working-class neighborhood devastated by mortgage foreclosures. The man responsible for many of those foreclosures, a small-time broker named Mark Kellogg, who was the subject of a NEWSWEEK story I wrote last spring ("Mortgages and Madness," June 2,), was finally indicted this week, on 73 counts involving alleged mortgage fraud, by the Cuyahoga County prosecutor. But the main supplier of those bad mortgages wasn't Third Federal; instead they were major nonbank lenders like Countrywide.
Headquartered as far away as California, these big lenders "bundled" huge amounts of these loans-many of them fraudulent and doomed to default, the day they were signed-and then sold them en masse to feckless Wall Street banks. Unlike other Ohio-based banks, such as National City—which had to be bailed out for $7 billion—Third Federal refused to take part in the securitization furor and kept most of its loans on its own portfolio, the traditional way of ensuring that customers' credit is good.
"Basically we thought it was unconscionable to be caught up in lending money in that fashion," says Third Federal president Marc Stefanski, whose father started the $10 billion bank. "We wanted to make sure loans were going to be paid back." Stefanski notes that now, in an era when the investment banks are no more, his business is booming. We can only hope that once the crisis passes, somebody in Washington remembers who the real culprits were, and maybe even rewards the banks and other financial firms that didn't lose their heads or sacrifice their principles.
Whatever their squabbling in Washington this week, one thing Democrats and Republicans were able to agree on was the apparent novelty of the country's current financial woes. "We have an unprecedented crisis," said House Minority Leader John Boehner, in a phrase frequently invoked by other congressional leaders.
But, in truth, the dire situation in the United States does have a precedent: It looks remarkably like the crisis that struck Japan 20 years ago, when a stock market meltdown exposed years of speculative lending, mostly dependent on real estate, and led to an economic collapse. In response, Japan's government launched a strategy that actually made the problem worse, leading to ten years of stagnation, which became known as Japan's "lost decade. " The bad news is that, today, the United States may be making some of the same mistakes; the good news is that, just as Japan ultimately righted its economy, so can we.
Much like American financial institutions in the 2000s, Japanese banks in the 1980s loaned wildly, gambling on rising real estate prices. Quickly, a bubble built up. At one point in 1990, the value of land in Japan was reportedly greater on paper than the value of all the land in the rest of the world. But, in December 1989, the gamble failed, as the stock market turned down and investors realized how many bad loans the banks had made, many of them with Japan's overvalued land as collateral. Most Japanese banks became afraid to lend any more money, and capital dried up.
At first, Japan's leaders propped up the value of financial assets, convinced that the banks--intertwined as they were with Japanese corporations--were too important to fail. This protected Japan's ailing banks, allowing them to continue lending when they should have been cutting back. The government also started plowing money into the public sector to keep the economy alive. "The additional spending was largely directed toward public works projects, shoring up a weak financial system, and subsidies to the weakest of Japan's businesses, which, in retrospect, ought to have been allowed to fail," writes American Enterprise Institute economist John Makin.
"While the direct stimulus of government works projects and subsidies to weak businesses kept the economy from falling back into negative growth for a time, the weakness resumed once the direct stimulative effects of the spending packages wore off." Indeed, the stimulus just served as a smoke screen. Banks, never forced to acknowledge their mistakes, appeared healthier than they were, and companies that should have gone bankrupt stayed open. Initially, the strategy did produce a minor boost in growth, but the economy never regained its momentum.
Worse, Japan became addicted to the idea of recovery without pain, so, for ten years, one Japanese prime minister after the next did what they could to keep the economy afloat through multibilliondollar infusions. Yet banks never gained enough confidence to lend aggressively, weak companies barely stayed alive, and uncertainty kept consumers out of the stores. By 2000, Japan had piled up debt worth more than 150 percent of its gross domestic product, and average citizens were no better off--more than $10 trillion in wealth and savings destroyed since the early '90s.
Fortunately, unlike Japan, which helped its banks hide their bad loans, the United States is taking a crucial first step by using taxpayer funds to help banks remove nonperforming loans from their books, in theory allowing them to once again lend. But, as in Japan, the bailout will do nothing to encourage financial institutions to change the business models that got them in trouble in the first place. Instead of accepting that weak actors, no matter how large, often must be allowed to fail, Washington has decided that many financial institutions, such as American International Group (AIG), are too large to go under--or, as the Fed put it, "in current circumstances, a disorderly failure of AIG could add to already significant levels of financial market fragility."
But this sends exactly the wrong message to the banking sector. If the practices that got you in trouble in the first place--in Japan, easy credit to cozy corporate friends; in the United States, rapid overexpansion and speculation on subprime loans--ensure you'll get bailed out, why change? In fact, in the wake of the bailout proposals, financial institutions like Bank of America, which just scooped up Merrill Lynch, will continue growing so large that they, too, can count themselves as "too big to fail."
As University of Chicago finance professor Luigi Zingales told Bloomberg News, Bank of America's move will "definitely make [its] bonds safer" because Washington cannot let it collapse. "It is a pretty significant comparative institutional advantage." Yet there is no evidence that the waves of mega-mergers on Wall Street before the collapse made the banks better; it was independent investment bank Goldman Sachs that often posted the strongest results because it knew its strengths and successfully managed its risks--although it made some bad loans, it got rid of some of the worst before the crisis really hit.
Worse, the Bush administration has made no move to undo the decades of deregulation, most notably the repeal of the Glass-Steagall Act, that enabled the crisis. At the very least, it might have mandated disclosure rules that made it harder for Wall Street firms to hide bad assets, or created an independent agency to oversee the bailout, one not linked to the Treasury Department or the Federal Reserve. The bailout will simply transfer most of the risk to the government--and thus to taxpayers--and not actually punish the banks. In any final package, the U.S. government should have a significant equity stake in any company whose nonperforming loans it absorbs, giving it a greater say in how they are run.
That's what ultimately made the difference in Japan. In 2001, the country's maverick prime minister, Junichiro Koizumi, slashed government spending and forced banks to cut nonperforming loans by creating a government body that allowed them to admit the loans had failed and still sell them off, thereby giving government more say in how banks were run. Koizumi's strategy "subjected [the banks] to more rigorous loan write-offs and forced changes in management," notes one study of Koizumi's first term, published in Asian Perspective.
This changed the way Japanese banks operated, forcing them to scrutinize borrowers, even companies with which they had been cozy, and prompting them to overhaul their business models. For good measure, Koizumi's leading economic adviser declared in a high-profile interview that no bank was too big to fail--a warning to everyone in Japan's financial sector. By the first quarter of 2004, Japan's economy was growing at over 6 percent, one of the fastest rates in the industrialized world, and the stock market had risen by 50 percent over the previous year. Since then, Japan's economic recovery has continued, with the country growing by nearly 3 percent in 2006 and just over 2 percent in 2007.
Koizumi's strategies were actually based on lessons learned after America's savings and loan crisis, when nearly half of the country's S&Ls went out of business and the rest were forced to adapt their business models. "A central lesson to remember from the U.S. [S&L] experience is that ... in the end, the principal use of public funds was to put institutions out of business," notes economist Benjamin Friedman in a study comparing the S&L crisis to Japan in the '90s.
Today, public funds are being used to do the opposite--to keep companies in business regardless of whether they change their practices, meaning that, as in Japan, the government might have to intervene again in a few years. Japan was able to afford repeated infusions of state cash in part because it was an export powerhouse. But, in the United States, which already boasts $10 trillion in public debt and regular trade deficits, another round of bailouts would be truly catastrophic. It could doom the entire U.S. economy throughout the next president's term. A "lost decade," you might say.