Shreveport, Louisiana. Fourteen-year-old Messenger #2 for Western Union.
Says he goes to the Red Light district all the time.
Ilargi: Ireland this week announced full insurance for all bank deposits in the country, to the tune of some $650 billion. This is twice the country’s GDP. For comparison, if the US were to do the same, about $25 trillion would be required.
Is this realistic, in either of the countries? You kidding me? Ireland would only need one major bank run to turn into a scary mess, adorned with fighting in the streets. Let alone two or three.
For its part, the US has huge problems passing a $700 billion "rescue" (the Senate raised it to $800 billion), and its FDIC banking insurance fund has maybe $45 billion left.
No problem, the FDIC keeps reiterating: we can always borrow from the Treasury. Well, nice and all, but then you’re back to square one, ain’t you? You would have to put the taxpayer in deeper debt, in order to insure that same taxpayer’s bank deposits. How does that qualify as a plan?
How idiotic this whole thing has been allowed to get, becomes clear when you see that in the years when banks were raking in money beyond their wildest dreams, the FDIC waived their legal obligation to pay into the fund designed for lean years. Now the fund is nearly empty, the banks are barely living, and the FDIC starts requiring higher payments. Huh? What is that, a covert way to bankrupt banks?
Meanwhile, another US regulatory agency, the SEC, keeps on changing rules and laws on the fly. The ban on short-selling, as usual presented as very temporary (like so many emergency measures), gets another extension. That is as weird as it is useless; investors can still bet against financials with credit default swaps.
Talking about CDS, there’s a field that would seem to need regulation and oversight. Problem is, nobody has either the guts nor the knowledge to take on $62 trillion worth of fresh stinking corpses. It’s much easier to look the other way.
Still, the short selling blubber isn't nearly as strange as the never-ending niceness on mark-to-market valuation of assets that banks hold. The US government may buy $700 billion of it, which is plenty crazy all by itself, but the total derivatives outstanding are 1000 times as much. No, they're not all in the US, and they won't all be failing, but if I suggest that 10% will, perhaps you get the picture.
In fact, that looking the other way thing has been all the US government and regulators have done for many years. It’s more like a policy. And they would now like to extend that privilege to the entire nation. All representatives, as well as the entire legal system, are politely asked to look the other way, or else, while a "part-time temporary employee" decides about the life and death of all financial institutions in the country.
What has our experiment with democracy turned into? Who represents you? I applaud every single man and woman who votes against the braindead bailout bill, but I seriously wonder who among them says NO only because they fear for their seat. These are all people who have been utterly silent year after year while the smelly pile was building up. Who among them has ever spoken out against the FDIC’s unlawful policies, or the SEC’s, etc.? It cannot be true that democracy counts only once every 4 years. Not for the citizens, and neither for the people they elect to represent them.
I get the feeling that the whole thing is rotten from the core, that none of it is anything else than showboating. I have addressed the issue of the legitimacy of a government without control over its economy many times before, and I don’t see that issue discussed nearly enough. It’s not just the US, the entire whole is as much in question in Europe and Japan. As economic times get harder, it becomes the most important question in a society, and fast.
And if the only answer we can come up with is to give dictatorial powers, never mind that they’re supposedly temporary, to folks who haven’t even been elected by the people, then perhaps it’s time to stop fooling ourselves about this democracy notion. It’s not like nobody’s ever gone down (note the down) that exact same road before.
Another road well travelled is railing against foreigners, an issue that features quite prominently in criticism of the Paulson plan. We'll get more than enough of that soon enough. In the meantime, a society's level of civilization can best be recognized by the way it treats the weakest amongst itself, and the foreigners it comes in touch with.
Our economic problems are so formidable that they can no longer be solved without all of us being severely burned in the process. This way of life is over. We should prepare as best we can for the one that is about to take over.
Instead, we keep on lying to ourselves and each other. It’s in our genes, the human mind has no reverse gear. It has no gears at all, nor a steering wheel. Politicians lie all the time, and so do business leaders. We accept that because we all do the same.
All we have left now is a faint sort of hope or belief that it will all get better, everything has become faith-based. The issue there is akin to what Bill Maher said in commenting on his new film Religulous, on organized faith: the problem with the Christian religion is that they make it all up as they go along.
We are now making up democracy as we go along, without much of any respect for our constitutions. When you get to think about it: in a faith-based system, who needs a constitution? You can solve all your problems in bible class; all you need to do is believe. Still, maybe someone should have told the FDIC about those lean years.
So much for tirades against American greed
It took a weekend to shatter the complacency of German finance minister Peer Steinbrück. Last Thursday he told us that the financial crisis was an "American problem", the fruit of Anglo-Saxon greed and inept regulation that would cost the United States its "superpower status". Pleas from US Treasury Secretary Hank Paulson for a joint US-European rescue plan to halt the downward spiral were rebuffed as unnecessary.
By Monday, Mr Steinbrück was having to orchestrate Germany's biggest bank bail-out, putting together a €35 billion loan package to save Hypo Real Estate. By then Europe was "staring into the abyss," he admitted. Belgium faced worse. It had to nationalise Fortis (with Dutch help), a 300-year-old bastion of Flemish finance, followed a day later by a bail-out for Dexia (with French help).
Within hours they were all trumped by Dublin. The Irish government issued a blanket guarantee of the deposits and debts of its six largest lenders in the most radical bank bail-out since the Scandinavian rescues in the early 1990s. Then France upped the ante with a €300 billion pan-European lifeboat for the banks. The drama has exposed Europe's dark secret for all to see. EU banks took on even more debt leverage than their US counterparts, despite the tirades against "le capitalisme sauvage" of the Anglo-Saxons.
We now know that it was French finance minister Christine Lagarde who begged Mr Paulson to save the US insurer AIG last week. AIG had written $300 billion in credit protection for European banks, admitting that it was for "regulatory capital relief rather than risk mitigation". In other words, it was underpinning a disguised extension of credit leverage. Its collapse would have set off a lending crunch across Europe as banking capital sank below water level.
It turns out that European regulators have allowed even greater use of "off-books" chicanery than the Americans. Mr Paulson may have saved Europe. Most eyes are still on Washington, but the core danger is shifting across the Atlantic. Germany and Italy have been contracting since the spring, with France close behind. They are sliding into a deeper downturn than the US.
The interest spreads on Italian 10-year bonds have jumped to 92 points above German Bunds, a post-EMU high. These spreads are the most closely watched stress barometer for Europe's monetary union. Traders are starting to "price in" an appreciable risk that EMU will break apart.
The European Commission's top economists warned the politicians in the 1990s that the euro might not survive a crisis, at least in its current form. There is no EU treasury or debt union to back it up. The one-size-fits-all regime of interest rates caters badly to the different needs of Club Med and the German bloc.
The euro fathers did not dispute this. But they saw EMU as an instrument to force the pace of political union. They welcomed the idea of a "beneficial crisis". As ex-Commission chief Romano Prodi remarked, it would allow Brussels to break taboos and accelerate the move to a full-fledged EU economic government.
As events now unfold with vertiginous speed, we may find that it destroys the European Union instead. Spain is on the cusp of depression (I use the word to mean a systemic rupture). Unemployment has risen from 8.3 to 11.3 per cent in a year as the property market implodes. Yet the cost of borrowing (Euribor) is going up. You can imagine how the Spanish felt when German-led hawks pushed the European Central Bank into raising interest rates in July.
This may go down as the greatest monetary error of the post-war era. The ECB responded to the external shock of an oil and food spike with anti-inflation overkill, compounding the onset of an accelerating debt deflation that poses a greater danger. Has it committed the classic mistake of central banks, fighting the last war (1970s) instead of the last war but one (1930s)?
After years of acquiescence, the markets have started to ask whether the euro zone has the machinery to launch a Paulson-style rescue in a fast-moving crisis. Who has the authority to take charge? The ECB is not allowed to bail out countries under EU treaty law. The Stability Pact bans the sort of fiscal blitz that has kept America afloat. Yes, treaties can be ignored. But as we are learning, a banking system can implode in less time than it would take for EU ministers to congregate from the far corners of euroland.
France's Christine Lagarde called yesterday for an EU emergency fund. "What happens if a smaller EU country faces the threat of a bank going bankrupt? Perhaps the country doesn't have the means to save the institution. The question of a European safety net arises," she said.
The storyline is evolving much as eurosceptics predicted, yet the final chapter could end either way as the recriminations fly. Germany has already shot down the French idea. The nationalists are digging in their heels in Berlin and Madrid. We are fast approaching the moment when events decide whether Europe will bind together to save monetary union, or fracture into angry camps. Will the Teutons bail out Club Med? If not, check those serial numbers on your euro notes for the country of issue. It may start to matter.
Bailout bill passes Senate, faces stiff fight in House
The Senate voted reluctantly but solidly in favor of a modified $700 billion Wall Street rescue plan last night, but it remained uncertain whether the legislation - even with a carefully designed package of tax breaks - would withstand the fierce crosswinds of liberal and conservative resistance in the House later this week.
The measure passed the Senate 74-25, with a majority of Democrats and Republicans voting in favor - among them presidential nominees Barack Obama and John McCain. The centerpiece of the legislation gives the government the authority to buy up billions of dollars of the toxic assets, primarily mortgage-backed securities, that have poisoned financial markets and threaten to contaminate the rest of the economy.
"This rescue package ... is not for the titans of Wall Street. It's not for those whose greed got us here, who chose greed over prudence," said Senate Majority Leader Harry Reid, a Nevada Democrat. "It's for families across Nevada and across America who are fighting to keep their jobs, save their homes and make one paycheck last until another one." The Senate action came two days after House members, facing re-election in a few weeks and confronted by angry constituents, rejected an earlier version of the plan and sent the stock market into a tailspin. The House will take up the new bill tomorrow morning.
House Minority Leader John Boehner, an Ohio Republican, said the package has a "much better chance" of passing the House than the measure that was defeated Monday 228-205. But he said he was "not taking anything for granted." "I do think that the big [stock market] drop on Monday really had a chilling effect on a lot of our members and a lot of their constituents," Boehner said on Fox News. The market reaction, compounded by opinion polls suggesting the public is more confused by the plan than opposed to it, led the Senate to add provisions in the hopes of attracting enough votes to pass both chambers this week.
Some additions were meant to appeal to a broad range of Americans, such as an increase in the limit for federally insured bank deposits to $250,000 from the current $100,000 and the move to shield 20 million Americans from paying the alternative minimum tax. Others were aimed at narrower interests to win the votes of specific lawmakers, such as a tax break to encourage Hollywood studios to do more filming in the United States.
The tax provisions added more than $100 billion to the cost of the bill. From a three-page proposal by the Treasury Department 10 days ago, the bill has swelled to 451 pages of legislation. Rep. Steny H. Hoyer of Maryland, the second-ranking Democrat in the House, said he expected many GOP lawmakers would find the tax and FDIC provisions appealing. "Clearly we have said all along that passing this bill sooner is better than passing this bill later," Hoyer said.
The presence of both presidential candidates added pressure on senators to go along with the man from their party who might occupy the White House in a matter of months. "To Democrats and Republicans who've opposed this plan, I say, step up to the plate. Let's do what's right for the country," Obama said in a speech on the Senate floor. McCain walked into the Senate chamber nine minutes after Obama had arrived and swept by the Democrat. A few minutes later, Obama crossed to the other side of the floor, and the two shook hands and exchanged a brief greeting. McCain did not address the chamber.
Obama's running mate, Sen. Joe Biden, a Delaware Democrat, voted "aye." Treasury Secretary Henry M. Paulson Jr. and President Bush lauded the Senate's action and urged the House to follow suit. Rep. Steve King, an Iowa Republican, said the new version of the bill contains a biodiesel tax credit he has championed, but he still plans to vote against the measure again. However, other lawmakers may be swayed, he said. "I think that they probably put enough sweeteners in it that they will be able to get the votes," he said in an interview.
Rep. Lloyd Doggett, a Texas Democrat, was similarly unconvinced. "The Senate measure has changed my position from 'No' to 'Heck, no,' " he said. "With the Senate amendment, the bailout has gone from bad to worse, $105 billion more in public debt worse." Some of the changes appeared aimed at enticing specific lawmakers to change their votes to "yes."
For instance, the bill now includes a provision to boost insurance coverage of mental illness, a priority of Rep. Jim Ramstad, a Minnesota Republican, who voted against the bailout bill Monday. It also includes a tax benefit for bicycle commuting sought by Rep. Earl Blumenauer, an Oregon Democrat, also a "no" vote on Monday. And there's an extension of the solar tax credit, a priority of Rep. Gabrielle Giffords, an Arizona Democrat, who has said that she wants to make her state the "Silicon Valley of solar energy."
The tax breaks and accounting rule changes for Hollywood were seen as aimed at two Southern California Democrats - Reps. Adam Schiff and Brad Sherman - who voted against the plan. Sherman, who led the defection of a group of Democratic skeptics, insisted he would not be enticed to vote for the rescue plan. "The one thing that's been proven is the absolute fear-mongering that's being used to drive us is false," Sherman said. "I've seen members turn to each other and say if we don't pass this bill, we're going to have martial law in the United States."
Polls conducted in recent days show that while two-thirds of Americans are angry about the rescue plan, they tend to think the bill is "the right thing to do." A poll conducted by the Pew Research Center showed between 38 percent and 45 percent of the public favoring the plan. On the Senate floor, it was clear that lawmakers, even from the president's party, were still of two minds.
"If we don't get the credit markets working again, we will face a dramatic downturn of proportions which we have not seen in my lifetime in the United States of America and in our economy," said Sen. Judd Gregg of New Hampshire, the Republicans' lead negotiator. "And it is something that we should not risk. We should not roll those dice." But others dug in their heels.
"Many around here are finding comfort in the notion that 'something is better than nothing.' I believe that is a false choice," said Sen. Richard Shelby of Alabama, the top Republican on the Senate Banking Committee. "The choice we faced was between pursuing an informed response or panic. ... Unfortunately, we chose panic."
Senate Adds Another $100 billion in Tax Breaks to Paulson Plan
The U.S. Senate approved tax cuts valued at more than $100 billion, including a host of alternative energy credits and dozens of breaks for businesses and individuals, as part of its $700 billion bank rescue bill.
The legislation, which the House likely will act on tomorrow, passed the Senate on a 74-25 vote. It would give the Treasury Department authority to buy troubled assets, chiefly mortgage- backed securities that are burdening financial institutions.
The Senate added the tax provisions to woo Republican votes in the House, where an earlier version of the bailout plan failed by 12 votes on Monday. The tax package would spare 24 million American households from a scheduled alternative minimum tax increase this year, renew credits for business research, and extend $17 billion in energy incentives.
House adoption of the provisions would end a 10-month stalemate in Congress over how to deal with the budget impact of the tax breaks. It would also bolster the balance sheets of companies such as Microsoft Corp. and Harley-Davidson Inc. that rely on the research credit, as well as those producing energy from wind and solar sources.
It would be "virtually impossible" to expand solar energy without the credit, Madison Grose, a managing director at Starwood Capital Group LLC, said yesterday in an interview before the vote. "The cost to the rate base for these types of projects is substantially higher without the investment tax credit being part of the capitalization of the projects." Power bills from solar facilities would be as much as double those from other power sources, meaning solar power would not be "economically possible or viable," he said. Starwood has an agreement with Lockheed Martin Corp. to finance solar projects.
The breaks for the energy industry include $1.9 billion for an eight-year tax extension for solar energy, $5.8 billion for wind, geothermal, biomass and other alternative energy production and $900 million for retooling refineries to process heavier oils from shale and Canada's tar sands. The tax legislation also includes $42 billion in incentives for businesses and individuals for two years, including about a $9 billion annual research and development benefit.
The bailout bill now goes to the House where it may face a close vote. House Republican leaders who support the bailout and tax measure say some members have been swayed by a torrent of calls from voters pressing lawmakers to pass the bill and a 777- point plunge in the Dow Jones Industrial Average Sept. 29 when the House defeated the initial bailout package. "I can't assure you that the Republicans have the votes," House Majority Leader Steny Hoyer said on MSNBC yesterday.
Hoyer and a group of 49 self-described fiscally conservative Democrats, known as Blue Dogs, object that the tax credits are not fully paid for by offsetting new tax revenue. Twenty-five of the Blue Dogs voted for the failed House version of the bailout legislation on Monday. Five of them said yesterday they would continue to support the measure, even with tax provisions that add to the deficit.
John Berger, chief executive officer of Houston-based Standard Renewable Energy Group LLC, which invests in solar and energy efficiency projects, said he would say to House lawmakers that may defeat the bailout, "I'd like to have your number because I can't cover payroll next week because I can't borrow money from the banks to cover it." Berger said in a telephone interview yesterday his company's annual revenue of almost $20 million can be increased by five or six times if the tax credits are passed.
Monica McGuire, executive secretary for the R&D Credit Coalition, said her member companies have been forced to look to other countries while the tax benefit lapsed in the United States for the past 10 months. "Many of our trading partners offer more generous R&D tax incentives that do not lapse 13 times such as the U.S. R&D tax credit," McGuire said.
The measure would pay for all of the energy tax breaks and about half of the business and individual so-called extenders by curtailing tax breaks oil companies get for job creation and overseas production, and by ending the deferral of taxes on profits earned in offshore funds.
The measure also includes dozens of other tax breaks large and small, ranging from the abolition of a 39 cent excise tax on makers of wooden arrows designed for children to a multi billion dollar incentive for U.S.-based financial services companies. Other tax breaks benefit Hollywood producers, stock-car racetrack owners and Virgin Islands rum-makers. Lawmakers also included more than $8 billion in tax-relief intended to help Americans affected by natural disasters such as hurricanes and floods in recent years.
If There Must Be a Bailout, Here's How to Do It
Maybe Congress isn't so dumb after all. The fatal flaw in Treasury Secretary Hank Paulson's $700 billion bailout plan was that it wouldn't fix the problem: Too many important financial institutions don't have enough capital.
If the government wants to save dying banks before they take others down with them, it should choose the clean and direct path: Inject capital into them. Take ownership stakes in return. And, where that's not feasible, seize them and sell their assets in an orderly way, just as the Resolution Trust Corp. did after the 1980s savings-and-loan crisis. Only after a company's shareholders and debtholders have been flattened should taxpayers take a hit. And for a $700 billion investment, U.S. taxpayers should get a lot more in return than a gargantuan pile of toxic waste.
For that much money, at yesterday's prices, the government could buy 23 of the 24 banks in the KBW Bank Index, including Bank of America Corp. and Wells Fargo & Co. And it still would have money left to buy a stake in JPMorgan Chase & Co., the largest company in the index. Infusing capital directly, though, was too simple for Paulson. It lacked subterfuge. He decided the way to save the financial system from the evils of structured finance was through more structured finance.
Instead of asking Congress to let Treasury recapitalize needy banks, he proposed buying some of their troubled assets at above-market prices. This would have let other banks create phony capital by writing up the values of similar assets on their own balance sheets, using Treasury's prices as their guide.
In short, Paulson's plan was one part robbery (with the banks doing the robbing) and one part accounting sleight of hand. No wonder House members rejected it. If Paulson or congressional leaders devise a Plan B, they should look to the example of Fortis, Belgium's biggest financial-services company. This week, the governments of Belgium, the Netherlands and Luxembourg invested 11.2 billion euros ($16.3 billion) in Fortis. In exchange, they got ownership of almost half its banking business.
That's how a government intervention is supposed to work. The company gets fresh capital, which has the added benefit of not being fake. The buyers get equity. Legacy shareholders get slammed with dilution. And if the company recovers, the government can sell shares to the public later, maybe even at a profit.
Such simplicity might feel unnatural to someone like Paulson, who used to run Goldman Sachs Group Inc., or a congressman such as Barney Frank who depends on campaign checks from bankers like an infant needs mother's milk. And lots of taxpayers might object anyway, because it still would involve sending big checks to banks.
At least voters could understand a plan in the European mold, which might lead them to be more forgiving about any unpleasant details. That's better than trying to scare the public into supporting a bailout that doesn't make sense. As for the illiquid assets still on banks' balance sheets, the best way to find out what they're worth is to start disclosing every conceivable piece of data about them, right down to the daily cash flows they produce. A big reason subprime mortgage-related securities aren't selling is that outsiders can't see what's underlying them on a timely basis.
Remove the kimonos, and capitalism will take its course. At some price, buyers will emerge, once they can see what they're buying. Banks could clear their books. The companies that are able to attract fresh capital would survive. And the ones that couldn't would die, as they should.
What Congress must remember is that Americans don't exist at the pleasure of the country's banks. It's supposed to be the other way around. There's still time for the politicians to come up with a rescue plan that will work. The important part is making sure you and I get something of value in return for our money.
ECB Keeps Rate at 4.25% Even as Recession Looms
The European Central Bank kept interest rates at a seven-year high today to curb inflation, even after the credit crunch forced governments to bail out banks and increased the likelihood of a recession. ECB policy makers meeting in Frankfurt left the benchmark lending rate at 4.25 percent, as predicted by all 58 economists in a Bloomberg News survey. The bank will cut borrowing costs in February next year, another survey shows.
The financial crisis reached new heights in Europe this week as governments stepped in to help rescue five banks and credit costs soared to records. With the euro-region economy on the brink of a recession and retreating oil prices pushing down inflation, the ECB may have more room to lower rates.
"The risks to growth are clearly mounting and that means over the medium term that risks to inflation are easing significantly," said Nick Kounis, chief European economist at Fortis in Amsterdam. The chances of the ECB "cutting interest rates in coming months have increased sharply."
ECB President Jean-Claude Trichet holds a press conference at 2:30 p.m. to explain today's decision. Marks & Spencer Group Plc, the U.K.'s largest clothing retailer, today urged the Bank of England to cut interest rates, saying it would "give confidence to consumers." The BOE, whose key rate is currently at 5 percent, next decides on borrowing costs on Oct. 9.
There's a 58 percent probability that the Federal Reserve will lower its key rate by half a point to 1.5 percent on Oct. 29 and zero chance it won't cut at all, according to Fed funds futures. Banks have recorded almost $600 billion in writedowns and losses tied to the U.S. mortgage market since the start of 2007.
Fallout from the crisis that drove Lehman Brothers Holdings Inc. into bankruptcy on Sept. 15 hit Europe this week, with France, Belgium, Luxembourg and the U.K. rescuing lenders and Italian Prime Minister Silvio Berlusconi pledging to prevent losses for depositors. With credit markets freezing as banks refuse to lend to each other, the ECB has injected billions of euros and dollars into the banking system. That hasn't stopped money-market rates surging.
"It could well be that the ECB will cut rates earlier than expected," Stephan Rieke, an economist at BHF-Bank AG in Frankfurt, said in a Bloomberg Television interview. "The economic and the financial environment have deteriorated to such an extent that we could see a rate cut of 50 basis points."
Still, Trichet said on Sept. 30 that the ECB remains focused on fighting inflation. There's a "clear separation" between interest-rate policy and liquidity provision, he said. While crude oil prices have retreated 31 percent from a record $147.27 a barrel on July 11, they're still up 23 percent over the past year. Euro-region inflation slowed to 3.6 percent in September. The ECB aims to keep the rate below 2 percent.
Some labor unions are pushing for bigger wage increases to compensate workers for the higher cost of living. In Germany, Europe's largest economy, the IG Metall labor union representing 3.2 million workers is seeking 8 percent more pay, the biggest increase in at least 16 years.
Inflation in Europe is "still too high," said Marc Stocker, director of economics at the Brussels-based BusinessEurope lobby group, who used to work as a forecaster at the ECB. "Inflation needs to come down fast for growth to pick up. The slowdown in Europe this year was mostly related to high commodity prices, not banks refusing credit," Stocker said.
Trichet "will continue to stress that upside inflation risks remain the central bank's primary concern," said David Mackie, chief European economist at JPMorgan in London. He nevertheless expects the ECB to cut rates in December. "At some point the dysfunction in the financial system becomes so great that it becomes the dominant force driving" the economic outlook, Mackie said.
The ECB's preferred gauge of five-year inflation expectations today slumped to 2.52 percent from 2.66 percent.
Companies may be reluctant to raise prices as the economy of the 15 euro nations shows few signs of recovering from a contraction in the second quarter. The manufacturing, services and retail sectors all shrank for a fourth month in September and confidence in the economic outlook is the lowest since the slump following the Sept. 11 terrorist attacks in 2001, according to the European Commission.
Investors have fully priced in a cut in the ECB's key rate to 4 percent by December, Eonia forward contracts show. "We do not expect the ECB to suggest that a rate cut is imminent," Gilles Moec, an economist at Bank of America Corp. in London, said in a research note to clients. "However, we expect the ECB President to state that the economic downturn will be deeper and longer than the Governing Council thought." Trichet may "explicitly mention the rate-cut option," Moec said.
Trichet steering ECB back into reality
The market couldn't have expected the European Central Bank to totally junk its inflation obsession. After all, unlike the U.S. Federal Reserve, the ECB only explicit consideration is inflation, and not economic growth and not financial stability.
And so, ECB President Jean-Claude Trichet on Thursday said there are still upside risks to price stability, even if they have "alleviated somewhat" -- and considering the wage demands from the key German union IG Metall, he has some basis for noting price risks even if oil and other commodities have dropped sharply in value.
But he did make clear the ECB is keeping an eye on the financial market disruptions, noting that "financial market turmoil" has intensified and that economic activity is weakening. This isn't the same as making a surprise rate cut. But it is setting the stage for rate cuts down the road from a 4.25% that seems too high with the European economy effectively in recession.
The markets read Trichet in that manner, and the euro sell-off intensified. The ECB has set the stage for cuts as early as November, or maybe December. This was the only realistic move that the central bank could have taken in response to the credit crisis -- and it's the one they took.
Ireland ‘had to act quickly’ on guarantees
Brian Lenihan has had a baptism of fire. Just four months after taking over as Ireland’s finance minister, the former barrister this week found himself in the global market spotlight after the Irish government decided, late on Monday night, to guarantee the deposits and debts of the country’s six largest financial institutions.
The unprecedented decision was greeted with a mixture of shock and anger outside Ireland. European governments and the European Commission expressed surprise that Ireland would take such a dramatic unilateral step. British politicians and bankers were furious at a move they believe creates an uneven playing field both in Britain – where Bank of Ireland and Allied Irish Banks offer accounts – and in Ireland, where Royal Bank of Scotland and HBOS have local subsidiaries. After frantic lobbying, the Irish government on Thursday signalled it would consider applications from foreign banks with large branch networks in Ireland to be included in the guarantee.
Mr Lenihan insists Ireland did not want to strike out on its own, but needed to act quickly. ”Our government and I would have preferred a European approach to guaranteeing confidence and stability of the banking sector,” he says in an interview with the Financial Times. ”But in the absence of a European approach a small sovereign state like Ireland is obliged to ensure the stability of the banks that are orphaned with us.”
Ireland’s banks are caught in a perfect storm. They are heavily exposed to both residential and commercial property in a country that has enjoyed a dramatic housing boom. At the same time, they rely on the capital markets for a significant proportion of their funding. Following the collapse of Lehman Brothers the debt markets shunned any financial institution perceived as risky, leading to a growing risk of a loss of confidence in Irish banks.
When the US Congress on Monday unexpectedly rejected the US government’s bail-out, the Irish government decided it had no choice but to guarantee the liabilities of the country’s six largest banks – worth a combined €400bn. ”We believed we had to take firm, decisive action to show that Ireland was open for business and would remain open for business,” Mr Lenihan says.
Nevertheless, the move is fraught with problems. Aside from straining relations with Britain, it could be extremely costly. If the Irish government had to honour its guarantee, the national debt would balloon from 25 per cent of gross domestic product to 242 per cent, according to analysts at Collins Stewart.
It is also far from clear how Irish banks will be prevented from abusing the guarantee, which runs for two years. Mr Lenihan says the banks will be charged for the guarantee, but will not be drawn on how this will work in practice. Ireland’s move could also fall foul of European rules on state aid. But Mr Lenihan says Ireland has learned from the UK, which sought approval from Brussels for the nationalisation of Northern Rock, the mortgage lender.
”We’ve taken great care to ensure that we’re in compliance with our obligations that do permit an intervention when there is a risk of a systemic failure,” he says. ”We’re satisfied what we’ve done is in accordance with the European rules.” In response to the crisis, the Irish government is also seeking to relax competition rules so that it can approve bank mergers it deems in the national interest. But Mr Lenihan rules out investing directly in banks, as the Belgian government did this week when rescuing Fortis and Dexia. ”If the state were to become involved in the capitalising of banks that is a much more radical step.”
For a small country, he says, the risks of a loss of confidence meant it had to intervene to support up the entire system. ”Our assessment was that intervening on a case by case basis where you have only six institutions would precipitate a collapse. If you’ve a very small number of banks, the dangers are very great.”
Brown to attend EU credit crunch summit
Gordon Brown is to attend an emergency summit of European leaders on the global financial crisis, Downing Street confirmed today. But the Prime Minister's spokesman said a EU-wide bail-out of banks like the one proposed in the US would not be in agenda.
French president Nicolas Sarkozy's office announced the summit this morning and said German and Italian leaders would also be there along with and the presidents of the EU Commission and European Central Bank. The meeting - to be held at the Elysee Palace in Paris on Saturday - comes ahead of a forthcoming summit of the wealthy G8 nations on the credit crunch.
Confirming Mr Brown's attendance this morning, his spokesman said: "President Sarkozy confirmed to the Prime Minister that it was not the case that the French were proposing a Europe-wide bail-out." The discussions were announced as Ireland passed legislation guaranteeing all deposits in Irish banks there which has caused concern in the UK and elsewhere.
It has been criticised by the British Bankers' Association, which claims it puts domestic banks at a disadvantage with customers considering switching to take advantage.
Mr Brown has so far refused to meet calls for a similar blanket ban in the UK, although the sum covered is to be raised from £35,000 to £50,000. The Government said yesterday that all such deals should be examined by the European Commission to ensure they were within state aid rules.
It also came amid reports that the PM was to set up an emergency committee to take charge of Britain's response to the financial crisis. The body would formalise the series of regular meetings that have been called since the start of the turmoil on the markets.
The Irish pledge covers six institutions - Allied Irish Banks, Bank of Ireland, Anglo-Irish Bank, Irish Life and Permanent, Irish Nationwide Building Society and the Educational Building Society including UK branches. Last night the US Senate voted to back a revised 700 billion dollar (£385 billion) bail-out package to rescue America's battered economy.
It still has to be passed by the House of Representatives however, whose rejection of it last week caused share prices to plummet. New banking rules to clamp down on the causes of the financial crisis were put forward by the EU yesterday. Among the demands from the European Commission was that sellers of risky loans be made to hang on to part of the investment and share the risk.
There was also gloomy news from the High Street today as retail giant Marks & Spencer announced its worst performance for more than three years. The high street bellwether said UK like-for-like sales fell 6.1 per cent in the 13 weeks to 27 September - its worst quarterly performance since January-April 2005.
U.S. auto sales plunge
Sales at the nation's top automakers fell sharply in September, as tighter credit for buyers and dealers combined with high fuel prices resulted in industrywide U.S. sales falling below the 1 million mark for the first time in more than 15 years.
The sales declines were broad based, with Japanese automakers reporting the same kind of double-digit declines that hit U.S. brands earlier this year when the record gasoline prices sent buyers scurrying from SUVs and pickups to more fuel efficient car models. Overall Asian brands saw a 31% drop in sales, more than the 24% drop among traditional domestic brands.
This time it was the credit crisis, not just gas prices, that cut into sales. Many buyers were unable to get the credit they needed to buy a car and a growing number of dealers saw their own credit cut off, causing widespread failures. Add to that general nervousness about the economy and the industry was poised to sell fewer than a million cars in the United States for the first time since 1993. And auto executives say they don't think they've seen the bottom yet.
Overall industry sales toppled 27% to 964,873 vehicles, according to sales tracker Autodata, a level not seen since February, 1993. It was the biggest year-over-year drop in sales since January 1991, as the nation prepared for the start of the first Gulf War and experienced a gasoline price shock.
George Pipas, Ford's director of sales analysis, said the company estimates that industrywide sales to consumers were down slightly more, a 30% compared to last year, although a more narrow decline in fleet sales to business clients such as car rental companies limited the overall percentage drop.
Industrywide sales of light trucks, such as pickups, SUVs and vans, edged ahead of cars for 50.3% of industrywide sales. It marked the first time since March of this year that trucks outsold cars. But demand for both types of vehicles plunged from year-earlier levels with truck sales off 31% and car models down 22%. Pipas said that sales, as well as traffic in showrooms, were down even more sharply the last 10 days of the month as the economic crisis got more and more attention.
"There are customers who are adopting a wait and see attitude," he said. "When the Dow falls 777 points [as it did this past Monday], I can assure you there weren't many people closing on a car or an HD TV or a home for that matter." Market research firm CNW Research, which has tracked dealership traffic for 22 years, confirmed Pipas' view. The firm's reading on traffic in showrooms for the end of September was the worst it has ever reported, down 50% compared to a year earlier.
"Manufacturer incentives aren't pulling in the crowds. Dealer 'blow out sales' aren't working. And without showroom traffic, it's tough to sell anything," said Art Spinella, president of CNW. Tom Libby, senior director of industry analysis for J.D. Power & Associates, said that even though the problems facing automakers in September were well known, the final numbers were "shocking."
Libby said it's now clear that credit market problems have become the greatest headwind for auto sales as buyers would need to pony up more cash if they really want a car. "Who's going to put down $25,000 or $30,000 in cash right now? That explains a lot of this," he said.
General Motors reported that sales of cars and light trucks dropped 16% from a year ago. That was better than the forecast of a 24% decline from sales tracker Edmunds.com but it was still clearly a sign of weaken demand. Still GM executives said they were pleased with the results. "September marked the second consecutive month where GM performed extremely well in tough market conditions," said Mark LaNeve, the GM vice president in charge of North American sales. Sales of GM's cars fell 10% while sales of light trucks - such as pickups, SUVs and vans - declined 19%.
Toyota Motor reported that its sales toppled 32% from a year earlier. The forecast was for an overall drop of only 18%. It was the sharpest percentage drop in U.S. sales for the Japanese automaker in 21 years. Sales of cars dropped 28% and light truck sales plunged 38%. After years of steady gains that made it No. 2 in terms of U.S. sales, Toyota has now had year-over-year declines in U.S. sales in all but one month since last December.
The news was just as bad at Ford and Chrysler LLC. Ford reported that U.S. sales tumbled 35% from a year earlier. The forecast had been for only a 25% drop. "Consumers and businesses are in a very fragile place," said Jim Farley, Ford group vice president. "An already weak economy compounded by very tight credit conditions has created an atmosphere of caution."
Privately-held Chrysler LLC, which includes the Chrysler, Dodge and Jeep brands, posted a 33% decline, as light truck sales tumbled 34% and car sales dropped 29%. Sales of virtually every model of car and truck at the two U.S. automakers fell by more than 10%. Among the exceptions where the Chrysler and Dodge minivans and Ford's Crown Victoria and the Lincoln Town Car. The latter two were helped by fleet sales.
Honda Motor posted a 24% drop in U.S. sales, far worse than the 6% drop forecast by Edmunds. It was the worst drop in Honda's sales since 1981, and a sign that good fuel economy is no longer enough to buck broad industry declines. Nissan posted a 37% drop in sales, far worse than the forecast of a 12% decline.
Buffett Says Economy 'on Floor' After Cardiac Arrest
Billionaire Warren Buffett, the world's preeminent stock picker, said the U.S. economy is "flat on the floor" after a cardiac arrest as companies struggle to secure funding and unemployment increases. "In my adult lifetime I don't think I've ever seen people as fearful, economically, as they are now," Buffett said today in an interview with Charlie Rose to be broadcast tonight on PBS. "The economy is going to be getting worse for a while."
The biggest housing slump since the Depression has spurred a wave of defaults and a yearlong contraction in global credit markets, squeezing companies' capacity for investment. Buffett's Berkshire Hathaway Inc., based in Omaha, Nebraska, agreed in the past two weeks to buy $8 billion in preferred shares from General Electric Co. and Goldman Sachs Group Inc. to help the companies fund their businesses. The credit freeze is "sucking blood" from the U.S. economy, Buffett said.
The bankruptcy of Lehman Brothers Holdings Inc. and Washington Mutual Inc., and the emergency sales of Merrill Lynch & Co. and Wachovia Corp. fueled fears about the vulnerability of firms that rely on capital markets for short-term funding. Buffett is taking advantage of fragile stock markets, the lack of available credit and his own reputation as a picker of successful companies to extract outsized payments for Berkshire's cash and endorsement. He has told shareholders that his strategy is to be "greedy when others are fearful."
"He's seizing the opportunity," said Tom Kersting, an analyst for Edward Jones & Co in St. Louis. "His philosophy is always to keep some powder dry. That allows him to take advantage of the current turmoil we're in and take advantage when others can't."
For both Goldman and GE, Buffett's endorsement comes with a cost. Both companies agreed to pay Berkshire a 10 percent dividend on his preferred shares, and each gave him warrants to buy their common stock at any point in the next five years at a price that's a discount to where it's currently trading.
Who's profiting from the crisis? Goldman Sachs, of course
Not often do you regard a company whose stock is about 50% off its 52-week high as a success story. But a success is exactly what Goldman Sachs Group Inc. is shaping up to be at this stage of the credit crisis. If we were to begin the long journey back to stability today, Goldman would undoubtedly emerge even more powerful than before. Did anyone expect another outcome?
Commercial banks such as Citigroup Inc., Bank of America Corp. and J.P. Morgan Chase & Co. are obvious winners in the credit debacle. They've been able to buy battered banks at fire-sale prices. America is about to become a country with three national banks that have big broker/dealers as subsidiaries. These new superbanks will be formidable, but there is a question of how much risk-taking they'll be willing to stomach.
Logistics are an issue too. They're integrating firms that may have been priced like single-branch banks but, from an infrastructure standpoint, are giants of American finance. Morgan Stanley , whose stock is 65% off its high, has shored itself up by selling a 20% stake to Tokyo's Mitsubishi UFJ, but will still need to add deposits, just like Goldman. Only Goldman, by virtue of its investment from Warren Buffett and its ability to buy retail bank deposits, will be the last bulge-bracket investment bank unencumbered by commercial-bank ownership.
You don't have to be a conspiracy theorist to recognize that a series of decisions and events have transpired to put Goldman at the top of the heap. Well before the credit crisis, people worried about Goldman's influence in the markets. Several former executives of the investment bank have senior roles in government and at the New York Stock Exchange, and its analysts are among the most powerful in the space.
Let's limit the discussion to the start of the credit crisis in the summer of 2007. Just before the market turned, Goldman traders got a hunch and began shorting and hedging the mortgage securities that were eating away at rivals' revenue. Trading revenue soared 70% that quarter to $8.23 billion.
It was Goldman's last quarter in a series in which each new profit report exceeded expectations and prior results. Goldman's share price was in shouting distance of $300. It was also when grumblings about the investment bank's transparency became louder. That's important because Goldman continues to give few details about its "proprietary trading" business. What is it exactly? No one knows for sure.
What followed was notable for what didn't happen: write-downs. Goldman has admitted to less than $5 billion in write-downs, including the $1.1 billion when it reported earnings Sept. 16. That's on a balance sheet of $1 trillion. In between those earnings announcements, Goldman lost its biggest competitor in prime brokerage, Bear Stearns Cos., on March 17. In September, it also lost the biggest competitor in debt underwriting, Lehman Brothers Holdings Inc. , and a big rival in investment banking, Merrill Lynch & Co., in an emergency sale to a commercial bank.
Judging by the government's reaction, Morgan Stanley and Goldman should have been next -- either through a crisis sale like Merrill or a liquidation like Lehman. Investors sent their stocks reeling. Morgan Stanley quickly began talks with Wachovia Corp., while Goldman kept quiet.
During all of this, Goldman Chief Executive Lloyd Blankfein was in the middle of talks about the future of another crippled company, American International Group Inc., at the New York Federal Reserve. As Gretchen Morgenson reported in the New York Times last week, those talks resulted in an $85 billion bailout of AIG via a government loan, and, oh yeah, the deal may have saved Goldman $20 billion in losses due to its trading position with the insurer." Goldman poured cold water on that claim saying in a statement it "had no material exposure to AIG. "Our counterparty risk was offset by collateral and hedges, and that remains the case."
There have been other fortuitous decisions, too. For instance, the Securities and Exchange Commission's ban on short-selling was lifted for market-makers such as Goldman, and U.S. regulators may be willing to back Goldman's purchase of $50 billion in troubled assets from other banks, according to a Financial Times report.
It was the Buffett investment that was the master stroke. Announced on the same day that President Bush, Congress and presidential candidates worked on the first draft of Treasury Secretary Henry Paulson's bailout plan, everyone hailed the deal as a huge financial gain for Buffett and an expensive vote of confidence for Goldman.
If it were only that, the price was rich. But the investment earned Goldman permanent access to the Federal Reserve discount window, lowered its leverage to just over 18 times equity, brought it closer to its new bank-holding company structure, and, according to Fox-Pitt Kelton analyst David Trone, wasn't costly for Goldman. "Goldman's raise will simply pad its equity capital cushion to appease the market's recent concern about its model," he wrote. It put "to rest doubts that a company could raise without fundamentally needing it."
Goldman, like its rivals, is on the prowl for deposits, but unlike its competitors, it will be the acquirer. Goldman emerges from this mess essentially the same institution. It has the same lack of transparency. It still manages hedge funds and private-equity businesses. It still has a thriving prime brokerage business.
As former Drexel Burnham Lambert CEO Fred Joseph said last week, investment banking is "not disappearing at all. [Banks] will act more like advisory firms and underwriters and lenders. They'll act a little bit more like banks, and less like hedge funds." That doesn't mean those enterprises won't disappear. And Goldman will be one of the few left open for business.
Libor Rises a Fourth Day as Banks Hoard Cash After Bill Passed
The cost of borrowing in dollars in London for three months rose for a fourth day, signaling that banks haven't started to lend after the U.S. Senate approved a $700 billion plan to rescue beleaguered financial institutions. The London interbank offered rate, or Libor, that banks charge each other for such loans climbed 6 basis points to 4.21 percent today, the highest since Jan. 11, the British Bankers' Association said.
The corresponding rate for euros advanced 3 basis points to a record 5.32 percent. The Libor-OIS spread, a gauge of cash scarcity among banks, widened to a record. "We still see upward pressure on maturities from one week," said Patrick Jacq, a fixed-income strategist in Paris at BNP Paribas SA, France's biggest bank. "The situation is still blocked and we're unlikely to see spreads decline before confidence has been restored."
Credit markets have frozen as financial institutions hoard cash to meet future funding needs amid deepening concern that more banks will collapse. Libor, set by 16 banks in a daily survey by the British Bankers' Association, is used to set rates on $360 trillion of financial products worldwide, from home loans to derivatives.
The U.S. Senate passed the Bush administration's bank- rescue package yesterday with inducements for the House of Representatives to approve the measure after an earlier version was rejected. The legislation, approved on a 74-25 vote, authorizes the government to buy troubled assets from banks rocked by record home foreclosures.
Interbank rates have soared as governments in Europe and the U.S. rescued six financial institutions in the past week. The Libor-OIS spread, the difference between the three-month dollar rate and the overnight indexed swap rate, widened to a record 260 basis points today. It was at 197 basis points a week ago and 79 basis points a month ago.
Lenders are balking at offering cash for longer than a day even as central banks pump an unprecedented amount of cash into the banking system. The European Central Bank today offered $50 billion of overnight cash at a marginal rate of 2.75 percent. The Swiss National Bank awarded $9 billion. The Bank of England sold $8.9 billion. The Libor for overnight dollars fell 111 basis points to 2.68 percent, the BBA said.
Rates in Asia rose earlier. The cost of borrowing in dollars in Singapore for three months surged to 4.16 percent today, the highest since Jan. 11. The rate in Hong Kong, known as Hibor, climbed 13 basis points to 3.79 percent. "There are a lot of bids but no offers," said Pang Meng Yam, a money-market dealer at KBC Bank NV in Singapore. "There's no lending, most money markets are frozen and the discrepancy between the benchmark rates and the actual trading rates are getting wider."
Financial institutions worldwide posted $588 billion of writedowns and losses tied to U.S. subprime mortgages since the start of last year, according to data compiled by Bloomberg. The difference between what banks and the U.S. Treasury pay to borrow money for three months, the so-called TED spread, was at 336 basis points today. The spread was 110 basis points a month ago.
U.S. September Job Cuts Rise 33% From Year Ago
Job cuts announced by U.S. employers climbed 33 percent in September from a year earlier, led by reductions at computer- and automakers, according to a private placement firm.
Firing announcements rose to 95,094 last month from 71,739 in September 2007, Chicago-based Challenger, Gray & Christmas Inc. said in a statement today. Hewlett-Packard Co., the world's largest computer-maker, said last month it would eliminate 24,600 jobs, accounting for much of September's increase, Challenger said. A slowdown in consumer spending and the ongoing housing recession are forcing businesses to trim payrolls to preserve profits. Firings may continue to rise as banks make credit more difficult to obtain.
"It may take several weeks or months for the fallout from September's Wall Street turmoil to hit the unemployment numbers," John A. Challenger, chief executive officer of the placement company, said in a statement. "Companies are cutting costs, and investments in new technology may be put on hold."
The Labor Department may report on Oct. 3 that the economy lost jobs in September for a ninth consecutive month. Economists surveyed by Bloomberg News forecast payrolls dropped by 105,000 in September after declining by 84,000 in August. Companies have announced a total of 763,090 cuts so far this year, up 30 percent from the first nine months of 2007, according to Challenger's survey.
The number of planned job cuts increased 7.2 percent in September from the 88,736 announced in August, Challenger said. The figures aren't adjusted for seasonal effects so economists prefer to focus on year-over-year changes instead of monthly figures. Computer companies led industries in announced reductions last month, with 25,715. Cutbacks at automotive firms, totaling 14,595, followed. Apparel makers announced 8,350 cuts and the financial industry announced 8,244 cutbacks.
Year-to-date, the financial industry has been the hardest hit in the wake of the housing slump and spreading losses, accounting for 111,201 announced cutbacks, followed by the automotive industry, with 94,918 announced firings. "Everyone else is waiting to see if Congress agrees to provide a bailout package for all ailing financial firms," said Challenger. "The question is whether the final legislation will directly or indirectly result in workforce reductions among the firms operating with far less capital than usual."
U.S. Initial Jobless Claims Reach Seven-Year High
First-time applications for U.S. jobless benefits rose to the highest level in seven years as more Americans were thrown out of work in the aftermath of the Gulf Coast hurricanes and employers cut staff to meet slowing demand. Initial jobless claims increased 1,000 to 497,000 in the week that ended Sept. 27, from a revised 496,000 the prior week, the Labor Department said today in Washington. The total number of people collecting benefits was the highest since 2003.
Mounting job losses spawned by the biggest housing recession in a generation undermined consumer spending even before the latest financial meltdown threatened to magnify the slump. The government may report tomorrow that the economy lost jobs in September for a ninth consecutive month.
"The financial turmoil and panic of the past several weeks has clearly done substantial economic damage," Ryan Sweet, an economist at Moody's Economy.com in West Chester, Pennsylvania, said in a Bloomberg Radio interview. "This pretty much leaves little doubt that we're in a recession."
Initial claims were estimated to decrease to 475,000 from 493,000 initially reported for the prior week, according to the median projection of 39 economists in a Bloomberg News survey. Estimates ranged from 432,000 to 525,000. Claims figures in recent weeks have been distorted by the fallout from Hurricanes Gustav and Ike that hammered the coasts of Texas and Louisiana and forced the evacuation of more than 2 million people from eastern Texas.
Job losses following the storms increased the number of claims by about 45,000, the Labor Department said. Excluding the hurricane-related jump, initial claims would have been about 439,000 last week, according to Bloomberg News calculations. The four-week moving average of initial claims, a less volatile measure, climbed to 474,000 from 462,500, today's report showed.
The number of people continuing to collect jobless benefits increased to 3.591 million in the week ended Sept. 20, the most since September 2003, when the economy was recovering from a recession two years earlier. The unemployment rate among people eligible for benefits, which tends to track the jobless rate, was unchanged at 2.7 percent. These data are reported with a one-week lag.
Seventeen states and territories reported an increase in new claims, while 36 reported a decrease. Claims in Texas jumped by 22,000 and applications in Louisiana rose by 9,700 in the week of Sept. 20, reflecting the hurricanes. Initial jobless claims reflect weekly firings and tend to rise as job growth -- measured by the monthly non-farm payrolls report -- slows. So far this year, weekly claims have averaged 388,000 compared with an average 321,000 for all of 2007.
The economy has lost 605,000 jobs in the first eight months of 2008. Tomorrow's payrolls report from the Labor Department may show another 105,000 jobs were eliminated in September, the most this year, according to economists surveyed by Bloomberg. The latest chapter in the credit crisis that led to the government's takeover of American Insurance Group Inc. and the bankruptcy of Washington Mutual Inc. and Lehman Brothers Holdings Inc. this month will spur more layoffs.
Barclays Plc, the U.K. bank that bought parts of Lehman Brothers U.S. businesses, may cut as many as 5,000 jobs at the bankrupt company, Wall Street recruiters said last week. "We've seen a lot of job losses already in the banking sector and I think we'll expect to see that continue," John Haley, chief executive officer of Watson Wyatt Worldwide Inc., an Arlington, Virginia-based human resources consulting firm, said in a Sept. 30 interview on Bloomberg Television.
Carmakers and other manufacturers are also trimming staff. Chrysler LLC, cutting back as its U.S. sales shrink, said it will fire about 250 employees as part of a plan to eliminate 1,000 salaried positions last month. The rest of the reductions will be through buyouts and early retirements, the Auburn Hills, Michigan-based company last week
SEC Extends Ban on Short Sales to Let Congress Approve Bailout
The U.S. Securities and Exchange Commission will extend a prohibition on short-sales of financial stocks, keeping restrictions on bets against companies' shares in place while Congress works on a $700 billion bailout plan.
The restriction will expire three days after lawmakers give Treasury Secretary Henry Paulson authority to buy illiquid assets that are burdening banks and other financial firms, the SEC said in a statement yesterday. The short-sale prohibition will end no later than Oct. 17 if Congress fails to complete passage of the measure approved by the Senate last night.
"There are circumstances in which short selling can be used as a tool to mislead the market," the SEC said in its statement announcing the extension. It can be used as a "downward manipulation" in which traders spread "lies about a company's negative prospects."
The SEC took on short-selling last month after Morgan Stanley Chief Executive Officer John Mack and New York Senator Charles Schumer blamed the practice for driving companies to the brink of collapse. Hedge funds opposed the ban, arguing that regulators were blaming traders for companies' mismanagement and the banking industry's over-concentration in mortgage-backed securities that lost value after credit markets froze last year.
Under the SEC rules, investors are barred from short- selling almost 980 stocks, from New York-based Citigroup Inc., the biggest U.S. bank by assets, to firms getting a fraction of revenue from financial activities such as Fort Lauderdale, Florida-based AutoNation Inc., the largest U.S. car dealer. Short-sellers try to profit by betting stock prices will fall. In a short sale, traders borrow shares from their broker that they then sell. If the price drops, they buy back the stock, return it to their broker and pocket the difference.
The SEC handed hedge funds a victory by dropping a separate rule requiring investors who manage more than $100 million to publicly disclose their short positions. The SEC is now requiring funds to only reveal short positions to the agency. That requirement may be in place indefinitely, the agency said.
In addition, the regulator continued its crackdown on so- called naked shorting by adopting two regulations that pressure traders and brokers to actually deliver borrowed shares to buyers. A third rule extension makes it a securities fraud when sellers deceive brokers about delivering borrowed shares. The SEC acted amid concern investors are using abusive tactics to flood markets with sell orders and drive down stock prices.
Hedge funds plead with SEC to let short ban expire
Lobbyists for the $2 trillion hedge fund industry made a last ditch effort on Wednesday to convince U.S. securities regulators to let an emergency order prohibiting short selling in more than 950 financial firms expire on Thursday.
"The orders have not prevented price declines of financial institutions, volatility in the securities of these firms, or the failure of a financial institution," said Richard Baker, president of hedge fund lobby group Managed Funds Association. Baker said the emergency orders have increased volatility, reduced liquidity and abruptly halted capital-raising, including through the issuance of convertible securities.
But a number of securities law experts expect the Securities and Exchange Commission to extend the ban beyond Thursday because of the current fragile state of the markets. Under the SEC emergency measures, short selling in the U.S.-listed financial firms stocks has been prohibited for about two weeks. Big money managers have also been required to disclose their short positions in other companies to the SEC.
Those positions were submitted to the SEC on Monday and will be made public on October 13. The Managed Funds Association is urging the SEC to amend that rule so the short positions are kept secret. The SEC's measures were implemented to help restore equilibrium to markets rocked by bank failures and fears of economic uncertainty. But since the rules went into effect on September 19, markets have swung wildly on hopes for a $700 billion government bailout package for the U.S. financial system.
The measures underpinned concerns from regulators around the world that short selling, in which an investor sells borrowed stock in the anticipation the price will fall, has exacerbated the decline in financial stocks. Regulators in the United Kingdom, Australia and Canada have imposed similar bans.
It is not known whether pleas from the MFA will be enough to persuade SEC commissioners, who were discussing further action on Wednesday afternoon. The short sale ban and disclosure rules expire at 11:59 p.m. EDT on Thursday and can only last a total of 30 days. Another set of emergency rules designed to crack down on abusive short selling are set to expire at 11:59 p.m. EDT on Wednesday. Those rules include one that makes it fraudulent for short sellers to deceive broker-dealers about their intention or ability to deliver securities in time for settlement
Understanding the Significance of Mark-to-Market Accounting
"Suspending mark-to-market accounting, in essence, suspends reality."
-Beth Brooke, global vice chair, at Ernst & Young
Misinformation, bad dope, and spin seem to be dominating the current discussion on Mark-to-Market accounting. Let's see if we cannot simplify the arcane complexity of the accounting rules regarding FASB 157. Understand why this is even an issue: Many banks, brokers, and funds chose to invest in certain "financial products" that were difficult to value and were at times thinly traded. If you are looking for the underlying cause of why some arcane accounting rule is an issue, this is it.
In my office, we don't buy our clients beanie babies or Star Wars collectibles or 1964 Ferrari 275GTBs. We purchase stocks and ETFs and bonds and preferreds for them (some clients also own options and commodities). Why? Because we believe -- and our clients have insisted upon -- the need for instant liquidity. Nothing we have purchased cannot be liquidated on a moments notice. We know what the fair value of these holdings are second by second.
While we may have been tempted by potential greater returns that some of these other products offered, we simply could not justify the risk of owning hard to value, thinly traded, hard to sell items. And, we never had to rely on the models of the individuals who created and sold us these products in the first place, to determine an actual price. If ever a product was rife with self-interested conflicts of interest, this one is it.
That is one of the key elements of the current situation. A decision was made to bypass the broad, deeply traded traditional markets (Equities, Fixed Income, Commodities and Currency) and instead create new markets for new products. No one should be surprised that the net result was a flawed system of garbage paper, with too little room at the exits in case of emergency.Let's puts this into some context:"Accounting is a way of portioning economic results by time periods. It doesn’t affect the cash flows, but tries to allocate economic profits proportional to release from risk. If we were back in an era where the financial instruments were simple, then the old rules would work. But once you introduce derivatives, and securities that are called bonds, but are more akin to equity interests, you need to mark them to market."
Exactly. Otherwise, you are left with public companies, who have made capital allocation and investment decisions that are hidden from their owners (shareholders) and the investing public. Now that the garbage is on the books, no one wants to admit the original error of purchasing this class of assets. Its not just that the trade has gone bad, its the original buying decision was so flawed even if the trades were not such giant losers.
Recent actions of corporate titans in the financial sector are essentially an admission that their business model was deeply flawed. No one would invest any capital for a ROI of 50 bps per year. They of course knew this -- so they leveraged up that 50 bps 35X or so, creating the false appearance of more attractive returns. This higher risk, potentially higher return paper was part of that misleading process.
Suspending FASB 157 amounts to little more than an attempt to hide this broken business model from investors, regulators and the public. Its not just getting through the next few quarters that matters; Rather, its allowing the market place to appropriately reallocate this capital to where it will serve its investors best. That is what free market capitalism is, including Schumpeter's creative destruction.
I have been steadfast over the past 2 years about why I did not want to own any of the financials that held this paper on its books. The key was that we could not figure out what the liabilities were relative to the assets. That is investing 101. If FASB 157 is suspended, I would advise our clients and the investing public that owning any financials that failed to disclose their holdings accurately were no longer investments -- they were pure speculations, with more in common to spinning a roulette wheel than owning Berkshire Hathaway or Apple or Google.
Indeed, I know of no faster way to end up on the DO NOT OWN list than to hide from your shareholders what is on your books. If investors cannot trust the valuations of what is on a firms books, they simply cannot invest in these firms PERIOD.
There are other alternatives for the institutions that now must deal with this discounted, thinly traded hard to value junk paper. They can sell it for whatever price a the market will bear, they can spin it off into a separate holding company, they can write it down to zero and reap the rewards of mark ups in future quarters.
But suspending the proper accounting of this paper is the refuge of cowards. It reflects a refusal to admit the original error, it hides the mistake, and it misleads shareholders. I find it to be totally unacceptable solution to the current crisis. As Japan learned, not taking the write downs only delays the day of reckoning. They propped up insolvent banks, and suffered a decade long recession for it. That way disaster lay . . .
As Cash Leaves, Money Funds Sign Up for U.S. Protection
Less than a week after the Treasury Department announced its ad hoc insurance program for money market funds, some of the nation’s largest mutual fund companies have already announced that they are signing up for coverage.
Those companies include Charles Schwab, Federated, Morgan Stanley, Putnam Investments, BlackRock and JPMorgan Chase. Several other companies said they would most likely enroll before the deadline on Wednesday. But despite this new government safety net, investors have continued to pull cash out of money funds, especially the so-called prime funds, which have the widest latitude to provide short-term credit to banks and businesses.
According to iMoneyNet, a research firm, almost $80 billion was withdrawn from prime funds even after the new guaranty plan was announced on Sept. 19. Data show that from Friday through Tuesday night, almost $48 billion was moved from prime money funds. Even after counting additions to less risky government funds, the net amount withdrawn over that time was more than $20 billion.
All told, money fund assets have shrunk by $100 billion, to $3.33 trillion, over the last three weeks, and prime funds have dwindled by more than $370 billion, to $1.6 trillion. Continued shrinkage in prime money funds will increase the risks to the nation’s economy because they are an important source of short-term credit for businesses.
Without fresh cash flowing in, money funds cannot purchase the commercial paper and other short-term corporate notes that businesses sell to raise cash. Indeed, continuing withdrawals will force them to sell assets they already own, a move that would further worsen the business credit squeeze by pushing up rates for all short-term credit.
The goal of the Treasury insurance plan was to prevent that vicious circle by reassuring investors that their money funds would not “break the buck” by reporting a per-share value of less than a dollar. Fear of such losses has increased since Sept. 16, when the Reserve Fund, the original money fund sponsor, announced that three of its funds, including its $64 billion Primary Fund, had broken the buck. The company announced this week that the Primary Fund had shrunk to just $20 billion and would be liquidated.
The final amount recovered by the fund’s investors will most likely be determined by litigation. At least four lawsuits have been filed against the fund’s management, including two that accuse it of tipping off some institutional customers in advance so they could withdraw their cash from the fund before its per-share value fell below a dollar.
But the details of the Treasury insurance plan may actually discourage investors from entrusting additional cash to their money funds. Under the terms of the plan, only the shares that investors owned on Sept. 19, not shares bought later, are protected against a decline in value. If Congress raises the coverage limits on federally insured bank deposits, bank accounts may become more attractive to small investors, prompting additional withdrawals.
Corporate treasurers and other big institutional customers still need money funds for cash management, but they are increasingly seeking out less-risky Treasury funds. And with the yields on Treasury securities dropping, in contrast to corporate debt, it is hard for money fund sponsors to offer any yield at all to investors without waiving their management fees, said Geoffrey Bobroff, an industry consultant.
Besides working free, the fund sponsors also take on the risk of having to bail out a money fund if the credit market distress does not ease. “You have to ask, does anybody want to be in this business today?” Mr. Bobroff said. In fact, he said, he has heard reports of some Treasury funds refusing money from large investors unless they agree to leave the cash alone for some specific period of time — reducing the risk that the fund will have to sell assets suddenly in a bad market to cover withdrawals.
“With the credit market so sludgy, the funds don’t want fast money that wants to go in and come out quickly,” Mr. Bobroff said. “Unfortunately, that’s the virtue of a money fund — you can go in and come out anytime you want.”
GE's Stock Sale Said to Be Priced as Low as $22.25
General Electric Co. may sell stock at a discount of as much as 9.2 percent to yesterday's closing price as the company seeks to raise $12 billion from investors to help fund its operations, according to two people with direct knowledge of the sale. Fairfield, Connecticut-based GE's shares slid 7.1 percent to $22.75 at 8:21 a.m. in New York after closing at $24.50 yesterday.
The offering, still ongoing, may be priced between $22.25 and $22.50, said the two people, who declined to be identified before the company makes a statement. GE said yesterday it will sell $12 billion in common stock and that Warren Buffett's Berkshire Hathaway Inc., in a separate deal, will buy $3 billion in preferred shares as Chief Executive Officer Jeffrey Immelt gathers more cash to fund operations amid the worst U.S. financial crisis since the Great Depression.
Goldman, Sachs & Co. will manage the sale to investors, GE said yesterday. The company said it also expects Bank of America Corp., Citigroup Inc., Deutsche Bank AG, JPMorgan Chase & Co. and Morgan Stanley will be additional bookrunners. GE spokesman Russell Wilkerson didn't immediately reply to a message left on his mobile phone. London-based spokespeople for Goldman weren't immediately available to comment. Buffett's preferred shares will pay an annual 10 percent dividend and are callable after three years at a 10 percent premium.
GE's stock through yesterday tumbled 34 percent in New York trading this year. GE and Immelt, 52, told investors as recently as Sept. 25 there was no need for outside capital, including selling a large equity stake to an outside entity. Immelt that day reduced his annual profit forecast for the second time this year. He also suspended a $15 billion buyback program, shifting capital to protect GE's dividend and AAA credit rating as volatility in credit markets reduced profit at its finance arm, GE Capital.
Deposit Plan Will Cost Banks More
When banks were flush, most of them paid nothing for a golden government guarantee. Bank failures were so rare that, for a decade, the Federal Deposit Insurance Corporation waived most of the premiums it normally would have collected to insure bank deposits.
But now the government plans to raise the amount of deposit insurance that consumers have, leaving the F.D.I.C. — and potentially taxpayers — in a bind. After forgoing premiums from 1996 to 2006, the agency must now turn to struggling banks and ask them to pay more, putting more pressure on the industry. If a large number of banks fail, the F.D.I.C. may have to turn to the Treasury for more money, forcing taxpayers to foot the bill.
“It’s unfortunate that we didn’t have more time to build up the fund in the good times,” said Sheila C. Bair, the F.D.I.C. chairwoman, in an interview Wednesday. “It is what is, and we are dealing with the situation.” The measure to raise the limit is part of the government bailout plan that the Senate voted to approve on Wednesday night. The F.D.I.C. board, for its part, will propose raising premiums for its member banks on Oct. 7 to shore up the insurance fund, and that increase may not be the last, Ms. Bair said. Banks that the F.D.I.C. deems risky will have to pay higher rates.
The F.D.I.C. insures roughly $4.5 trillion in deposits, and has $45.2 billion in its fund. If the bill passes, those numbers would change substantially. Currently, the F.D.I.C. insures deposits up to $100,000. The proposal is to raise that to $250,000. The limit has not been raised for nearly three decades and the increase is intended to bolster customers’ confidence and avert the kind of runs that toppled Washington Mutual, the nation’s largest savings and loan.
The Congressional Budget Office estimated that the new provision would extend F.D.I.C. coverage to $700 billion of currently uninsured deposits. That would increase insured deposits nationwide by about 15 percent, according to a letter sent Wednesday to Christopher J. Dodd, the Senate Banking Committee Chairman. Proponents say that the move should help calm the nerves of depositors and stabilize the banking industry. After the emergency takeovers of WaMu and the Wachovia Corporation, bankers have worried about customers withdrawing their money.
Among the biggest beneficiaries will be retirees and small-business customers, who tend to have higher account balances.
Raising the limit should help reassure depositors they do not need to withdraw their money at the first sign of trouble. It sharply reduces the risk of keeping more than $100,000 in the bank.
“It will bring peace of mind of mind to grandmother and mom and dad,” said Cam Fine, the head of the Independent Community Bankers of America, an industry group that lobbied for the increase. “My bankers are getting numerous customers coming into their lobbies and saying, ‘is my money safe?’ ”
But Mr. Fine acknowledged that potentially the biggest impact would be on small-business customers, which often must have more than $100,000 in cash to meet payroll requirements and other needs. If the insurance coverage is increased to $250,000, about 68 percent of all small-business deposits will be insured, according to Oliver Wyman data. Today, about 51 percent of small-business deposits are protected.
Indeed, the move will likely strengthen the competitive position of smaller banks, which are being elbowed out by giants like Bank of America, Citigroup, and JPMorgan Chase. Small-business customers have flocked to those institutions, thinking their money is safer because they are “too big to fail.” Some consider keeping deposits in community banks more risky: Despite their local touch, they may be too small for the government to save.
Others, however, question how much the measure will really help. One reason is that customers most likely to pull their money tend to be midsize corporations that keep more than $250,000 in cash in an account. “A greater stabilizing source would be to insure all deposits in transaction accounts, without limits,” said Michael Poulos, an Oliver Wyman consultant. That would cover about 81 percent of small-business deposits, “but that would look like a giveaway to businesses, rather than helping mom-and-pop with a big C.D.”
William M. Isaac, who was the chairman of the F.D.I.C. between 1981 and 1985, said that lifting the limit to $250,000 is “all show, no substance.” “It doesn’t do what needs to be done,” he said. “It might make somebody’s grandmother feel good, but that is not the problem that we have in the financial world: banks won’t lend to other banks.”
For more than a decade, the banking industry pressed the government to increase its insurance coverage. Congress last raised the limit on insured deposits in 1980, to $100,000 from $40,000. But despite years of rising prices, lawmakers resisted increasing the cap. The concern was that raising the limit would increase the moral hazard, giving banks and customers incentives to take more risk than they otherwise would take. But with the banking industry under siege, that view appears to have changed.
Still, the move will put more pressure on the insurance fund. Regulators arranged the emergency takeovers of WaMu and Wachovia without suffering any new losses. But a wave of new bank failures could deplete the fund, and eventually force the F.D.I.C. to draw down on its $30 billion line of credit from the Treasury, or at worst, ask Congress for more cash. Ms. Bair played down the risks. “I am confident that there is enough money in the fund and that we have ample authority to borrow from Treasury,” she said.
Bad credit-card debt could be next shot to economy
Credit-card debt is on the brink of imploding and will be the next storm to hit the fragile finance industry, an investment research firm predicted this week.
According to Innovest StrategicValue Advisors, banks will charge off $18.6 billion in delinquent credit-card accounts in the first quarter of 2009 and $96 billion in all of 2009, more than double the research firm's forecast for all of this year. Innovest projects that amount would be high enough to damage some of the biggest card issuers.
Credit-card charge-offs are "defying gravity" when compared with the problems in the mortgage market, according to Gregory Larkin, senior banking analyst for Innovest. But that will change as they catch up with mortgage charge-offs, which have spiked eightfold since the third quarter of 2007. "If history is any indicator, there should be an equivalent surge of credit-card charge-offs very soon," he said, though he concedes that an eightfold increase would be very aggressive.
Comparatively, charge-offs reached $4.2 billion in the first quarter of this year and $3.2 billion in the same period a year before, according to the Federal Reserve, which only reports non-securitized debt. Innovest's projections include all credit-card debt, which the firm believes is double what the Federal Reserve reports. For all of 2007, charge-offs tallied $26.6 billion, according to Innovest's calculations, and the firm estimates they will reach $41.5 billion at the end of this year.
The jump in credit-card charge-offs is linked in part to the credit crisis now in play. As banks have tightened lending standards, they have mostly done away with the once-popular roll-over options -- usually at 0% introductory rates -- that allowed borrowers with delinquent accounts to get new cards elsewhere. Larkin believes all that bad credit is going to surface quickly and could have a similar impact as the mortgage crisis has had on banking.
But credit-industry analysts shake those prognostications off, noting that the number of dollars involved in credit cards loans versus mortgages is substantially lower. "Defaults on $2,000 or $5,000 in credit-card debt are entirely different than someone defaulting on a $500,000 mortgage," said Greg McBride, senior financial analyst for Bankrate.com. "I'm skeptical that the magnitude of credit quality is going to be as severe as some say," he added.
The average credit-card debt is $2,200, according to the Federal Reserve. On a revolving basis, there was roughly $970 billion owed on credit cards at the end of July. However, because many people use credit cards for the rewards programs and pay off their debt each month, it's unclear how much of that total is actually outstanding. What's more, as delinquencies rise -- and they will because of the weakness of the economy -- credit-card issuers will take steps to stem the tide. That will include cutting credit off from problem borrowers and tightening restrictions on new cards.
"Banks already are starting to minimize their risk and drop their credit limits that they extend to people and especially those at a higher risk," said Bill Hardekopf, a partner at LowCards.com. American Express, for example, upped its loan-loss reserves to $2.6 billion in the second quarter compared with $1.4 billion in the year-ago period. In the second quarter, Capital One's provisions for loan losses nearly doubled to $1.1 billion compared with $535 million in the second quarter last year.
"There's no doubt there's going to be pain in the credit-card markets," said Justin McHenry, research director with IndexCreditCards.com. "But I don't see anything to the magnitude of what we've seen in the mortgage market. "This is a different financial animal in terms of how much is being loaned out," he added. "And credit-card companies can take that credit and cut it in half. That's a tool that they have."
Larkin admits that Innovest's projections run against the financial tide: "I think they're wrong," he said.
Laura Nishikawa, Innovest's consumer finance analyst, said the credit-card crisis will hit earnings, in particular at companies that glean high percentages of net revenue from their U.S. credit-card revenues. "Companies that have pursued aggressive portfolio growth and higher yields at the cost of prudent risk management will struggle to manage rising loan losses, which will definitely cut into earnings or even worse," she said.
Discover Cards, for example, is a pure-play credit-card company with 97.8% of net revenue from credit cards. Capital One gets 62% of its net revenue from credit cards while American Express' clocks in with 24.5%. J.P Morgan Chase's garners 20.5% of net revenues from credit cards. Nishikawa is also worried about companies that target lower-income consumers and use delinquencies and late payments as a means of making money.
"Delinquent borrowers become cash-flow generators," she said. "At the extreme end, the goal becomes, 'How do we get borrowers into delinquent status as soon as possible, in order to maximize returns?'" J.P. Morgan and Amex are what Nishikawa considers best of class, while Capital One has an unsustainable business model that's based on penalty pricing -- high fees for missed payments, shooting interest rates for surpassing limits -- and that she thinks has a high exposure to subprime credit-card holders and low payment rates.
"When the economy turns bad, this strategy clearly cannot be sustained," she said. "While a hit to topple credit cards may not topple the bank completely, it will cut into core earnings," she added.
Specialists' Moves Monday May Have Staved Off Bigger Market Fall
Black Monday could have been even darker. Proponents of open-outcry trading say that specialist market makers on the New York Stock Exchange, faced with a flood of selling orders late Monday, took the buy side or aggressively solicited for buyers on several large financial companies that were selling off. By assuming the role of buyers or soliciting them, these specialists may have helped limit losses at the bell.
In this solicitation, specialists that represent some financial companies said they would take buy orders in a late crossing session - a move that helped create a floor to some of the selling and kept an even bigger decline from occurring. "If this was purely electronic, it could have been down 1200 or 1300 on the Dow," said Bernie McSherry, a senior vice president with Cuttone & Co., the largest independent floor operator at the NYSE. For the session, the Dow lost more than 777 points as the defeat of a proposed $700 billion bailout package in the U.S. House of Representatives sent traders scrambling.
At many Wall Street companies, traders reacted to live footage of the vote count on the floor of Congress around 2 p.m. EDT with heavy selling. Going into the 4 p.m. close, brokers on the NYSE floor say specialists published huge sell imbalances in many financial names, but were actively looking to find buyers. Specialists surveyed their books to find brokers that had purchased the financials on their books at certain levels in the past and went asking again.
To solidify this negotiation, specialists made verbal commitments to settle up buy trades in a late crossing session, while continuing to execute sell orders. While this helped specialists pare some of the large positions they would have to keep on their books thanks to the trade imbalance, it also served to help create a floor on some of the trading.
"[Specialists] created trades that otherwise would not have occurred...when someone alerts a broker and says look at this, you create an interest. That facilitates trading that doesn't happen in other markets," said Dave Humphreville, president of the Specialist Association, which represents market makers on the floor of the NYSE. Still, a trader at one leading Wall Street algorithmic firm said the volume of stock handled by the specialists was small compared with the overall listed volume, and may not have had a broad impact.
Overall, specialists executed 141.5 million shares on Monday, more than double the 63.4 million shares they execute on an average day year-to-date. Overall volume was high, however, with about 7.3 billion shares trading on the NYSE Composite, meaning that the specialists handled about 1.9% of the volume. "The New York Stock Exchange floor in general is shrinking as things go more electronic," the trader at the electronic-trading unit said.
The dark pool, an electronic crossing network that is an alternative to stock exchanges, at this firm and others are seeing record volumes during the recent volatility. One such venue traded half a billion shares in a single session earlier in September. As for who bought from specialists, representatives for two floor brokers say specialists disseminated information out to "anyone in the stock market community" that they would take these buy orders in an extended session.
The "specialist helps in price discovery so, if they slow the market down, there would be better price discovery," said Tim Mahoney, chief executive of Bids Holdings, an electronic trading group that has partnered with the NYSE. Among the names that changed hands in the crossing session were some of the large banks, including JPMorgan Chase & Co., Bank of New York Mellon Corp., and Morgan Stanley.
"The specialists performed an important function by soliciting contra-side buy interest and that helped cushion some of the downward move. It's happened on a stock by stock basis over the years, but I haven't really seen that happen on as broad a basis before," said McSherry. Nonetheless, the "selling imbalance" at the close of the session, when sell orders flooded in, meant that prices slipped steadily during the extended trade.
After being down fewer than 600 points at the closing bell, the Dow had taken a loss of 738 points by 4:12 p.m. EDT and at 4:15 p.m. EDT, when all orders were processed and closed, the loss was more than 777 points. The Standard & Poor's 500 also took a long time to settle at its final close, ending down 8.8%. The Nasdaq Composite, which settled more quickly than the other two indices and had no specialist involvement, fell 9.1% - a comparable loss. "A lot of [specialists] went home way more long than they usually do. It's not what they like to do, but there was a buyers' strike towards the close," said Ray Pellecchia, a spokesman for the NYSE.
Putin turns on US 'irresponsibility'
Vladimir Putin has accused the United States of "irresponsibility" as he criticised its primary role in the economic and financial turmoil that has undermined the foundations of global capitalism across the world.
The Russian Prime Minister's remarks yesterday came after several European leaders, including the French President Nicolas Sarkozy and the German Chancellor Angela Merkel, said the spiralling crisis started by toxic housing debts in the US raised questions about the "Anglo-Saxon" way of doing business.
"Everything that is happening in the economic and financial sphere has started in the US," Mr Putin told a government meeting in Moscow. "This is a real crisis that all of us are facing. And what is really sad is that we see an inability to take appropriate decisions. This is no longer irresponsibility on the part of some individuals, but irresponsibility of the whole system, which as you know, had pretensions to [global] leadership."
The Russian stock market has collapsed by 50 per cent from its peak last May as a result of the global uncertainty, coupled with investor nervousness following the Georgian crisis.
M. Sarkozy, speaking in Toulon a week ago, said: "A certain idea of globalisation is drawing to a close with the end of a financial capitalism that had imposed its logic on the whole economy and contributed to perverting it. The idea of the absolute power of the markets that should not be constrained by any rule, by any political intervention, was a mad idea. The idea that markets are always right was a mad idea."
The German Finance Minister Peer Steinbrück said "the US will lose its superpower status in the world financial system". He hesitated to predict the long-term consequences of the upheaval, which he described as "above all a US problem" but said: "The world financial system is becoming multipolar."
Leaders of developing countries have also lashed out at the US over what Gordon Brown called the first crisis of globalisation, in the light of the Bush administration's failure to swiftly put an end to the bloodletting in the financial markets. "The managers of big business took huge risks out of greed," said the Costa Rican President Oscar Arias, whose economy is highly dependent on US trade. "What happens in the United States will affect the entire world and, above all, small countries like ours."
Another ally of Mr Bush, the Colombian President Alvaro Uribe, criticised Washington's failure to deal with the uncontrolled financial speculation. "The whole world has financed the United States, and I believe that they have a reciprocal debt with the planet," he said.
France and Germany are calling for greater EU intervention to regulate the markets, while Britain is wary of such a move. But Mr Brown used his UN speech last Friday to press for international regulators to set up "colleges" overseeing the megabanks with branches across the world.
Latin America Economic Boom Threatened as Credit Freeze Deepens
Latin America's fastest economic expansion in 30 years may be coming to an end as the global credit crunch stunts investment and squeezes demand for the region's commodities. "We're in a serious economic crisis," Colombian Vice President Francisco Santos said in an interview in his Bogota office. "Financing is going to get scarcer and scarcer, and that means that investment is going to be difficult to attract."
The region's growth in 2009 may be cut to less than 3.3 percent, from 4.6 percent this year, according to economists at Barclays Capital. The slowdown will make it harder to further reduce poverty that's fallen to its lowest levels since before the "Lost Decade" of the 1980s in which countries borrowed more than they could repay.
The crisis will test Latin America's decade-old commitment to debt reduction and open markets. Mexico this week shelved plans to privatize an airport, citing the U.S. crisis, while Costa Rican President Oscar Arias warned the country's growth rate may halve as investment drops. In Brazil, lending that has powered the country's fastest expansion in more than a decade is drying up, said Ricardo Espirito Santo, head of the Brazilian unit of Portugal's Banco Espirito Santo SA.
"The last four or five years were very good for Latin America, but that cycle is coming to an end," said Rodrigo Valdes, chief Latin America economist at Barclays Capital in New York. "We expect a deceleration in practically all economies." Brazilian economists lowered 2009 growth projections to 3.6 percent on Sept. 26, from 4 percent two months earlier, according to a central bank survey. JPMorgan Chase & Co. cut its forecast for Latin America's largest economy to 3.2 percent from 3.8 percent.
Mexico, the second-biggest economy, may expand 2.5 percent next year, according to the average estimate of 33 economists surveyed by the central bank, which released its report yesterday. They had previously forecast 3 percent. The region has posted average growth of 5.5 percent a year during the past five years, a pace not seen since 1970 to 1974, according to International Monetary Fund statistics.
Latin America may also see a drop in remittances from emigrants living in the U.S. Money transfers from Mexicans living outside the country dropped a record 12.2 percent in August, the central bank said yesterday. Remittances accounted for almost 3 percent of Mexico's gross domestic product last year. "Mexico is very tied to the U.S., and they're going to get hammered," said Mark Weisbrot, co-director of the Washington- based Center for Economic and Policy Research.
Empresa Brasileira de Aeronautica SA, the world's fourth- largest aircraft maker, said last week that tightening credit markets are making plane purchases difficult for some buyers. Brazil's Localiza Rent a Car SA, the region's biggest car- rental company, delayed this week a 300 million real ($157.6 million) bond sale because of "adverse market conditions." Central banks are injecting liquidity as foreign credit lines dry up. Chile's central bank canceled planned purchases of dollars and opened up a $500 million foreign currency swap window as the cost of borrowing dollars climbed.
"Local banks had counterparties overseas who provide them with dollars, but those banks have failed, been bought or tightened credit," said Ricardo Gomez, head of fixed-income sales and trading at Larrain Vial SA in Santiago. Prices for commodities such as soy, gold, copper and oil, which helped fund the region's boom, have fallen 28 percent since their July 2 high, according to the RJ/CRB Commodity Price Index. Should prices return to their 10-year average, Latin America's balanced budgets would quickly revert to a deficit of 4.1 percent of gross domestic product, Morgan Stanley said in a Sept. 29 report.
Venezuelan President Hugo Chavez, who has relied on oil to fund his "21st-century socialism," said the U.S. crisis will hit the region with the force of a "hundred hurricanes" and that "no country can say it won't be affected." Venezuela is the country most vulnerable to a commodity slowdown, having seen its terms of trade, a measure of export earnings, more than double since 2001, according to a study by Brazil's national development bank. Brazil and Mexico's trading terms improved less than the 22 percent regional average, according to the same study based on United Nations data.
"The big question for Latin America is how long and deep is this cyclical downturn going to be, and how much is it going to reduce commodity prices," said Nicholas Field, who helps oversee about $18 billion in emerging-market equities at London- based Schroders Plc. Analysts including Paulo Leme, chief Latin American economist at Goldman Sachs Group, Inc. say the slowdown may be milder than in previous crises. Many regional governments have used revenue from the commodity boom to pay down debt and build reserves.
The eight largest South American economies shrank their debt as a proportion of gross domestic product from 2001 to 2008, according to Merrill Lynch research. Merrill expects growth to slow to 3.4 percent next year from 4.6 percent in 2008. "It was a good ride," said Gray Newman, chief Latin American economist at Morgan Stanley in New York. "But the era of abundance is over."
Ron Paul: Buying bad debt is the wrong solution
John Roberts: Congressman, great to see you. I was browsing around on your Web site, Campaign for Liberty. And right there on the very front page, you are appealing to your supporters -- and there are tens of thousands of them -- to get in touch with key senators to tell them to vote this bill down when it comes to a vote in the Senate at sundown tonight. Why do you want them to vote it down?
Rep. Ron Paul: I think it's a bad bill. I think it's bad for the taxpayers. I think it's doing more of the same thing. The same policy that we're following now with this bill is exactly how we got into that trouble.
And you know, I really don't have that much clout in Washington, D.C. And I recognize it. But there are a couple people outside of Washington that care about what I'm thinking and care about free market ... economics. And they will respond. And I think we did help generate a little bit of mail to the House members. So you go where you can have the influence. And I think that people -- the grassroots -- understand this a lot better than members of Congress give them credit for.
Roberts: So, instead of the bills that are currently before the Senate, the one that may be before the House as early as Thursday, what would you do?
Paul: Well, we need to do a lot, but a lot differently. We have to recognize how we got into this problem. We have too much debt. We have too much malinvestment.
Roberts: OK, OK. So we recognize all of the things that got us here. But, right now, today, what would you do, if not this bill?
Paul: You have to liquidate those mistakes. Those mistakes were made due to monetary policy. So you have to allow the market to adjust prices downward. And that's what we're not allowing to do. If there are too many houses and the prices are too high, the sooner we get the prices down to the market level, as soon as we quit trying to encourage more housing -- this is what we're doing. They're trying to stimulate houses and keep prices high. It's exactly opposite of what we should do.
So, we should get out of the way and not buy up bad debt. There's illiquid assets, but most of those are probably worthless. They're mostly derivatives. And we're sticking those with the taxpayer. So we have to recognize that the liquidation of debt is crucial. And if we did that, we would have tough times, there's no doubt about it, for a year. But if we keep propping a system up that's not viable, we're going to have a problem for decades, just like we did in the Depression. That's what we're on the verge of doing.
Roberts: Congressman Paul, what do you think of this idea that's being floated -- this process called mark to market, which would, they would modify the rules so that the, right now, paper that a lot of these institutions are holding, which is worth nothing, they would actually be able to assign some sort of value to it.
Some people are saying that that would just hide the problem. Other people are wondering if maybe that might create some sort of voodoo accounting that would allow widespread abuse in the system. What do you think?
Paul: It demonstrates the problem. You know, when they prevented them from marking them down, this was an SEC [Securities and Exchange Commission] regulation. Shows how regulations backfire. If you had a market economy and then if you had a market-adjusted FDIC, where insurance was based on the strength of the bank, this would have happened on a daily basis.
But instead, we insure everybody, no matter what the bank is doing, and we do it, either we overkill -- we give you too much credit on bad investments -- and then we make changes all of a sudden, and they're drastic, to what they have done. So, it's impossible. It's either too little or too much. And what you need is insurance of, FDIC type of insurance, has to be driven by the marketplace to measure the viability of a bank.
Roberts: So what do you think?
Paul: This adds to all the moral hazard that we have in the system.
Roberts: So what do you then think of this idea of raising the limit on [FDIC] insurance to $250,000, from its current cap of $100,000?
Paul: Well, on the short run it will calm the markets. People will feel better. I might even personally feel better for a week or two.
But I know that long term, it's the wrong thing to do. I opposed this in the early '80s when they went from 30 [thousand dollars] to 100 [thousand dollars], saying it would lead to more problems like this with malinvestment. It would cover over the mistakes. And the same thing will happen.
But if we raise it to 250 [thousand dollars], people are going to feel better, then it will keep the bubble going for a little while longer and putting more pressure on the dollar. If the dollar lasts longer, then finally the world will give up on the dollar -- and then we will have a big problem that nobody has even really begun to think about.
Roberts: A lot of people might hope that you're wrong with your projection.
Paul: I do too. I hope I'm wrong.
Roberts: You tend to be right on these things on occasion, though. Dr. Paul, it's good to talk to you. Appreciate it.
Paul: Thank you.
The Great Bank Robbery of 2008
In very simple terms, the Paulson Plan is a straight-up transfer of $700 billion — and counting! — from the taxpayers to a few big financial institutions. (Some smaller banks are complaining that they don't own the exotic mortgage-backed derivatives, but rather simple mortgages. They do not believe they will see a dime of the Paulson money.)
It's easy to get all twisted around, but just remind yourself of this: the Paulson Plan has the federal government borrow $700 billion (through issuing Treasury debt) in order to buy assets from Wall Street banks. (We are neglecting the time delay in the program; the entire $700 billion wouldn't be spent all at once.)
Some analysts think that the price paid for these "toxic" assets is important. No it isn't. The government officials running this operation will dole out the favors on both ends, when the mortgage-backed securities are coming and when they are going. Neglecting this insight, some people want to say that if the government pays $700 billion for a portfolio of assets that is really only worth $400 billion, then the taxpayers really only lost $300 billion, not the full $700 billion.
Yet this thinking is naïve. The taxpayers are not going to be treated as equivalent to shareholders of a firm that just acquired $400 billion in assets. The taxpayers are not going to get a cut of the monthly mortgage payments (less the servicing costs on the $700 billion in new debt) tied to the government's massive portfolio.
Instead, the government will simply bump up its annual spending by a few billion dollars. Maybe it will have to spend the money on homeownership programs, or homebuilder job retraining, but the net income from those government-owned assets certainly won't translate into a dollar-for-dollar tax cut.
And then at some point — during a future Republican administration, no doubt — there will be a push to "privatize" the secondary mortgage market, and the government's portfolio at that time will be auctioned off at very generous prices to politically connected institutions. For example, maybe the $400 billion portfolio is auctioned off for $250 billion.
(Perhaps the big banks have to set up subsidiaries owned by minorities and women who get preferential treatment in the bidding process. But whatever the ruse, they will find a way to justify the low prices.) When all is said and done, the government will have played hot potato with the MBS, and the national debt — borne by taxpayers — would be $450 (=$700-$250) billion higher. The favored financial institutions would be "up" roughly the same amount, collectively. (Throughout, we are ignoring the timings of the payoffs and the effect on present discounted value.)
It is the crudest Keynesianism to view the Paulson Plan as an injection of capital or "liquidity." That money has to come from somewhere. If it is taxed or borrowed, then it is just a shell game; the liquidity is drained from elsewhere, to be injected into Wall Street.
Besides taxing or borrowing, the government has a trump card: it can have the Federal Reserve simply create the new money out of thin air, by engaging in some "Open Market Operations." Yet even in this case, real wealth still hasn't increased. Certain nominal figures, like "aggregate asset values" might go up. But that's not very relevant, because the economy isn't really richer.
After all, there aren't more tractors or office buildings just because Bernanke allows the monetary base to grow more rapidly. So what happens in this case is that prices rise; people find it harder to buy milk, bread, and gasoline. But the Wall Street fat cats are fine with the general price hikes, because they got their hands on the newly injected funny money early in the game.
But Won't the Credit Markets Collapse? Some observers would admit the legitimacy of my analysis above. "However," they might say, "the Paulson Plan, or something like it, is necessary to avert a total meltdown of the financial system. We're not trying to boost aggregate investment, so much as clearing out a clogged pipe." This talk of a breakdown in the financial system is a bogeyman. Steve Landsburg does such a great job of exploding this myth that I will simply quote him:So what's special about banks [that they deserve a bailout]? According to what I keep reading, it's that without banks, nobody can borrow, and the economy grinds to a halt.
Well, let's think about that. Banks don't lend their own money; they lend other people's (their depositors' and their stockholders'). Just because the banks disappear doesn't mean the lenders will. Borrowers will still want to borrow and lenders will still want to lend. The only question is whether they'll be able to find each other.
… [A]s any user of match.com can tell you, the technology for finding partners has improved since [the 1930s]. When a firm wants to raise capital, why can't it just sell bonds over the web? Or issue new stock? Or approach one of the hedge funds that seem to be swimming in cash? Or borrow abroad?
… I'm not sure these big Wall Street banks are really necessary, and I'm not sure we'd miss them much if they were gone. Maybe there's something I'm missing, but if so, I think it should be incumbent on Messrs. Bernanke, Paulson and above all Bush to explain what it is.
The Paulson Plan is a heist. It is a grand scheme in which the public will end up owing hundreds of billions of dollars to holders of new debt claims issued by the US Treasury. The plan won't "prop up" asset values and it won't provide any real stimulus to the economy. Despite the dire warnings — coming from the same folks who brought you the Iraq invasion to remove WMD — there is no threat of a financial meltdown. If Goldman Sachs failed, the sun would still rise the next morning.
Far from providing stability and confidence, the Fed, Treasury, and SEC's recent moves have ensured that US capital markets will now function with the same efficiency as public education in this country. The Paulson Plan is one more step in the socialization of America, but it is also a great bank robbery.