Mississippi girl, works all day in a cannery.
Ilargi: The losses in Asia and Europe are so large that there's no telling whether Wall Street will be open for trade by the end of the day. A fall of 1100 points before 2 PM EDT will trigger an automatic 1-hour trading halt. Pre-market stock futures trading was suspended when they reached their daily limit.
Still, I don’t think it’s wise to focus on Lower Manhattan too much. At noon, Wall Street was down "only" 4%, and there's always a chance that somehow the downfall can be mitigated, although it's getting hard to see how it could be achieved. Hey, at least there's a beautiful excuse here to spend more of your money on heroic rescues. Does Paulson still need to announce the next plan, or can he just implement the next trillion dollar blowout sight unseen?
No matter how the Dow fares, it'll be a weekend to remember. And I don't think American stocks will be the main story.
On the international front, there are many miles of dams and dikes about to burst. Denmark joins the list of trouble with a desperate rate hike; Romania does the same. ING Groep loses another 20%, even though it got $14 billion last week. Sterling and the Euro keep plunging (which makes Europeans happy). The Yen is heading for the skies beyond infinity, which takes enormous additional amounts of credit out of the markets, a much bigger issue than you might think.
The IMF announces a plan to help developing nations, but even if we were to assume that they have noble intentions -which we don't-, it is too little too late. The Fund is now talking to perhaps a dozen countries at the same time, and it can't seem to conclude any deals. It doesn't want to, it won't, and it can't. There'll be token amounts handed out, but only to countries that agree to give up what can basically be labeled their sovereignty.
The Fed’s huge dollar swap injections included only the "richest economies" (it's starting to get funny just to write that). For all the rest, it's every man for himself. So now the poorer nations face steeply rising interest rates on their loans. Not good. East Asian stock exchanges lost $860 billion this week, and they come with an $80 billion rescue plan. Anybody got a calculator?
I don't think the world markets have ever had a Black and Blue Sunday, but they could see a first. Investors have lost all confidence in Russia, and even though it has huge foreign reserves, there is a breaking point in every system. However, I still doubt that Russia will be exposed as the weakest link.
There is simply no way that all the holes around the planet can be plugged for much longer; it's a matter of days now. Trillions of dollars 'worth' of global equity value have vanished today alone, regardless of Wall Street. We have started down the path towards the worst financial crisis in history, an unprecedented event. Don't listen anymore to anyone anywhere saying there 'might' be a recession. This is a depression, and it will be much worse than the Great One.
How it will unfold is impossible to predict, but one thing is for sure: the rich will attempt to save themselves at the cost of the poor. And that should be a wake-up message for all of you. Politicians and bankers everywhere will keep insisting that their particular economy is in better shape than the others; they will continue to say this until it is no longer credible. I just see Canada's central banker and Treasury secretary pull that very rabbit from the same old hat. No matter that personal debt in Canada is higher than in the US, I guess. Politics and economics are faith-based systems.
Politicians lie; it's an integral part of their job description. It gets them votes. You vote for the guy and gal with a happy tale.
The problem with that is that it prevents their countries from preparing for what is the real, instead of the imaginary, future. And that in turn is a deadly threat for the poorer people within their societies, as well as the poor elsewhere in the world. The sense of entitlement of the middle classes, those who are not among the poor, is being maintained at unrealistic fantasy levels, and for an unrealistic length of time. The proof in the pudding: today’s report that US existing home sales numbers are up. You have to wonder what these folks are thinking. 98% are digging themselves into a hole for life.
Our societies, all of them, need to spread their remaining wealth, because if they don't, they will fall apart. The poverty this crisis will unload upon our lands will make that inevitable. You either share, or you face street fighting men. Over 90% of the 'money' that makes the world go round is make believe, and it's being renditioned and disappeared at lightning speed, to never be heard from again.
In a sense, that's a very healthy development. Yet, the way we are approaching it to date will not end well for many of us. Forget the Wall Street "bloodbath". Unless we change our ways real soon, we are talking real physical bloodbaths.
U.S. Stock-Index Futures Plunge by Daily Limits
U.S. stock-index futures plunged by their daily limits after slumping earnings at automakers and technology companies spurred concern the financial crisis has infected the broader economy. General Motors Corp. declined 13 percent and Ford Motor Co. lost 10 percent after Toyota Motor Corp., the world's second- largest automaker, reported its first sales decline in seven years.
Apple Inc. fell 8.4 percent as Samsung Electronics Co., Asia's biggest maker of chips and mobile phones, had its steepest profit drop in more than three years. Exxon Mobil Corp. lost 8.2 percent as oil and gasoline prices retreated. "It's the spillover of the banking crisis into real economies around the world," said Michael Mullaney, a Boston- based money manager at Fiduciary Trust Co., which oversees $10 billion. "Everything's going down hard. Diversification is not working right now, that's what it amounts to. We're throwing everything out."
Standard & Poor's 500 Index futures expiring in December fell 60 points, or 6.6 percent, to 855.20 as of 9:11 a.m. in New York. The SPDR Trust Series 1, an exchange-traded fund tracking the S&P 500 that was not subject to the trading limit, slumped 8.9 percent to $83.54. Dow futures dropped 550, or 6.3 percent, to 8,224, while Nasdaq-100 Index futures retreated 85, or 6.8 percent, to 1,168.50.
S&P 500 futures will not trade below 855.20 until U.S. exchanges open for regular trading at 9:30 a.m. New York time, said Jeremy Hughes, a London-based spokesman for the Chicago Mercantile Exchange. Dow Average futures won't trade below 8,224, while Nasdaq-100 futures won't fall below 1,168.50, he said. The "limit down" suspension allows both contracts to trade above those levels, he said.
The New York Stock Exchange plans to open for U.S. trading today, spokesman Richard Adamonis said. Under so-called circuit-breaker rules, the NYSE will halt trading for an hour if the Dow drops 1,100 points before 2 p.m. A 2,200-point decline before 1 p.m. will halt trading for two hours, while a 3,350-point slide will close trading for the remainder of the day.
Today is the 79th anniversary of "Black Thursday," the first of three sell-offs on the New York Stock Exchange that erased a quarter of the Dow average's value over five days. Some investors speculated that today's declines were being exacerbated by hedge funds facing margin calls, or demands to repay borrowed money used to buy shares.
"This must be forced selling, probably hedge funds," said Nick Sargen, chief officer at Fort Washington Investment Advisors, which oversees $30 billion in Cincinnati. "A rational investor, and I emphasize rational, wouldn't be selling now." The MSCI All-Country World Index, a gauge of equity markets in 48 developed and emerging nations, has tumbled 47 percent this year as a freeze in credit markets sparked by $659 billion of asset writedowns and credit losses at banks raised concern that the global economy is headed for a recession. About $30 trillion of market value has been erased from global equities in 2008, according to data compiled by Bloomberg.
Europe's Dow Jones Stoxx 600 Index slumped 7.4 percent today and the MSCI Asia Pacific Index sank 5.2 percent. The S&P 500 has declined 3.5 percent this week, while the Dow average has dropped 1.8 percent. The Nasdaq Composite Index is down 6.3 percent. GM, the biggest U.S. automaker, dropped to $5.30 today and Ford, the second-largest, declined to $1.81. GM reiterated today that bankruptcy is "not an option" for the company. Speculation regarding GM's financial stability is unfounded, spokesman Tony Cervone said in an interview.
Toyota sold about 2.236 million vehicles worldwide in the three months ended Sept. 30, down 4.3 percent from 2.336 million a year earlier. GM will release its third-quarter sales figure on Oct. 29. Volvo AB, the world's second-largest maker of heavy trucks, cut its industry growth outlook for this year, and PSA Peugeot Citroen, Europe's second-biggest carmaker, cut its full-year targets. Apple, the maker of iPhones and iPods, dropped $8.21 to $90.02. Intel Corp., the world's largest chipmaker, declined 6.6 percent to $13.55. Samsung's profit tumbled as oversupply drove down prices of semiconductors.
Earnings at the 200 companies in the S&P 500 that reported third-quarter results so far dropped by an average of 23 percent, trailing analysts' expectations by 1.6 percent, according to data compiled by Bloomberg. General Electric Co., the economic bellwether whose products range from power-plant turbines to locomotives, dropped 5.9 percent to $17.70. The company said it plans to use the Federal Reserve's short-term funding facility when it starts next week. American International Group Inc. declined 14 percent to $1.81. The insurer said it has used $90.3 billion of a U.S. government credit line since it was bailed out last month, an amount that exceeds the size of the original loan meant to save the company. Microsoft Corp. retreated 6.1 percent to $20.96 even as the world's largest software maker reported profit and sales that beat analysts' projections.
Exxon, the biggest U.S. oil company, declined to $65.86. Chevron Corp., the second-largest, lost $5.79 to $64.60. Crude oil lost 6.9 percent to $63.18, copper dropped 7.6 percent and corn lost 4.2 percent. An S&P GSCI index of 24 raw materials has dropped 35 percent since September, poised for a record quarterly decline. The U.K.'s FTSE 100 Index dropped 7.4 percent after the economy shrank for the first time since 1992. South Korea's Kospi Index sank 11 percent as the country's economy grew at the slowest pace in four years. Russia's Micex Stock Exchange suspended trading until next week.
The yen climbed to a 13-year high against the dollar as the prospect of a global recession prompted investors to dump higher-yielding assets funded in Japan. The dollar rose to a two-year high versus the euro.
"This is once-in-a-lifetime stuff, we're all sat under our desks with tin hats on"
The Dow Jones Industrial Average and the Standard & Poor's 500 tumbled as fears of a full-blown global recession intensified and investors dumped risky assets. Within minutes of the exchanges on Wall Street, the Dow Jones was down 2.6pc and the S&P was off 3.2pc. The drops comes after futures on Dow Jones and Standard & Poor in New York have been limited after they fell by more than 6pc.
To trigger a one-hour suspension of stocks trading on Wall Street, the Dow would have to fall 1,100 points, or currently 12.6 percent, before 2:00 pm New York time. "It's carnage," David Buik, of BGC Partners said. "Confidence is shot to rippons. We need action now. It is a catastrophe that we have got to recession, but we have got to learn to live with it, and that means saving the markets." In London, the FTSE 100 has joined a worldwide rout of stock markets today as fears of a full-blown global recession intensified and investors dumped risky assets.
The index of 100 leading shares tumbled 292 points, or 7pc to 3,794 as official figures confirmed Britain is on course for its first recession since the early 1990s. The FTSE collapse is being led by the banks, once again, with HBOS sinking 19pc to 59p, Barclays off 14.4pc to 187p and the London Stock Exchange down 14pc to 453p. Mining stocks also tumbled, with Eurasian Natural Resources Corporation (ENRC) fell 14pc and Vendanta Resources was off 11pc.
"This is once-in-a-lifetime stuff, we're all sat under our desks with tin hats on,'' said Neil Mellor, a currency strategist at Bank of New York told Bloomberg. Sterling plunged seven cents against the dollar as official figures showed the UK's gross domestic product fell by 0.5pc, the first contraction since the 1990 recession.
The chancellor Alistair Darling told the BBC: "It's obvious now that our economy, other economies across the world, are moving into recession. Yes, it's going to be difficult, yes it's going to be tough, but we can get through it." Across Europe Germany's Dax 30 fell 9.1pc to 4,105 and France's CAX 40 is down 8.4pc to 3,032. Overnight some Asian markets tumbled to five-year lows, as economic indicators brought back ugly reminders of the Asian Financial Crisis a decade ago.
Tokyo's Nikkei 225 average led the slump closing down 811.9 or 9.6pc at 7,649.08, its lowest level since May 2003. It has lost half its value this year, much of that this month as the economy was reported to have officially contracted. South Korea's Kospi index, which has been in freefall all week, fell another 10.6pc or 110.96 points at 938.75, breaking the psychologically important 1,000 barrier for the first time in three years. In Hong Kong, the Hang Seng index fell 486.87 points, 3.5pc, to 13,273.62.
Russian default risk tops Iceland as crisis deepens
Russia's financial crisis is escalating with lightning speed as foreigners pull funds from the country and the debt markets start to price a serious risk of sovereign default. Russia's financial crisis is escalating with lightning speed as foreigners pull funds from the country and the debt markets start to price a serious risk of sovereign default.
The cost of insuring Russian bonds against bankruptcy rocketed to extreme levels yesterday. Spreads on credit default swaps (CDS) reached 1,123, higher than Iceland's debt before it sought a rescue from the International Monetary Fund. Moves by Hungary, Ukraine and Belarus to seek emergency loans from the IMF have now set off a dangerous chain reaction across Eastern Europe.
Romania had to raise overnight interest rates to 9% on Wednesday to stem capital flight, recalling the wild episodes of Europe's ERM crisis in 1992. The CDS spreads on Ukraine's debt have topped 2,800, signalling total revulsion by investors. Rating agency Standard & Poor's issued a downgrade alert on Russian bonds yesterday, warning that a series of state rescue packages worth $200bn (£124bn) could start to erode the credit-worthiness of the state.
S&P said Russia's budget was likely to slip into deficit in 2009 as result of the dramatic slide in oil and metal prices this autumn, and cautioned that "the ongoing concentration of the financial system in state hands" had become a political risk. Russian companies must roll over $47bn of foreign loans over the next two months, and a further $150bn or so next year, a task that has become close to impossible as investors flee Eastern Europe.
President Dmitry Medvedev said yesterday that disaster could still be kept at bay. "We can avoid a banking, forex or debt crisis and get through today's difficulties. Russia has not yet got in this difficult situation. It must avoid this," he said. Hans Redeker, currency chief at BNP Paribas, said markets no longer believe Russia is strong enough to guarantee the estimated $530bn of foreign debts accumulated by its companies during the break-neck expansion of the oil boom. "The surge in Russian CDS spreads is paralysing the whole system. The government can offer very little help to the banks at this point because its own sovereign debt is in question," he said.
"This crisis is starting to look like the Black Wednesady in 1992. Unless we see an extension of central bank swaps in dollars and euros to Eastern Europe within days to stop this uncontrolled process of deleveraging, this could get out of control and do serious damage to Western Europe. We could see the euro fall to parity against the dollar by next year," he said.
Kingsmill Bond, chief strategist at Russian investment bank Troika Dialog, said Russia's Achilles Heel is the lack of a proper rouble bond market. This had forced companies to raise half their money abroad, in foreign currencies. "The consequence is that foreign debt repayment has had a dramatic impact. It has led to a scramble for assets and forced selling of good assets in order to raise cash to pay debt. The only way for oligarchs to raise money at present is by selling their equity," he said. Russia's "unique fragility" is that over $1 trillion of debt needs to financed from a domestic capital pool of $600bn.
Even so, Mr Bond said Russia is still sitting on over $500bn of foreign reserves – the world's third biggest – despite losses of $67bn since August from capital flight. "The government still has enormous firepower to solve the problem," he said.
Global auto market may "collapse" in 2009: J.D.Power
The global auto market may experience an "outright collapse" in 2009 amid growing concerns around credit availability of credit and general economic stress, an influential industry tracking firm said on Thursday.
J.D. Power and Associates forecast U.S. light vehicle sales would fall to 13.2 million units in 2009 after likely settling at 13.6 million units this year, adding that a pronounced recovery is more than 18 months away.
"While the global automotive industry is clearly experiencing a slowdown in 2008, the global market in 2009 may experience an outright collapse," said Jeff Schuster, executive director of automotive forecasting for J.D. Power.
"While mature markets are being impacted more severely than emerging markets, no country or region is completely immune to the turmoil," Schuster said.
Asian indexes fall hard on bloody Friday
Asian markets were mauled Friday, with Japanese, Indian and South Korean indexes slumping more than 9.5% each to end below crucial psychological milestones as fears of a global recession swept across the region. Benchmarks in Hong Kong, Australia, Singapore and Taiwan dropped to their lowest levels in at least three years.
Japan's Nikkei 225 Average sank 9.6% to end at 7,649.08, a closing level it hasn't seen since April 29, 2003. The benchmark is now valued at less than a fifth of its all-time high of 38,915.87, which it touched in December 1989. "There is a complete loss of confidence and it was brought on by the decline in Japan," said Francis Lun, general manager at Fulbright Securities in Hong Kong. "We are going back to the stone ages."
South Korea's Kospi index dropped even more, plunging 10.6% to close at 938.75, registering its first fall below the 1,000-point level since June 30, 2005. India's Sensitive Index hit the day's bottom at 8,566.82, a level it hasn't seen since November 2005, before ending down 11% at 8,701.07. During the tumultuous week, the Nikkei lost 12% and the Sensex shed nearly 13%, while the Kospi sank more than 20%. Hong Kong's Hang Seng Index, which ended below the 14,000-point level a day earlier, fell past even the 13,000 milestone during the session for the first time since October 2004. The index ended down 8.3% at 12,618.38.
"I don't think the turmoil will be finished any time soon. I think it'll continue this quarter and the next. It's very difficult to see the bottom in the near-term," said Hirokazu Yuihama, head of regional strategy at Daiwa Institute of Research in Shanghai. The losses in Tokyo were led by Sony Corp., which slumped 14.1% to end at its lowest level since 1995, after the company on Thursday cut its full-year profit forecast to 150 billion yen ($1.54 billion) from 240 billion yen, citing a stronger yen, weaker sales in its electronics unit and hard times in the financial-services segment. Other exporters were also hammered in the wake of Sony's profit-warning after the U.S. dollar fell below the 96 yen-level, as risk-averse investors unwound their carry trades.
Australia's S&P/ASX 200 dropped as low as 3,830, the lowest it has seen since November 2004, before paring some losses to end at 3,869.40 for a loss of 2.6%. Taiwan's Taiex ended at its lowest point of the day -- 4,579.62, a level it hasn't seen since May 2003. Singapore's Straits Times index touched the day's bottom at 1,590.36, a level it hasn't seen since September 2003, before ending down 8.3% at 1,600.28. China's Shanghai Composite and New Zealand's NZX 50 index were among the best performers of the day, with the Shanghai index ending down 1.9% at 1,839.62, while the NZX 50 index lost 1% to 2,778.55.
Yuihama said recession worries were in place, and that it was "almost certain" that the U.S. and Europe could go into a recession during the third and fourth quarters of 2008. "That is very negative for Asian economies. Export-dependent economies like South Korea, Taiwan and China will be hit hard," he added. He said Hong Kong's Hang Seng Index was expected to find support near the 12,000-point level, Singapore's Straits Times index near 1,500 and Taiwan's Taiex close to 4,300. Analysts said fears of further earnings downgrades for regional corporations also likely contributed to the sell-offs.
Peter Hilton, head of Asian equities research at Royal Bank of Scotland in Hong Kong, said analysts were likely to downgrade corporate earnings for 2009. "In general, strategists and economists had held some hope that in the second half of 2009, we might be moving ahead, but now, that's being rapidly discounted and analysts are going to have to continue to discount 2009 earnings," said Hilton. After the crisis in the financial markets and the credit markets, "the next step is for the real economy, which is slowing quickly in the third quarter," said Hilton.
Over $820 billion wealth lost in a week The weekly losses this week across the top eight stock markets in the region -- Tokyo, Hong Kong, Shanghai, Sydney, Mumbai, Seoul, Singapore and Taipei -- totaled nearly $820 billion, according to FactSet Research data. Of those losses, Tokyo, the largest stock exchange in the region by market capitalization, lost more than $190 billion, while Hong Kong lost almost another $180 billion.
The credit crunch claims its biggest victim - Argentina
The credit crisis could be about to claim its biggest victim so far. It started with subprime borrowers, moved on to banks and has now progressed on to whole countries.
Iceland has already virtually thrown in the towel, and now Argentina has returned to the verge of bankruptcy. It's all further proof that the 'de-coupling' concept is a load of junk, as well as another big sign that the 'crunch' is a very long way from reaching the finishing straight. And Argentina won't be the last country to succumb…
Iceland clearly didn't have its troubles to seek. Any country with gross domestic product (GDP) – i.e. annual output - of $20bn, but whose banks owe almost three and a half times that amount in foreign debt, is in very hot water indeed. But Argentina's a different kettle of fish altogether. Its GDP is roughly 13 times the size of Iceland's – yet for the second time this decade, it looks like the country's creditors could be unlucky.
Though perhaps unlucky's not the right word. Naïve, or just plain daft, might be a better one. That's because Argentina has form, and quite recent form at that. In December 2001 it reneged on its $95bn of sovereign debt. At the time, that was the biggest default in world history, though these days such a number looks like chicken feed compared with what the world's bankers have recently managed to mislay.
Only in 2005 did Argentina sort the final details, with a 'take-it-or-leave-it' 70% 'haircut' on face value, again the largest sovereign debt markdown ever. Three years later, it's back to square one. Inflation is rocketing (some estimates put it at 20% annualised) and the government is once again running out of cash. Argentina's borrowing needs will swell to as much as $14bn next year from $7bn in 2008, says RBC Capital Markets. And any confidence that the country will be able to repay what it owes is fast flying out of the window.
Argentina's 8.28% government bonds are due to be redeemed in 2033. Fat chance of that, the way things are looking right now. Now priced at 22 cents on the dollar, they currently yield 31%, as against 'just' 12% a month ago. And still no one wants them.
What's more, the price of credit default swaps – market insurance that investors can buy to protect themselves against default - covering the country's sovereign debt has more than quadrupled over the past month. These CDS now stand at more than three times the Icelandic level, and suggest there's almost a two to one chance that Argentina will go bust this year.
In fact, things have now got so bad that the state has decided to take over $29bn of the country's privately managed pension funds to get its hands on some cash. This is being presented as an emergency move to meet financing costs that have soared as commodity prices have tumbled.
In a breathtaking piece of bravado, President Cristina Kirchner said the proposal would "protect" retirees from the global financial crisis, according to Bloomberg, while denying she was trying to "grab the cash" to pay off debt or to finance new programmes or projects. Pull the other one. The last time Argentina sought to tap into workers' savings was just before that 2001 default.
For now, the funds being targeted are 'just' retirement accounts, but the entire $97bn pool of private pensions contains a lot of juicy and much-needed hard currency. Understandably, this hasn't gone down at all well in the money markets. "It's the final of many nails in the coffin from an institutional investor perspective," said Bill Rudman at WestLB Mellon Asset Management. "Argentina is disappearing into irrelevance".
It's all a classic sign that the de-coupling concept – whereby some areas of the planet remain unaffected by the woes of the rest of the world – is as big a load of junk as all those Argentine bonds. At least the country's track record means it's been shut out of international capital markets, so that even the most gullible lenders should have avoided loading up on its dodgy debt.
But Argentina's problems also show that the credit crisis still has a long way to run. So is it a harbinger of similar dangers elsewhere? As the recession bites harder, more governments will start to find out that their tax take is on the slide. What's more, bond markets aren't going to be very keen on making up the revenue shortfalls, as least at the sort of cost that taxpayers will be happy to pay. So with state coffers under siege, there could be more of this sort of appropriation in the pipeline.
"The G7 states are already acquiring an unhealthy taste for the arbitrary seizure of private property", says the Telegraph's Ambrose Evans-Pritchard, "it's a foretaste of what may happen across the world". Already governments in the US, Britain, and Europe have got the taste for meddling in the markets under the guise of 'saving the system', such as taking stakes in banks that rank above the existing owners, and then telling these banks how much to lend.
And those same governments have shown themselves quite prepared to bend the rules if they think they can get away with it, like letting bank mergers go through regardless of so-called competition rules. There have already been vague mutterings about government-backed hedge fund bailouts, to stop the stock markets sliding. So if the excuse arrives to 'help out' the odd pension fund or two, what are the odds of Gordon Brown importing the Argentine model and finding a way to hoover up some of the available cash? It may not seem likely right now, but then a year ago, nor did the nationalisation of half our banking system.
Libor for Overnight Dollars Rises as Recession Concern Mounts
The cost of borrowing in dollars overnight in London rose as the increased likelihood of a global recession spurred banks to hoard cash even after policy makers pumped record amounts of the U.S. currency into financial markets.
The London interbank offered rate, or Libor, that banks charge for such loans climbed 7 basis points to 1.28 percent today, British Bankers' Association said. It gained for the first time in 10 days yesterday. The comparable rate for U.K. pounds jumped 19 basis points to 4.75 percent. The Libor-OIS spread, a measure of cash scarcity, widened by the most since Oct. 10.
"The level of activity in the money markets remains significantly below standard norms and subject to sporadic abnormalities that can only be a function of illiquidity," said Charles Diebel, head of European rates strategy at Nomura International Plc in London. The thaw in lending that began earlier this month after policy makers pumped cash into money markets and governments bailed out banks may be faltering as the global economy slides into a recession. Credit markets froze after the bankruptcy of Lehman Brothers Holdings Inc. on Sept. 15 as financial institutions hoarded cash on concern more banks would fail.
Stocks plunged around the world, sending futures contracts on the Dow Jones Industrial Average and Standard & Poor's 500 Index down by their daily limits. The U.K. pound fell the most in at least 37 years against the dollar after the British economy contracted more than forecast in the third quarter. The yen surged to a 13-year high versus the U.S. currency, while 10-year Treasuries headed for their biggest weekly gain since 1987.
The Libor-OIS spread, which measures the difference between the three-month dollar rate and the overnight indexed swap rate, widened 8 basis points to 262 basis points today. It was at 364 basis points on Oct. 10, widening from 354 basis points a day earlier. A basis point is 0.01 percentage point. The difference between what banks and the U.S. Treasury pay to borrow for three months, the so-called TED spread, was at 261 basis points, up from 257 basis points yesterday. It was at 112 basis points two months ago.
U.S. Treasury Secretary Henry Paulson is preparing to take stakes in a number of regional banks as he seeks to halt the freeze of credit to businesses and households, according to a person briefed on the matter. The plans may be announced as soon as today, the person, who was briefed by bankers and Treasury officials, said on condition of anonymity.
The purchases would be the second round in a $250 billion program to inject capital into financial companies, after an initial $125 billion was allocated to nine of the largest banks. Regional lenders, already suffering from the housing slump, are now getting hit by rising loan delinquencies as the economic downturn deepens, with unemployment at a five-year high. The European Central Bank said Oct. 21 its lending to banks reached a record 773.2 billion euros ($979 billion) through monetary operations, up from 739.4 billion euros a week earlier and a 68 percent surge from the first week of September. Policy makers in Europe and Japan have been offering banks an unlimited supply of dollar funding.
Libor is set by a panel of banks in a daily survey by the British Bankers' Association at about noon in London. Members provide estimates on how much it would cost to borrow in 10 currencies for terms ranging from one day to a year. About $360 trillion of financial products worldwide, from mortgages to company loans and derivatives, is tied to the Libor.
The three-month lending rate for Hong Kong dollars, known as Hibor, rose for the second day, gaining 5 basis points to 3.29 percent. Australian three-month interbank borrowing costs rose 3 basis points to 5.89 percent, the highest since Oct. 15. South Korea's benchmark 91-day certificate of deposit rate rose 1 basis point to 6.17 percent, the highest since January 2001. Indonesian three-month interbank rates climbed 4 basis points to 12.25 percent, 275 basis points above the central bank's main benchmark. That's the largest premium in three years.
Which country will go bust next?
Emerging markets and currencies are feeling the heat as the crisis in Iceland has turned the spotlight on other potential blow-ups across the world. So who else is in trouble? The western financial crisis is going global. Investors have been selling out of "anything remotely risky", notes Dresdner Kleinwort's Jon Harrison.
Commodity producers such as Brazil and Mexico have been hammered as jitters over global growth have mounted. Their stockmarkets are now down by around 56% and 40% respectively this year. But the spotlight has fallen mainly on countries with high debt levels and banking sectors that are dependent on external funding. There are "quite a few" more potential Icelands out there, says Lars Christensen of Danske Bank.
In Asia, Pakistan, struggling with political turmoil, a huge current-account deficit and dwindling foreign-exchange reserves, has had to turn to the IMF, the World Bank and the Asia Development Bank to secure funding to cover $3bn of debt that it will soon have to pay. The Korean won posted its biggest one-day fall in a decade last week.
The highly indebted private sector and Korean banks' heavy reliance on short-term foreign borrowings make it far "more fragile than other Asian financial systems", notes Leo Lewis in The Times; around 12% of the banking sector is funded by the gummed-up wholesale debt sector. And the current-account deficit is in the red. Early this week, the Korean authorities calmed the markets with a $100bn government guarantee of banks' foreign-currency debts maturing between now and June 2009. It also injected $30bn of highly sought-after dollars into the banking system.
Citigroup has highlighted Indonesia – where the stockmarket "recently seems to have spent more time closed than open", says the FT – and Korea as the Asian countries most vulnerable to the sudden reversal of external financial flows. Still, Korea looks much healthier than it did in 1997, says Capital Economics. The ratio of short-term external debt to foreign-exchange reserves was then 300%; now it's 72%. Moreover, Asia as a whole has over $4 trillion in foreign-exchange reserves that can be used to bolster currencies.
It also has little consumer debt and is by and large "a continent of current-account surpluses, well-capitalised banks and modestly leveraged balance sheets", as Louise Lucas says in the FT. So this time round, Asia's capital-flight problem looks "manageable". The larger problem is "how to cope when western markets lose their appetite for Asia's exports". The Asian Development Bank points out that 60% of Asia ex-Japan's exports go to America, Europe and Japan. Given the darkening outlook in these economies, and the fact that Asian earnings are still expected to grow by an unrealistic 14% in 2009, the Asian bear market is unlikely to be over.
But the risk of financial crises has been highest in central and eastern Europe. Virtually all the economies in this region (except Russia, which is using its foreign-exchange reserves to bolster banks and businesses hit by the shutdown in global borrowing) have large current-account deficits and hence high external debt to GDP ratios. So they are dependent on foreign financing just as investors flee risk. Current-account deficits have reached 15-20% in the Baltics and Balkans, and 10% in Ukraine. The downturn in western Europe is also denting confidence.
A particular worry is that in central and southeast Europe and the Baltic states, consumers and companies have borrowed in foreign currencies, notably euros and Swiss francs; last year almost 90% of loans were made in these currencies in Hungary. The interest rates on foreign-denominated loans were lower, but now that the local currency is sliding – it has hit a two-year low against the euro – consumers and firms are struggling as they are spending more on repayments. The western banks who supplied these loans via local subsidiaries are now under pressure and local lenders are cutting back on or raising the cost of foreign-denominated loans.
Hungary has received a €5bn credit line from the European Central Bank to cover local banks' shortage of euros, while the IMF is lending Ukraine and Iceland up to $14bn and $6bn respectively. It may also help Serbia. Such moves may help avoid the "poisonous cocktail of currency devaluations, spiralling inflation, sharp increases in bond yields and steep drops in output" that typify balance of payments crises, according to Capital Economics. But plunging commodity prices and hence export revenues may soon cause currency crises in poorly managed and hence especially vulnerable Ecuador, Venezuela and Argentina, reckons Win Thin of Brown Brothers Harriman. The emerging-market firestorm isn't over yet.
IMF bailout of Iceland delayed until fate of UK, Dutch savers’ frozen cash is resolved
Stalemate in talks between Iceland and Britain over the fate of the money from UK savers that is frozen in an Icelandic bank was being blamed last night for delaying a bailout of the stricken North Atlantic economy.
The International Monetary Fund is believed to be insisting that Reykjavik’s dispute with London over British savings held in Icesave, the UK offshoot of Iceland’s nationalised Landsbanki, is resolved before it will make a decision on the scale of emergency support for the tiny island nation.
The IMF’s governing executive board was meeting last night to debate a potential rescue package for Iceland, which could total $6 billion (£3.7 billion and is likely to be backed by several Scandinavian central banks and the Bank of Japan. It would make Iceland the first Western country to receive an IMF loan since Britain went to the fund in 1976. But it was feared last night that a deal to shore up the Icelandic economy and financial system could be delayed by the continuing obstacle posed by Reykjavik’s still unresolved row with Britain over Icesave.
Talks in the Icelandic capital between officials from the country’s government and the British Treasury broke up last night with no agreement. The negotiations are thought to revolve around Britain lending Iceland sufficient funds for it to repay the savers. Some reports have suggested that a loan from the UK of £3 billion may be required and is being sought by Reykjavik. However, Whitehall sources played down the figure.
About 300,000 British savers had accounts worth about £4 billion in Icesave, which suspended operations on October 7 and stopped customers from both depositing and withdrawing money. Before the talks broke up last night, Geir Haarde, the Icelandic Prime Minister, told a newspaper in the country that; “We have not accepted their [Britain’s] legal arguments.”
On Wednesday, Mr Haarde admitted on Iceland’s national radio services that IMF emergency support for his country’s economy was contingent on a deal with Britain being settled first. “The IMF would like to see those matters solved before any further steps are taken,” he said. He added that a package from the IMF was also contingent on a new national economic forecast being made, and one factor that would affect that would be the scale of other foreign loans to his country – presumably including a potential loan from Britain.
Iceland’s once-booming financial sector has been undercut after the global financial crisis of recent weeks sent the krona, the country’s currency, into virtual freefall, leading its government to seize control of banks including Kaupthing and Glitnir as well as Landsbanki. As a consequence, the bulk of the money that belongs to British savers, which is being held in Icesave, has been frozen since early October.
Petur Bloendal, chairman of the Icelandic Parliament’s tax and economic affairs committee, told reporters yesterday that he did not believe that Icelandic MPs would approve the proposals for a British loan. He said that British and Dutch demands over Icesave accounts in the two countries amounted to the equivalent for every Icelander of three to four times the reparations that were imposed on Germany after the First World War.
Last night the Treasury insisted that it was continuing to talk to Reykjavik, despite the winding up of the present round of negotiations. A spokesman said: “Any agreement with the IMF is always dependent on countries honouring their debts and treating creditors equally. The UK is not the only country involved in this process and other creditors will also expect payment. “The UK Government continues to work constructively towards a resolution with the Icelandic Government and looks forward to a swift solution.”
An Icelandic Government spokeswoman said: “This round of discussions has ended, but talks are not overand will be continued in the very near future.” She declined to give details of the talks or what progress was made, and did not give the exact date of the next round of talks.
Yen Rises to 13-Year High as Investors Exit High-Yield Assets
The yen climbed to a 13-year high against the dollar as the prospect of a global recession prompted investors to dump higher-yielding assets funded in Japan. The dollar rose to a two-year high versus the euro.
The Japanese currency also surged to the strongest in six years against the euro, posting its biggest gain, after Belarus, Ukraine, Hungary and Iceland joined Pakistan in requesting at least $20 billion of emergency loans from the International Monetary Fund. The pound fell below $1.53 in its biggest drop in at least 37 years after the U.K. economy shrank in the third quarter, bringing it to the brink of recession.
"There's a powerful de-leveraging and risk-aversion dynamic globally across all financial markets and that's helping prompt the strengthening of the yen," said Robert Minikin, a currency strategist with Standard Chartered in London. "We're seeing a lot of weakness in higher-yielding currencies and the yen is performing well. As balance sheets shrink and assets are repatriated, that can help the U.S. dollar."
The yen rose to 91.81 per dollar at 7:23 a.m. in New York, the highest level since Aug. 9, 1995, from 97.31 yesterday. Against the euro, it climbed 9.6 percent to 113.81, the strongest level since May 22, 2002, and the biggest daily gain since the euro's inception in January 1999. The dollar also headed for its best week ever against the euro, rising to $1.2497, the lowest since October 2006, from $1.2934 yesterday, and $1.3410 a week ago. The pound fell to $1.5269, the lowest level since August 2002. Against the euro, the pound weakened to a record 81.96 pence, from 79.69 pence.
The yen typically rises when demand falls for so-called carry trades, where investors borrow in currencies with low interest rates and buy assets in nations with higher rates. Japan's target rate of 0.5 percent is 550 basis points below Australia's and 325 basis points less than the euro region's. The yen touched a post-World War II high of 79.75 against the dollar on April 19, 1995, prompting the Group of Seven nations to intervene that year by buying the greenback to stabilize currency markets. The G-7 is comprised of Canada, France, Germany, Italy, Japan, the U.K. and the U.S.
The yen rose 8.9 percent this week against the dollar, the biggest gain since October 1998. It surged 14 percent against the euro, the biggest weekly advance since the 15-nation currency's 1999 debut. The euro headed for a 6 percent decline versus the dollar. The Australian dollar fell 15 percent to 55.13 yen. The New Zealand dollar declined 13 percent to 50.12 yen. The two currencies are favorites for carry trades. Financial-market moves risk erasing those profits.
The dollar advanced against every major currency except the yen as stocks tumbled after Samsung Electronics Co.'s profit slumped and Air France SA said it will be difficult to meet earnings targets. Volatility on one-month dollar-yen options, a measure of expectations for future price swings, rose to 28.14 percent, the highest since Oct. 13, indicating greater risk market moves may cut carry trade profits. It rose 32.175 percent on Oct. 10, the highest since Bloomberg began compiling data in December 1995.
Coordinated rate cuts by major central banks on Oct. 8 and financial system bailouts in the U.S. and Europe have failed to revive stock markets or encourage banks to resume lending. The MSCI World Index of shares lost 3.6 percent. It has fallen 44 percent in 2008 as credit-related losses and writedowns topped $660 billion in the worst financial crisis since the Great Depression. Europe's Dow Jones Stoxx 600 Index fell 7.1 percent, and the MSCI Asia Pacific Index sank 5.4 percent.
Trading in futures on the Standard & Poor's 500 Index and the Dow Jones Industrial Average was limited today after declines in the contracts of more than 6 percent triggered a so- called limit down restriction. The futures will not trade below 855.20 until U.S. exchanges open for regular trading at 9:30 a.m. New York time, said Jeremy Hughes, a London-based spokesman for the Chicago Mercantile Exchange. Dow Average futures won't trade below the 8,224 level, he said. The "limit down" suspension allows both contracts to trade above those levels, he said. The common European currency fell to a two-year low versus the dollar after Standard & Poor's Ratings Services threatened yesterday to cut Russia's debt ratings, adding to signs the credit crisis is spreading.
U.K. gross domestic product dropped 0.5 percent from the second quarter, the first contraction since 1992, the Office for National Statistics said today in London. Economists predicted a 0.2 percent decline, according to the median of 35 forecasts in a Bloomberg News survey. Growth stalled in the prior three months. The pound dropped and U.K. stocks fell after the report, which confirmed Prime Minister Gordon Brown's prediction this week that a recession is likely. His government's 500 billion pound ($805 billion) bank rescue package and the Bank of England's half-point rate cut this month, the biggest since 2001, may have come too late to prevent further contraction.
The euro and the pound may weaken as European and U.K. banks have five times as much loan exposure to emerging markets as the U.S. or Japan, with most lending to Eastern Europe, according to Morgan Stanley. "Part of the reason why euro-dollar continues to drift lower has to do with the rising risk that pressures in Eastern Europe will have a negative boomerang effect on Euroland," London-based currency strategists Stephen Jen and Spyros Andreopoulos wrote in a research note yesterday.
European banks' lending to emerging markets is about 21 percent of Europe's GDP and U.K. banks' loans are around 24 percent of national output, compared with 4 percent for the U.S. and 5 percent for Japan, the strategists wrote, citing data from the Bank for International Settlements.
"There are concerns over country risk in Europe," said Toshihiko Sakai, head of trading for foreign exchange and financial products in Tokyo at Mitsubishi UFJ Trust & Banking Corp., a unit of Japan's biggest bank. "Some currencies there appear to be under speculative attack because their banking sectors aren't sufficiently guaranteed by the governments." The euro may weaken to parity with the dollar by year-end, he said. The Hungarian forint weakened by 3.4 percent to 222.60 per dollar. The Polish zloty fell 3 percent to 3.0922 per dollar.
Danish Krone Thrown A Bone
Denmark has become the second country in Europe this week to raise interest rates in an attempt to prop up its currency. The Danish central bank said Friday morning that it was bumping its key rate of lending by 50 basis points, to 5.5%.
It follows a move by Hungary's central bank to increase interest rates to boost the Hungarian florint, which has fallen sharply in the wake of the credit crisis. The central bank of Denmark said it was raising rates "as a result of continued intervention to support the Danish krone." The move is in stark contrast to most of the world's other large central banks, which have been cutting rates recently in order to combat economic weakness.
Sweden's central bank on Thursday slashed interest rates by 50 basis points, to 3.75%, to stem the impact of its involvement in economically troubled Baltic nations. Denmark's trading at 7.4590 crowns to the euro compared with Thursday's low of 7.4609 crowns. The central bank's move illustrates the priority that Denmark is currently placing on the krone over its economic growth. A sharp decline in a country's currency can lead to imported goods becoming too expensive.
The recent collapse in Iceland's currency, for instance, has led to a potential public health problem as grocery chains find it more difficult to buy new supplies, leading to fewer products on their shelves. The Danish central bank may also be more comfortable to raise rates since Denmark's economy has already gone into, and out of, a recession in the first quarter of this year. Its economy has since recovered slightly, growing by 0.5% in the second quarter.
Bank of America analyst David Powell said Denmark's move was a perfect example of the vulnerability that some small countries, including Iceland, face when they have their own currencies, and said Denmark would now be moving more quickly toward trying to adopt the euro.
Denmarks' currency is pegged to the euro, but that peg has been under significant pressure in the last few weeks. The country's rates also typically follow euro zone interest rates, but they are currently now 175 basis points above the European Central Bank equivalent compared with 35 basis points in the beginning of October.
IMF plans rescue of emerging nations
The International Monetary Fund is working on a package it hopes to approve by early November which would let several emerging market economies exchange local currencies for dollars to ease short-term credit strains. The so-called liquidity swap facility would be available to a group of pre-selected “top tier” emerging market countries - those that are well-run but may be having difficulties obtaining credit.
Countries which could be eligible include Hungary, which is already in talks with the IMF, Belarus, Ukraine, Serbia and Pakistan. An IMF spokesman said the Washington-based fund was in discussions on possible loan packages for a number of countries.
“The IMF has sizable resources available for lending, which it can make available quickly if needed. IMF lending has a catalytic effect by generating other financing from private and public sources.” The size of the IMF’s financial package has not been revealed. The body said rumours that it could be as big as £500bn were untrue.
“It will help compensate for the deleveraging of countries’ traditional sources of external finance... "The objective is to wrap this up quickly because the need is now,” one official told Reuters last night. Hungary has already received a loan of £3.9bn from the European Central Bank.
U.K. Pound Weakens Most Since at Least 1971 as Economy Shrinks
The pound tumbled below $1.53 in its biggest drop in at least 37 years after a report showed the U.K. economy contracted more than forecast in the third quarter, bringing the nation to the brink of a recession.
The decline surpassed that of Black Wednesday in September 1992, when the U.K. was driven out of Europe's Exchange Rate Mechanism. Gross domestic product contracted in the three months through September by more than twice as much as analysts forecast, a report showed today, putting the economy on course for its first recession since 1991. The FTSE 100 index slumped as much as 9.1 percent and the yield on the U.K. 10-year gilt headed for its biggest weekly decline in a decade.
"This is once-in-a-lifetime stuff, we're all sat under our desks with tin hats on," said Neil Mellor, a currency strategist in London at Bank of New York Mellon Corp. "The U.K. is in the first step toward a recession and the dollar's bid because of repatriation flows." The U.K. currency fell to $1.5269, the lowest level since August 2002, and was at $1.5618 at 2:34 p.m. in London, from $1.6230 yesterday. Against the euro, the pound weakened to a record 81.96 pence, dropping for a fifth day, before trading at 80.80 pence, from 79.69 pence.
A collapse in credit markets and the worst housing slump in a generation have buffeted the British economy, Europe's second- biggest. The U.K. is already in a recession and the economy will contract for the next three quarters, Ernst & Young's ITEM Club, which uses the same forecasting model as the Treasury, said in a report on Oct. 20. The economy shrank 0.5 percent in the third quarter, the Office for National Statistics in London said today. The median forecast of 35 economists in a Bloomberg survey was for a contraction of 0.2 percent.
Today's drop in the pound brought the decline this week to 10.1 percent, the most since at least 1971, when former U.S. President Richard Nixon suspended the dollar's convertibility into gold and ended the global fixed exchange-rate regime established at the Bretton Woods conference after World War II. The currency lost 9.8 percent in the week when U.K. Prime Minister John Major pulled the pound out of the Exchange Rate Mechanism on Sept. 16, 1992 in what became known as "Black Wednesday." "These moves are absolutely without precedent," said David Watt, a Toronto-based currency strategist at Royal Bank of Canada Ltd. "The 1970s are pretty much the extent of the data you're going to get because currencies didn't even float that far back."
Volatility on one-month pound-yen options, a measure of expectations for future price swings, rose to 47.24 percent, the highest on record, indicating greater risk market moves may erode profits. The pound may fall to the $1.40s "very soon," said Hans- Guenter Redeker, London-based global head of currency strategy at BNP Paribas SA, the most accurate forecaster in a 2007 Bloomberg News survey. "It has a lot to do with the underlying conditions in the British economy and how the situation in Europe as a whole is currently developing," Redeker said today in an interview on Bloomberg television.
House prices will continue to fall and the pound may depreciate further, King said in a speech to executives in Leeds, England on Oct. 21. Prime Minister Gordon Brown predicted the next day that the U.K. will slip into a recession for the first time since he took charge of Britain's finances in 1997. The remarks were Brown's first admission that the country's longest unbroken streak of economic growth in more than a century is over. "The combination of a squeeze on real take-home pay and a decline in the availability of credit poses the risk of a sharp and prolonged slowdown in domestic demand," King said. The Monetary Policy Committee "will act promptly to ensure that inflation remains on track to meet our target."
The chances that the Bank of England will lower its benchmark interest rate by as much as three-quarters of a percentage point by year-end rose to 30 percent today, a Credit Suisse Group AG index of derivatives showed. The odds of a cut of that magnitude were 5 percent yesterday. Government bonds rose, with the yield on the two-year gilt falling 18 basis points to 3.03 percent. The 4.75 percent note maturing June 2010 climbed 0.28, or 2.8 pounds per 1,000-pound ($1,530) face amount, to 102.68. The yield on the 10-year security dropped 16 basis points to 4.31 percent, on course for its biggest weekly decline since at least 1998. Bond yields move inversely to prices.
$123 Billion Loan Not Enough for AIG: $90 Billion Spent in 1 Month
American International Group Inc. has used $90.3 billion of a U.S. government credit line since it was bailed out last month, an amount that exceeds the size of the original loan meant to save the insurer.
AIG may need more than the $122.8 billion now available to the New York-based insurer, Chief Executive Officer Edward Liddy said yesterday. The company, which agreed Sept. 16 to turn over majority control to the U.S. in exchange for an $85 billion loan, got access to an additional $37.8 billion this month. AIG's latest debt was revealed today by the New York Federal Reserve, and is up from $82.9 billion a week ago.
Liddy, the former Allstate Corp. CEO appointed by the government to run AIG last month, is selling businesses including U.S. life insurance, plane leasing and consumer finance to repay the loan. He named Paula Rosput Reynolds today to lead the restructuring six months after she arranged the $6.2 billion sale of Safeco Corp., AIG said. "Paula brings to AIG deep experience, not only as an insurance industry leader, but also as someone who has successfully realigned organizations to meet new challenges," Liddy said today in a statement.
Reynolds, the former CEO of Safeco, the Seattle-based auto insurer until it was sold to Liberty Mutual Group Inc. for $6.2 billion, was named AIG's chief restructuring officer. AIG, which averted collapse last month with the Fed loan, is dependent on "what happens to the capital markets," Liddy, 62, said late yesterday on PBS's "The NewsHour With Jim Lehrer." AIG needed cash after credit downgrades forced the insurer to post more than $10 billion in collateral to clients who purchased guarantees on bonds that lost value.
"To the extent they continue to go down and we have to keep posting collateral, as it's called in the vernacular of the industry, it's possible it may not be enough," Liddy said. "This emphasizes the uncertainty for anyone trying to put a number" on AIG's cash needs, said Bill Bergman, an analyst at Morningstar Inc. in Chicago. The financial-products unit responsible for most of the firm's losses "is a big black hole."
Liddy said in the interview that he thinks AIG "should be OK," that he still hopes to stay within the $122.8 billion ceiling and that Treasury efforts to spur lending "seem to be working." A spokesman for the New York Fed declined to comment. Brookly McLaughlin, spokeswoman for the Treasury, didn't immediately return a call seeking comment. "The money is to meet our cash needs while we work out the rest of our solution, it's not the total solution," said AIG spokesman Nicholas Ashooh. "We still have to sell businesses and still need a permanent solution to the liquidity drain" from securities lending and the fixed-income guarantees known as credit-default swaps.
AIG got the $85 billion credit line on Sept. 16 to stave off bankruptcy. It was given access to an additional $37.8 billion on Oct. 8 to shore up its securities-lending program, which lost money on investments made using collateral from assets it loaned to third parties. AIG agreed to turn over an 80 percent stake in the firm to the U.S. in exchange for the first loan.
The insurer may seek a third source of cash by tapping a Fed program that buys commercial paper, a person familiar with the matter said last week. AIG will probably borrow less than $10 billion through the program, which is scheduled to start next week, the person said.
Paulson Is Said to Plan Buying Stakes in Regional U.S. Banks
Treasury Secretary Henry Paulson is preparing to take stakes in a number of regional U.S. banks as he seeks to halt the freeze of credit to businesses and households, according to a person briefed on the matter. The Treasury may announce the plans as soon as today, the person, who was briefed by bankers and Treasury officials, said on condition of anonymity. The purchases would be the second round in a $250 billion program to inject capital into financial companies, after an initial $125 billion was allocated to nine of the largest banks.
Regional lenders, already suffering from the housing slump, are now getting hit by rising loan delinquencies as the economic downturn deepens, with unemployment at a five-year high. The 19- member Standard & Poor's 500 Banks Index has lost half its value in the past year. "We're going to give them initial indications very quickly," Neel Kashkari, the interim Treasury assistant secretary running the department's financial-rescue office, told lawmakers yesterday, referring to the next group of banks to get government stakes. "It will be a few weeks before the next batch are actually funded," he told the Senate Banking Committee.
The decision to buy stakes in more lenders comes after some of the mid-sized American financial institutions report mounting losses. National City Corp., Ohio's largest lender, Oct. 21 posted a wider loss, put aside more money for unpaid loans and announced plans to eliminate 4,000 jobs. Its third-quarter net loss widened to $729 million, from $19 million a year earlier. SunTrust Banks Inc., Georgia's largest lender, posted a 26 percent decline in third-quarter profit yesterday. The bank's board authorized the sale of $1.6 billion to $4.9 billion in preferred shares to the U.S. Treasury, Chief Executive Officer James Wells said in a conference call.
Paulson's focus on injecting funds into banks is a shift away from his initial emphasis on unclogging balance sheets by purchasing troubled mortgage-backed assets from financial institutions. Last week, the Treasury agreed to take stakes in nine firms including Citigroup Inc., Morgan Stanley and Bank of America Corp. Congress three weeks ago approved a $700 billion rescue package that gave the Treasury wide authority to buy and guarantee assets to prevent a U.S. financial collapse. Equity purchases "are on the front burner and the heat is under the pot," said Wayne Abernathy, a former Treasury official who is now an executive vice president with the American Bankers Association, a group that represents lenders of all sizes.
Paulson had to shift gears because "markets deteriorated much more quickly than we had expected," Kashkari, a 35-year-old former Goldman Sachs Group Inc. banker, told lawmakers. Taking stakes in banks offered a faster way to inject funds, he said. The person briefed on the matter didn't identify the financial companies getting the next round of money, or specify the total amount. Firms have until Nov. 14 to apply for government funds, though the department has indicated it may extend that for some, such as those that are privately held.
The Treasury's plans to buy devalued assets such as mortgage- linked bonds and collateralized debt obligations are weeks, though "not months" away from being put into effect, Kashkari said. Congress gave the Treasury 45 days, or until mid-November, to publish guidelines for how it would identify, value and purchase the assets. A Treasury official said then that it would take at least four weeks until the first auction was set up in an effort to price the toxic securities.
While the Treasury picked Bank of New York Mellon Corp. to keep the books for the purchases, it is still completing a review of more than 100 bids to serve as asset managers, Kashkari said. The aim of the asset purchases is to help restart a market for the securities, providing benchmark prices and inducing private capital to return. Both Republicans and Democrats on the banking panel yesterday urged the Treasury to use its new authority -- and a chunk of the bailout money -- to help the millions of American homeowners who are facing foreclosure.
The Bush administration hasn't shown "the required dedication" to curb mortgage foreclosures, Christopher Dodd, the Connecticut Democrat who chairs the Senate banking panel, said at yesterday's hearing. Richard Shelby, the committee's top Republican, said that unless the government deals with housing problems, "we're going to be wasting a lot of money." Kashkari told the panel that the Treasury is "looking very hard" at a proposal by Federal Deposit Insurance Corp. chief Sheila Bair to use federal loan guarantees to entice mortgage servicers to modify loans.
Bair's agency is developing experience in changing mortgages to make them more affordable after taking over IndyMac Bancorp Inc., the failed lender seized by regulators in July. The Treasury could offer "loan guarantees and credit enhancements" to help persuade the holders of home loans to modify them, Bair told the Senate committee yesterday.
Sarkozy lays out radical state intervention
French president Nicolas Sarkozy has pledged "massive" state intervention to support his country's industry, defiantly ignoring EU competition rules in the biggest shift to dirigiste ideology in 40 years. Calling for a fully fledged "economic government" in Europe to back up the single currency and tackle the credit crisis, he laid out far-reaching plans for a €175bn (£139bn) fiscal boost to the French economy and proposed a "strategic investment fund". It will start funnelling money into key sectors by end of the year.
Mr Sarkozy said the state would take dramatic action in all fields of economic management to head off the worst crisis since the "franc fort" deflation of the 1930s. "We will intervene massively whenever a strategic enterprise needs our money," he said. The fund managed by Caisse des Depots – the investment arm of the French state – will be used to buy shares in any company falling prey to sovereign wealth funds from Asia and the Middle East, hoping to snap up Europe's crown jewels on the cheap after the stock market crash.
"We mustn't be naive and leave companies at the mercy of predators. Europe must not be the only one not to defend its interests. There is no reason why we shouldn't do what the Chinese do, and the Russians do. There is no reason why France can't have an industrial policy worthy of the name," he said. It will focus on the car industry, aviation and high-technology, and any sector threatened by job losses abroad.
The proposals received a chilly welcome in Berlin, where economy minister Michael Glos said such notions clashed with Germany's deep-rooted philosophy of free trade and open markets. "Germany will remain open to capital from around the world", he said. The political shift in France came as countries across Europe continued to adapt to the sudden downward lurch in the region's economy. Sweden's Riksbank cut rates by half a point to 3.75pc yesterday to "alleviate the effects of the financial crisis in the Swedish economy".
New Zealand's central bank cut by a full point to 6.5pc earlier, fearing that the collapse in global commodity prices will push the country deeper into recession. Mr Sarkozy's sweeping reforms include a major cut in business taxes to kick-start investment and the creation of a "credit mediator" to police the banks and ensure loans are steered towards firms in distress.
He warned that bankers were now on probation after receiving a €360bn bail-out from the French taxpayer. "Public opinion will be their judge, and those who don't step up to the plate and fulfil their responsibility will forced out immediately." Any attack on sovereign wealth funds would be a major blow to the City, which is Europe's chief conduit for investment funds from China, East Asia and the oil-exporting states.
Ruth Lea, director of think-tank Global Vision, said the French plans were a warning to Britain that the free market is increasingly vulnerable as the backlash from this crisis gathers force. "It is quite clear that Sarkozy is using this an opportunity to roll back Anglo-Saxon free competition and to push the agenda of further integration in Europe," she said.
Is international trade grinding to a halt?
Trade finance exists thanks to what the Financial Times's Lex calls "one of the most disruptive technologies ever invented... the humble box". Two features of our modern economy – globalisation and our reliance on shipping – mean that huge volumes of everything from basic commodities to finished goods travel from sellers in one country to buyers in another in standardised metal containers crammed onto cargo ships.
But the fact that a shipment can take days or weeks to arrive raises some problems about payment. How can sellers ensure a buyer will pay on time, or indeed at all, and what do they do for cash in the meantime? A buyer's potential headaches include whether the right goods will turn up in the right port, and at the right time – clearly they're not keen to pay up until the goods have arrived intact. Throw in different laws, currencies and time zones, and what looks like a simple deal to ship iron-ore from one country to another could quickly become a nightmare. That's where trade finance comes in.
Trade finance: how does it work? In short, a bank or specialist trade finance boutique will take payment risk away for a fee. There are many 'trade finance' solutions, most of which have been around since the Middle Ages. The most commonly used is the letter of credit. Drawn up typically for a seller by a bank, the basic letter guarantees payment for goods once they are safely on board a ship, but before they arrive with a buyer. Without it the two parties may not trust each other to honour their side of a deal.
There are many variants – for example, a small exporter with cashflow worries may request the bank to pay it cash up front, where payment would otherwise not be due from the buyer for several months. This up-front payment is usually arranged at a 'discount'. In other words, the bank offers the seller less than the total value of the invoiced goods shipped, confident it can eventually collect the full amount due from the buyer later using the shipment as security ('collateral'). As such, trade finance, an industry expert tells Bloomberg, is normally "the easiest, cheapest and (being backed by a shipment of goods) most collateralised form of credit".
Trade finance: is it big business? Huge. As Jonathan Lynn notes on Reuters, the development of standardised containers and port equipment has "helped spur a 90-fold growth in the annual value of world trade" to around $14 trillion today. According to a trade official quoted in the Lloyds List shipping newspaper, "90% of that is financed in some way by credit". Individual letters of credit can underwrite some massive shipments – Deutsche Bank for example was recently involved in three shipments for Russian clients, each with a value of above $3bn.
How is trade finance coping with the credit crunch? Badly. Steve Rodley, director of London-based shipping hedge-fund Global Maritime Investments, puts it bluntly: "The whole shipping market has crashed." The trouble is that credit is the lifeblood of commerce, but it is built entirely on trust. And that has evaporated. As such, many ship owners can't get banks to issue letters of credit, particularly on cargoes of price-volatile commodities that no longer look like adequate collateral. Even those who can get letters of credit are finding that their counterparties may no longer trust the credit rating of anything other than large, well-established banks, many of which are now charging big premiums. Letters now cost three times the going rate of a year ago, according to Lynn.
How does this affect world trade? "Nothing is moving because the trader doesn't want to take the risk of putting cargo on the boat and finding that nobody can pay," says Khalid Hashim, head of Precious Shipping, in the Lloyds List. The freeze has seen commodity shipping rates plunge to "the lowest in more than five years", reports Bloomberg. The Baltic Dry Index – a key barometer of global freight activity and therefore world trade – fell 11% in just one day last week (see chart). As a result, grain cargoes have begun piling up in ports in the Americas, reports The Economist. So bad have things got for Brazil that the government plans to use its foreign-exchange reserves to increase credit lines for exporters in a bid to keep trade flowing.
What's being done about it? The World Trade Organisation (WTO) has hastily scheduled a meeting of key financial institutions on 12 November specifically to discuss the impact of what the director-general, Pascal Lamy, calls "very difficult conditions in international financial markets" on trade finance. Anxious to be seen to act, ahead of the key meeting the WTO raised its trade finance programme by 50% to $1.5bn. But Lamy wants a global solution, warning that "uncertainty... could fuel protectionism".
"It's one more thing in a big negative melting pot" is how one Danish shipping chief executive summarised the trade finance crisis on Bloomberg. The FT agreed, noting that if the November meeting of the WTO fails as comprehensively as July's world trade talks in Doha, the prospect of Smoot-Hawley-style unilateral action (US legislation in the 1930s that raised US tariffs, slowed global trade and helped turn the crash into a depression) can't be ruled out. Even if that is avoided, "without trade finance, global commerce will shrink".
Post-default liquidation now more likely -S&P
Companies that file for bankruptcy are more likely to be forced into liquidation in the current environment as the availability of financing for restructuring has dried up, Standard & Poor's said on Thursday. S&P said that's the conclusion of a review of some of the largest speculative-grade issuers rated "B-minus" or lower.
That rating is six notches into speculative, or "junk" status. "Under current market conditions, the availability of debtor-in-possession financing for some defaulted issuers may be in question, with the number of DIP providers dropping sharply," said S&P recovery analyst Tom Mowat. DIP is a loan made to help bankrupt companies reorganize their operations.
"We think it's reasonable to expect that we will see a rise in the number of bankruptcies leading to liquidation," Mowat said. In that scenario, the debtholders of defaulted entities may face recovery prospects below their original expectations, he said.
Earlier, Fitch Ratings said the coming wave of U.S. high-yield corporate bond defaults could be the worst ever and impact more industry sectors that the downturn of 2001 to 2002.
Polish, Hungarian, South African Currencies Head for Worst Week
The Polish zloty, Hungarian forint and South African rand headed for their biggest weekly declines as the global economic slump fuels concern of a worsening credit crisis in emerging markets. The zloty fell 3 percent against the dollar today, taking its weekly decline to more than 16 percent, the steepest since Bloomberg began tracking the data in 1993. The forint extended its weekly loss to a record 14 percent while the rand fell almost 17 percent in its biggest five-day slump since 1975.
Investors are selling emerging-market stocks, bonds and currencies as the rout that began with the collapse of U.S. subprime mortgages last year pushes the world toward a recession and lowers the price of commodities that sustain developing economies. South Korea's central bank said fourth-quarter economic growth was the slowest in four years, sending the Kospi stock index 11.7 percent lower today, capping its worst week since 1997, and pushing the won near a 10-year low.
"We're seeing funds fly out of Hungary, Poland and other eastern European countries," said Silvia Marengo, who manages about $130 million of emerging-market bonds at Clariden Leu in London. "The countries with the biggest falls are the economies that were most connected to developed nations." Foreign-currency loans make up 62 percent of all household debt in Hungary, up from 33 percent three years ago, and the nation has a larger budget deficit than anywhere else in eastern Europe. Hungary's economy grew 2 percent in the second quarter, compared with 5.8 percent in Poland.
The forint has plunged almost 30 percent this year against the dollar. The Budapest stock exchange index, which has lost more than half its value this year, fell 3.4 percent today to the lowest since 2003. Polish central bank Governor Slawomir Skrzypek said today he doesn't envisage any "intervention on the foreign exchange market" after the zloty's more than 20 percent slide against the dollar this year. The nation's benchmark WIG20 stock index dropped 5.9 percent today.
"The financial crisis is changing its nature at the moment, away from fear of systemic risk attached to money and credit markets and toward emerging markets and the economic consequences of the financial crisis," Lars Christensen, an emerging markets analyst at Danske Bank A/S in Copenhagen said in a research note. The plunge in commodity prices, which this week slid to the lowest level in four years, has contributed to a more than 70 percent drop in the rand this year. Commodities make up more than half of South Africa's earnings abroad, according to data from the Department of Minerals and Energy.
South Africa's key stock index fell to the lowest since June 2006, dropping 4.3 percent, as investors sold commodity stocks led by BHP Billiton Ltd., the world's largest mining company. Emerging-market stocks fell for a fourth day, with the MSCI Emerging Markets Index declining 6.2 percent to a five-year low of 482.24 at 11:25 a.m. in London. The Korean Kospi stock index was 11.7 percent lower today, capping its worst week since 1997, and pushing the won near a 10-year low. India's Sensex benchmark headed for the biggest daily slump since 2004 after the central bank said it will continue fighting inflation, reducing the likelihood of easier lending to bolster growth. The Czech PX index slid 8.6 percent, the most in a week.
Russia's Micex Index tumbled 7.5 percent before trading was halted for an hour. The yield on Russia's 30-year, 7.5 percent dollar notes increased to more than 12 percent for the first time since 2002. The extra yield investors demand to own developing nations' bonds instead of U.S. Treasuries rose 11 basis points to 8.68 percentage points, a six-year high, according to JPMorgan Chase & Co.'s EMBI+ Index.
GLG chief warns thousands of hedge funds on brink of failure
Emmanuel Roman, the co-chief executive of Europe’s biggest hedge fund GLG, has warned that thousands of hedge funds are on the brink of failure as the global economy contracts with unexpected severity. Emmanuel Roman, of GLG Partners, said 25pc-30pc of the world’s 8,000 hedge funds would disappear "in a Darwinian process", either going bust or deciding meagre profits are not worth their efforts.
"This will go down in the history books as one of the greatest fiascos of banking in 100 years," said Mr Roman, who with Noam Gottesman, co-runs GLG, a former division of Lehman Brothers Holdings with assets of $24bn (£14.8bn). "There need to be some scapegoats, and the regulators are going to go hunt people. That will be good in the long run." His views were echoed by Professor Nouriel Roubini, a former US Treasury and presidential adviser known for his accurate prediction of financial crises, who estimated that up to 500 hedge funds would fail within months.
Both men were speaking at the same hedge fund conference in London yesterday, and Prof Roubini said he would not be surprised if the US and other countries soon had to close their stock markets for more than a week to halt descent into "sheer panic". The economist warned that the world is heading for a protracted recession that will end the US’s financial dominance. "It’s the beginning of the decline of the US financial empire. The Great Depression ended in a massive war. I hope that’s not going to happen but it’s pretty ugly now," Prof Roubini said.
He added that turmoil over world trade, currency markets and debt is likely to cause geopolitical tensions between the Western world and emerging superpowers such as Russia, China and "a bunch of unstable oil states". The conference saw analysts, economists and hedge fund managers discussing the possibility that global recession could now last two years on fears that government bail-outs and nationalisations have failed to stop the markets slumping.
"We’re now paying the price for the biggest asset and credit bubble in history," Prof Roubini said, advising investors to stay clear of risky assets and keep money in cash. "The bail-outs have not worked because the markets are no longer rallying, and the policy-makers have run out of options." The global financial meltdown accelerated this month, with the UK and US governments being forced to take stakes in some of the world’s biggest banks. Stock markets around the world have fallen sharply this month as investors’ concern switches to the impact on the wider economy.
"It’s like we’re walking blind in a minefield," said Prof Roubini. "Every situation has become risky and no one can trust each other. The banks are too big to be allowed to fail, but they’re also too big to save." Research from Hedge Fund Intelligence (HFI) shows that despite one of the worst months on record for credit funds, US hedge funds alone still have $1.7trillion (£1trillion) in assets.
JP Morgan Chase chief Dimon sent death threats
The US Postal Inspection Service has offered a $100,000 (£62,000) reward for information after Jamie Dimon, the chief executive of JP Morgan Chase bank, was sent death threats. Jamie Dimon and various outlets of his bank – one of America's biggest - were targeted in at least 45 anonymous, typewritten letters which all seem to be from the same source.
The sender accused Mr Dimon of stealing Washington Mutual, whose banking operation was bought by JP Morgan Chase last month. "You need to be pay back. You will be killed in 10 days," one of the typewritten letters read, investigators told ABC News. Another letter sent to Mr Dimon in New York threatened a series of attacks culminating in a bombing similar to that in Oklahoma City, in which 168 people died in 1995.
At least 45 letters, all postmarked in Amarillo, Texas on October 17 and 18, were sent to Chase bank offices in nine US cities as well as the Federal Deposit Insurance Corporation, the Office of Thrift Supervision in Dallas and the Federal Home Loan Bank in Atlanta. The letters contained a powdery substance which tests have shown to be harmless but Chase branches across the US were said to be "on alert".
Federal investigators believe the letters could have been sent in anger about the downward spiral of the US economy. Authorities say the letters "articulated threat of bodily harm" and appeared to be connected to the bank's lending practices. Postal inspectors said the public should "take no action to apprehend this person" by themselves. Mr Dimon has been seen as a potential US Treasury Secretary if Barack Obama wins the presidential election.
Last week, just hours after his bank was forced to sell a stake in itself to the US government, he accused Washington politicians of worsening the banking crisis through dithering. In a separate case, the FBI is investigating a series of letters sent to the Los Angeles Times and the campaign offices of Senator Barack Obama in New York, Philadelphia and Los Angeles.
Those letters also contained substances, including sand and food seasoning. Officials said one letter claimed "the world will end" if Obama is elected. A letter containing similarly harmless white powder was also received by the New York Times on Wednesday.
Treasury bonds are perfect for dumping
"I can't stand to sell at these levels. But I don't have any choice. I need the cash now..."
One of my cycling buddies has a huge house. He spends $30,000 on property taxes every year. He's retired. So to make these payments, he sells a few shares of stock whenever the bills arrive. He built his portfolio around financial companies. This year, they cratered. "I used to sell 500 shares to pay my tax bill. Now I sell 5,000 shares. It's devastating my holdings. Even if the stock market rises again, I'm still screwed."
This story illustrates why the stock markets are falling so much. The world's financial system is founded on debt. Payments must be made every month to service this debt, like my friend must pay his property taxes. If cash runs out, the debtor must sell assets... or declare bankruptcy. Last week, the whole world rushed for the door. Everyone tried to make payments on their debt by selling assets. Corporations, states, hedge funds, governments, and millions of people like my friend. The stock market collapsed.
The best place to be in a debt crisis is government bonds. Credit crunches lead to recessions and depressions. Recessions are deflationary. Prices fall. Government bonds' fixed coupon payments and safe-harbour status make them the most attractive investments in the market. (Of course, debt crises end up being inflationary as governments pump lots of money into the economy, but that comes later.)
We're passing through the worst credit crunch in America's history. You'd think government bonds would have soared. But they didn't. The problem is, if Treasury bonds were the last investment on Earth, it wouldn't matter right now. The world needs cash. And it'll sell any asset to get it... even Treasuries. Look at the recent spike on the chart below. It shows the 10-year Treasury bond yield. When the yield rises, the bond price falls. So you can see bond prices have had a massive collapse, starting September 17. That's one day after the government bailed out AIG... and two days after Lehman declared bankruptcy.
Treasury bonds are perfect for dumping. They are liquid, so investors can sell them easily. And they have high prices. Unlike my friend's bank stocks, you can generate lots of purchasing power by selling them. My concern is, if this credit crisis gets worse, it's going to trigger even bigger whales to liquidate their Treasury bond holdings... whales like the Chinese, the Japanese, or the oil exporters. So far, we've only seen what happens when banks and hedge funds liquidate. If Japan and China start unloading – or even if they just slow down their purchases – the Treasury bond market will fall through the floor.
This sets off another vicious cycle. As prices fall, the interest rates Uncle Sam must pay rise. The higher interest rates rise, the more the US must pay... which makes bond traders mark down the country's credit rating. This sends bond prices even lower... If the trend grows, we'll see a biblical collapse in the Treasury bond market.
Mesa AZ faces huge budget crisis
Mesa is bracing for what could be the worst budget crisis in city history. City Manager Chris Brady said Thursday that in about a month the City Council will be forced to decide what essential services Mesa can afford in an economy whose daily headlines speak of home foreclosures, drastic slowdowns in construction and a calamitous drop in sales-tax collections. "Every department is going through and making reductions now," Brady said.
But when the council puts pencil to paper Nov. 20, Brady said, not every department will be treated equally.
Decisions will boil down to one question, Brady said. "What are the critical services we want to continue with?"
"There are no sacred cows," Brady said. "Everything's on the table. . . . It's a new economy. We're having to re-evaluate everything."
The Fire Department is already an early casualty. Fire Chief Harry Beck sent an e-mail to his staff Wednesday outlining $1 million in budget cuts beginning Monday. Mesa's budget problems are not unique to Valley cities. Phoenix and Scottsdale, among others, are struggling with unprecedented cutbacks. Phoenix's cuts could reach $250 million by June 30. Mesa budget officials have said they will not have figures on the city's total projected shortfall until shortly before the Nov. 20 council meeting.
For most of its modern history Mesa has lived on sales taxes, an increasingly iffy source of money as other Southeast Valley cities have become retail centers in their own right. Now, a desperate national economic picture, which has seen home values and people's retirement savings plummet, has devastated the retail segment.
Mesa first began grappling with lagging tax collections late last year and by spring was forced to impose $21 million in budget cuts to cover the fiscal period ending June 30, 2009. City officials took the slowing economy into account for the 2008-09 budget, expecting that sales taxes would drop somewhat from 2007 levels. The reality has been far worse than the forecasts.
Figures released Thursday show Mesa's sales-tax collections for June, July and August dropped 13.6 percent from what was collected during those months in 2007. In sheer dollars, retail sales taxes those three months were $5.3 million less than in 2007, and came in at $4.5 million less than what was budgeted. Beck's memo hit the streets just days before Mesa voters will decide whether to approve about $170 million in bonds for street, police and fire projects - bonds that more than likely would trigger the city's first property tax since World War II.
• Fiscal year 2008-09 operating budget (day-to-day city operations): $340.9 million.
• Estimated sales and use taxes for year: $147.2 million.
• Actual collections, June-August 2007: $38.7 million.
• Actual collections, June-August 2008: $33.5 million.
• Year-to-year drop, 2007-2008: almost $5.3 million.
• Budgeted sales- and use-tax collections, June-August 2008: $38 million.
• Deficit between budget and collections: $4.5 million.
Top Theorists Examine Rippling Economic Turbulence
As the financial sector shifts, so does the reach of the jolt to economic structures around the world. Economist Nassim Nicholas Taleb and his mentor, mathematician Benoit Mandelbrot, speak with Paul Solman about chain reactions and predicting the financial crisis.
RAY SUAREZ: Finally tonight, we return to a subject on many minds these days: the financial crisis. Our economics correspondent, Paul Solman, checked back in with one particularly prominent voice in the investment world and his colleague, who guided his thinking.
Here is the pair's sobering conversation on what may lie ahead.
PAUL SOLMAN, NewsHour Economics Correspondent: One of the world's hottest investment advisers these days, Nassim Nicholas Taleb, author of "The Black Swan," who's been warning of a crash for years, betting on one, and winning big. He's been ubiquitous in the financial media of late, from cable TV's "Colbert Report" to the BBC's "Newsnight," where he was infuriated by what he called "bogus accounting."
NASSIM NICHOLAS TALEB, Scholar and Author: The first thing I would get immediately, immediately, I would suspend something called value at risk, quantitative measures of risk used by banks, immediately.
PAUL SOLMAN: We sat down with Taleb and the man he calls his mentor, mathematician Benoit Mandelbrot, pioneer of fractal geometry and chaos theory. And even more than feeling vindicated, they're both scared.
NASSIM NICHOLAS TALEB: I don't know if we're entering the most difficult period since -- not since the Great Depression, since the American Revolution.
PAUL SOLMAN: The most serious situation we've been in since the American Revolution?
NASSIM NICHOLAS TALEB: Yes.
PAUL SOLMAN: Professor Mandelbrot, can that possibly be true?
BENOIT MANDELBROT, Mathematician: It's very serious.
PAUL SOLMAN: More serious than the Great Depression, possibly?
BENOIT MANDELBROT: Possibly. I hope not.
Complexities of the banking system
PAUL SOLMAN: Mandelbrot's key insight came in the '60s with a study of cotton price surges and plunges, suggesting the world moves in fits and starts, especially the human world. Decades later, after the stock market crash of 1987, Taleb came to the same conclusion. He appeared on the NewsHour two years ago to help explain the death of a hedge fund before the current crisis. He dubbed the event "a black swan," impossible, Europeans had always thought, because they'd never seen one.
NASSIM NICHOLAS TALEB: We saw a lot of white swans. Every white swan was confirming that, you know, hey, all swans were white.
PAUL SOLMAN: Taleb's book, published in April 2007, was called "The Black Swan" because, in 1697, Dutch explorers discovered Australia and black swans.
NASSIM NICHOLAS TALEB: And, sure enough, they saw that black version and said, "Hey, one single observation, OK, can destroy thousands of years of confirmation." So, likewise in the markets, all you need is one single bad month to destroy years of track record.
PAUL SOLMAN: In the book, Taleb wrote, "The increased concentration among banks seems to have the effect of making financial crises less likely. But when they happen, they are more global in scale and hit us very hard. True, we now have fewer failures, but, when they occur, I shiver at the thought."
NASSIM NICHOLAS TALEB: The banking system, the way we have it, is a monstrous giant built on feet of clay. And if that topples, we're gone. Never in the history of the world have we faced so much complexity combined with so much incompetence and understanding of its properties.
PAUL SOLMAN: But there's been complexity before. There has been overextension of credit before. We've had crashes in American history many times before. We're a resilient system. Won't we pull out of it?
NASSIM NICHOLAS TALEB: Let me tell you why it's not like before. Look at what's happening. The world is getting so fragile that a small shortage of oil -- small -- can lead to the price going from $25 to $150.
PAUL SOLMAN: A barrel.
NASSIM NICHOLAS TALEB: A barrel. A small excess demand in an agricultural product can lead to an explosion in price. We live in a world that is way too complicated for our traditional economic structure. It's not as resilient as it used to be. We don't have slack. It's over-optimized.
PAUL SOLMAN: What do you mean by "over-optimized"?
NASSIM NICHOLAS TALEB: Let me tell you what is happening in the ecology of the banking system. They're swelling to large banks, OK, because it's vastly more optimal to have one large bank than 10 small banks. It's more efficient.
PAUL SOLMAN: Well, we've certainly seen the consolidation of the industry.
NASSIM NICHOLAS TALEB: Exactly. And that consolidation is what's putting us at risk, because we are -- when one bank, large bank makes a mistake, OK, it's 10 times worse than a small bank making a mistake.
PAUL SOLMAN: And I guess I'm realizing that that's where your famous work comes in. It's always been characterized by the work that you're central to as the butterfly somewhere disturbs a little bit of air and, halfway across the world, a tornado hits or something, right? Is that what we're talking about here?
BENOIT MANDELBROT: Certainly very similar. The word "turbulence" is one which actually is common to physics and to social scientists, to economics. Everything which involves turbulence is enormously more complicated, not just a little bit more complicated, not just one year more schooling, just enormously more complicated.
PAUL SOLMAN: Turbulence is why, because it's badly understood, weather forecasters can't necessarily get it right.
BENOIT MANDELBROT: Precisely. In fact, the basic -- the basis of weather forecasting is looking from a satellite and seeing a storm coming, but not predicting that the storm will form. The behavior of economic phenomena is far more complicated than the behavior of liquids or gases.
Impacts from sudden changes
PAUL SOLMAN: So, getting back to your fundamental work and insight, this is a system that can become turbulent or is inherently turbulent, that doesn't have enough of a buffer, and that's the danger?
BENOIT MANDELBROT: That is not well-understood. In fact, that is misunderstood for which tools have been developed which assume that changes are always very small. If one of them comes, nothing bad happens. If several of them come together, very bad things have happened. And the theory does not take account of that, and the theory doesn't take account of very large and sudden changes in anything. The theory thinks that things move slowly, gradually, and can be corrected as they change, whereas, in fact, they may change extremely brutally.
NASSIM NICHOLAS TALEB: Now you understand why I'm worried. I hope I'm wrong. I wake up every morning -- actually, I don't wake up every morning now. I start to wake up at night the last couple of weeks hoping that I'm wrong, begging to be wrong. I think that we may be experiencing something that is vastly worse than we think it is.
PAUL SOLMAN: And we think it's pretty bad.
NASSIM NICHOLAS TALEB: It's worse. Of all the books you read on globalization, they talk about efficiency, all that stuff. They don't get the point. The network effect of that globalization, OK, means that a shock in the system can have much larger consequences.
Hedge funds' looming impact
PAUL SOLMAN: What is the doomsday scenario? I mean, what actually happens tomorrow, next week?
NASSIM NICHOLAS TALEB: I mean, I am convinced -- there's been a package recently of $700 billion. It's pocket money, because you don't understand -- they don't understand the ripple effect that hedge funds have, OK, that the banks not lending to hedge funds will force hedge funds to liquidate positions.
PAUL SOLMAN: Sell off?
NASSIM NICHOLAS TALEB: Sell off positions. These positions, sold off by hedge funds, will impact other entities.
PAUL SOLMAN: Driving down the price.
NASSIM NICHOLAS TALEB: Driving down the price. Driving down some prices. That a supermarket, OK, needing funding, will not be able to find a bank solvent enough to lend them money against inventory to make payroll, OK? You may have chain reactions we've never imagined before. And these come from the intricate relationships in the system we don't understand.
PAUL SOLMAN: You've been around a lot longer than we have. That's possible. Is it likely?
BENOIT MANDELBROT: Well, we don't know the probability. We don't have enough knowledge. We don't have enough information. We don't have enough reliable information on data which are not published. I mean, I sleep better, perhaps, than Nassim, but I don't sleep very well.
Challenges to prediction
PAUL SOLMAN: Is it possible that what's also unimaginable, which is that this will simply right itself, is that a possibility?
BENOIT MANDELBROT: Everything is a possibility. I mean, again, it is not -- I try my best to answer questions which are scientific, and which I can respond to and which have scientific evidence and not personal opinion. Everything is imaginable. What's the joke, that prediction is very easy when you predict the past or something?
PAUL SOLMAN: Well, predictions are -- predictions are difficult, particularly about the future.
BENOIT MANDELBROT: That's what I wanted to remember.
PAUL SOLMAN: Benoit Mandelbrot, Nassim Nicholas Taleb, thank you very much.
NASSIM NICHOLAS TALEB: Thank you.
BENOIT MANDELBROT: Thank you.
Destroying Companies For Profit
If you ever wondered how or why a stock price suddenly drops like a rock on incredible volume, or why executives battle damaging reports in the NY financial press and in analyst reports, see this video. But only if you want to know how Wall Street really works.
Wall Street has a profitable trading strategy that it has been carefully hiding, because it involves the destruction of companies. Just recently Deutsche Bank was found by the NYSE to have been selling massive amounts of shares it did not have nor deliver over a period of 22 months. This floods the market with "shares" and sucks out investors money - unbeknown to investors - and damages the companies - the more the better. This trading scheme is called "Naked Short Selling". And it is very profitable for those who do it. The more a company goes down - the more they make.
NYSE spokesman Scott Peterson said that Deutsche Bank sold "A LOT.” But this is just one example of many instances. Wall Street firms and hedge funds carefully hide this activity because it is amoral and illegal. But is is possible because the regulators, while they know about it, do nothing and journalists and analysts help put out the needed messages. Companies that need access to the markets or bank on their good reputation are choked off this way. It's easy money. Collect investor money, then kill the company.