Before Halloween came into its own as a holiday in the US, there was "Thanksgiving masking"
Kids would dress up and go door to door for apples, or "scramble for pennies."
Ilargi: In Britain, the average homeowner has lost more on the value of his property in the past year than his/her annual salary is worth. Moreover, more than 30% of the value of all private pensions is gone. While £6.7 billion was paid in, £157 billion disappeared.
in the US, the Case/Shiller housing index is down 22%, which means American homeowners lost on average about $45.000 in real estate value. As for their pensions, the news coming out these days leaves no room for hope American citizens are any better off than their UK counterparts.
While in continental Europe home prices have held up better, it’s getting increasingly clear that is merely the result of a time lag. The financial mayhem sweeping through the old continent is so severe that many parts of it will be hit much harder still than the US. The more leverage you have, the further and faster you will end up falling.
The 21st century Tulip Bubble, meanwhile, keeps on spreading. In Eastern Europe, access to foreign currencies is firmly restricted, raising people’s debts through their tattered roofs. Bank runs throughout the Arab world are a nasty sign of things to come. Wait till the effects of the latest oil price plunges starts to really seep through.
I’ve said for years that nobody presently under 50 years old will ever see more than a few pennies of their pensions. The 30% drops we have already seen so far, in a world that hasn't even begun to admit to being in a recession, let alone a depression, should be a wake-up call the size of a church bell on your night stand. Moreover, companies in many countries now want to pay less into pension funds, whose investments at the same time are bleeding billions of dollars.
Yes, there will be backlash against the loss of people’s retirement funds.
There will also be a backlash against the dropping home prices. You just wait till they fall below 50%, and people realize they won’t stop falling.
Another backlash will come against governments propping up banks and other failed businesses, while letting their populations go hungry.
A fourth backlash will rise up to stop increases in taxes of all sorts and on all levels. They will come. And you can't raise taxes on a people that is losing money and wealth left right and center. Not for long at least.
A fifth backlash, and perhaps the first one to erupt, will involve the $100's of billions in bonuses and other fees that Wall Street intends to spend on its executives and traders. If I were them, I would make sure to loudly proclaim that I have refused my 2008 bonus.
I would almost start to think that the present US government aims to leave a country mired in civil war and martial law come January 20. Just a few weeks ago, I was making lists of countries that were in financial trouble.
I’m now considering a list of those where people are about to take to the streets.
Call this a crisis? Just wait
David Walker, former U.S. Comptroller General
Actually, don't wait, because we've got to stop a bigger economic disaster in the making: 78 million baby-boomers eligible for Social Security and Medicare.
Staring into the abyss always focuses the mind, which can help you avoid falling in. So let's take a look at the potential catastrophe that awaits us once we survive our current crisis. At the dawn of the 21st century the U.S. had $5.7 trillion in total debt. As we approach the end of George W. Bush's presidency only eight years later, that sum has nearly doubled, thanks to war costs, tax cuts, spending increases, expanded entitlement programs, and now a welter of government bailouts and rescues.
This year was particularly bad. The federal budget deficit for fiscal 2008 hit $455 billion, up from $162 billion last year. That figure does not include the cost of the Emergency Economic Stabilization Act of 2008, which has an initial pricetag in the hundreds of billions of dollars. In fairness, some of that money presumably will come back to the Treasury, since the new rescue-related sums will be used to acquire preferred stock, mortgages, and other assets that someday could be sold at a profit.
Yet any such calculations are penny ante compared with the fiscal disaster that is bearing down on America. It's no longer an event in the misty future. It officially began earlier this year when teacher Kathleen Casey-Kirschling of Maryland became the first baby-boom retiree to collect Social Security benefits. She will be followed by about 78 million more boomers over the next 17 years.
The entitlements due from Social Security and Medicare present us with that frightening abyss. The costs of these current programs, along with other health-care costs, could bankrupt our country. The abyss offers no assets, troubled or otherwise, to help us cross it. Yes, some have suggested less-than-revolutionary measures that could help. Among them: budget savings that would accrue from repealing the Bush-era tax cuts, ending the Iraq war, or expanding the economy after the current downturn runs its course. But even if the economy were to grow at the level of 3.2% a year, as it did in the 1990s, and these other savings were achieved, they wouldn't come close to addressing our federal financial problem.
Nor can we be complacent about timing. The costs of these programs start to threaten our solvency in the next several years. The only way to get across the chasm is to begin making tough choices now to change our current course. Delay will make the problem worse. In fact, the deteriorating financial condition of our federal government in the face of skyrocketing health-care costs and the baby-boom retirement could fairly be described as a super-subprime crisis. It would certainly dwarf what we're seeing now.
The U.S. Government Accountability Office (GAO), noting that the federal balance sheet does not reflect the government's huge unfunded promises in our nation's social-insurance programs, estimated last year that the unfunded obligations for Medicare and Social Security alone totaled almost $41 trillion. That sum, equivalent to $352,000 per U.S. household, is the present-value shortfall between the growing cost of entitlements and the dedicated revenues intended to pay for them over the next 75 years.
Why call it a super-subprime crisis? Besides its gigantic scale, there are very disturbing similarities between the current mortgage-related crisis and our next potential disaster. First, like the securitized investment vehicles that blew up, federal programs were launched without adequately thinking through who would bear the ultimate cost and related risk. Just as originators of mortgages let themselves off the hook by unloading packages of dubious loans onto others, lawmakers have increased spending, expanded entitlement programs, and cut taxes while expecting future generations to pay the bill.
Second, just as a lack of transparency associated with mortgage-backed securities resulted in big surprises and large losses for investors, our nation's huge off-balance-sheet obligations for Social Security and Medicare present a threat wrapped in camouflage. After all, the government's "trust funds" don't really provide much security since they don't hold anything but more government debt.
Third, in the same way that private sector "risk management" executives failed to prevent the subprime mortgage crisis, overseers in Congress and the executive branch have turned a blind eye to costs associated with entitlement programs and tax cuts. While lax regulation of banks fed the current subprime crisis, a lack of statutory budget controls has led to a widening gap between the government's revenues and costs.
At the heart of these problems is our leaders' collective failure to act in the face of known challenges. Our country has veered from its founding principles, which held to individual responsibility and accountability today in order to create more opportunity tomorrow. When our constitution was written, the concepts of thrift and prudence were no less at the center of the American spirit than liberty and justice.
During past financial crises and wars, the government went into debt because our nation's survival was at stake. What has changed is that piling up debt has become business as usual, even during times of prosperity. Today we are headed toward debt levels that far exceed the all-time record as a percentage of our economy. In fact, by 2040 we are projected to see debt as a percentage of our economy that is double the record set at the end of World War II. Based on GAO data, balancing the budget in 2040 could require us to cut federal spending by 60% or raise overall federal tax burdens to twice today's levels.
Medicare, Medicaid, and Social Security already account for more than 40% of the total federal budget. And their portion of the budget is expected to grow so fast that their cost, and the cost of servicing our debt, will soon crowd out vital programs, including research and development, critical infrastructure, education, and even national defense. The crisis we face is one of numbers and demographics but also of attitudes. Promises were made in an earlier time, when they seemed more affordable. Like homeowners borrowing against the value of their homes in the expectation that the values would go up forever, the American government borrowed against the future and assumed that the economy would grow fast enough to make that debt affordable.
But our national debt is not limitless, and our foreign lenders are not fools. If we persist on our current "do nothing" path, our future will be jeopardized. Americans need to reconcile the government we want with the taxes we're willing to pay for it. True, attempts at reforming Medicare and Social Security have foundered in the past, and there may be some Americans who think that if the government can bail out the financial sector, it can bail out our entitlement programs. But the political difficulty of tackling these problems, hard as they are, has to be overcome this time.
The next President, working on a bipartisan basis with the Congress, must make sure that tough controls are put in place to get control of the budget, once economic conditions improve. (Example: We can require that all new spending programs, commitments, and tax cuts are paid for by comparable spending cuts or revenue increases in other parts of the budget.) We'll need to make some tough decisions on which of the Bush tax cuts we can afford to keep, and resolve what to do about the alternative minimum tax.
These problems are not beyond our ability to master them. Social Security can be made sustainable and secure with some modest changes over time in retirement benefits, the retirement age, and the tax structure, as Republicans and Democrats did in the early 1980s. As for Medicare, there are a number of good ideas that would introduce more cost sharing for the wealthy, increased competition, better cost controls, more use of technology, and other steps to curb the growth of health-care spending.
I urge the government to set up a bipartisan commission that would begin working in early 2009. It should keep everything on the table - all entitlements, other spending, and tax programs - and make recommendations on both sides of the federal ledger. If we bring together the talent and expertise that abound in our great country, we can see our way through the current financial crisis and find solutions for the next one. From Washington we'll need leadership rather than laggardship. The 78 million baby-boomers aren't getting any younger.
Traders warn of Italy iceberg
Investor flight from Italian bonds has pushed the yields on the country's debt to the highest level since the days of lira, raising concerns over Rome's ability to finance its budget deficit as a repayment falls due next year. The interest spread between Italian 10-year bonds and German Bunds has reached 108 basis points, the highest since the launch of the euro. Traders say it is nearing levels that risk setting off a an unstable chain reaction.
In effect, Italy now has to pay 1.08% more than Germany to entice pension funds and other investors to buy its state debt. It is unclear whether this is a temporary spike caused by a lack of liquidity in the bond markets, or whether it reflects concerns over the state of Italian finances. Italy's public debt is the third largest in the world after the US and Japan. At 107pc of GDP, it is the highest of any major economy in the eurozone and almost double the 60pc limit stipulated by the EU's Maastricht treaty.
Morgan Stanley calculates that Rome needs to roll over €198bn next year as a clutch of maturities comes due. This compares with €173bn for Germany, €135bn for France, and €57bn for Spain. Four EU states have had to cancel bond auctions this month due to a buyers' strike. "The outflows from Italian bonds have been relentless over the last year," said Simon Derrick, currency chief at the Bank of New York Mellon. "It has reversed all the inflows since 2003 and the intensity does reflect significant concerns about the level of public debt."
Risk consultants Stratfor warned this week that Unicredit has exposure of $130bn in central Europe and the Balkans, while Intesa has lent $50bn to the region. Silvio Berlusconi, Italy's premier, insists that Italian banks are in fine health and have largely avoided investments in US toxic assets, but Italy's financial stability committee has held three sessions over the last two weeks to discuss banking tensions.
Italy's financial daily Il Sole reported that the central bank is mulling moves to inject capital into the banks. It described a "sharp exchange" between Mario Draghi, the bank's governor, and finance minister Giulio Tremonti, who denies that there is a problem. The Italian cabinet is meeting tomorrow to discuss details of a state-rescue package. On the currency markets, the euro plummeted by six cents against the dollar today after the EU's eurozone confidence index crashed to a 15-year low.
"The message to the European Central Bank is that it must cut, cut, and cut again," said Julian Callow, Europe economist at Barclays Capital. "The ECB clearly made an error by raising rates to 4.25pc in July, but the banking crisis over recent weeks has brought it home to them how serious this is. We expect them to cut by half a point next Thursday, and go down to 2.25pc by next summer," he said.
In Eastern Europe, the brief respite following Hungary's $25bn rescue package from the IMF was already giving way to fresh angst. Romania was forced to deny persistent rumours that it was seeking an emergency loan from the fund. The country's prime minister, Calin Popescu Tariceanu, may have inadvertently fuelled fears when he told local TV that the global economy was sinking like the Titanic.
"On the lower levels, people are in water up to their necks, while on the upper floors the music still plays on, just as it did in the film. And those people listening to the people listening to the music, not knowing that the Titanic has hit an iceberg, that's us here in Romania. That's just what we're like," he said.
Meanwhile, Poland's central bank was in talks with the Swiss authorities and the ECB for a Swiss franc swap accord to relieve intense strains in the credit markets. Heavy use of foreign loans for mortgages and business debt has led to a sudden squeeze as the zloty crumbles, falling 21pc against the franc since August.
A report by JP Morgan said Poland was in worse shape than Hungary, citing concerns that the country's banks and companies will have to pay back $96bn in foreign currencies next year. Poland's foreign reserves are just $59bn. Polish officials vehemently disputed the claims.
Banks borrow record $199 billion from Fed
With sources of credit still largely frozen, banks borrowed a record amount from the Federal Reserve in the past week, according to Fed data released Thursday.
The Fed reported that commercial banks borrowed a record $111.9 billion a day, on average, from the Federal Reserve's emergency lending window over the past week. That's up $6.1 billion from the $105.8 billion they borrowed in the previous week. Investment banks, meanwhile, borrowed $87.4 billion a day, on average, down $23.9 billion from $111.3 billion a week ago.
Financial institutions have turned to the Federal Reserve for funds, as the traditional source of lending from private banks dried up after the collapse of Lehman Brothers in mid-September. As a result, the federal government has instituted several programs aimed at easing funding concerns for banks and encouraging lending between financial institutions. These include measures such as lowering interest rates, injecting capital into banks and providing insurance on all non-interest bearing accounts.
One such program, the Fed's Commercial Paper Funding Facility, has helped lower borrowing rates and provided critical short-term financing to businesses in desperate need of cash. The Fed said it has bought up $143.9 billion in commercial paper since the program began Monday. Many of these programs have only recently come online, and analysts say it will take time for the new initiatives to reduce the lending stranglehold currently gripping banks.
Fed Buys $145.7 Billion of Commercial Paper in Start of Program
The Federal Reserve bought commercial paper valued at $145.7 billion in the first days of the program aimed at backstopping the market, indicating the central bank is generating most of this week's record gains in short-term corporate borrowing.
The central bank extended $144.8 billion of loans as of yesterday to a unit that paid $143.9 billion for the debt, the Fed's weekly balance-sheet report said today. Separately, direct loans to commercial banks rose to a record $110.7 billion yesterday from $107.5 billion a week earlier. Cash borrowing by securities firms totaled $79.5 billion, down from $102.4 billion.
The Fed invoked emergency powers on Oct. 7 to start the loans as the credit freeze threatened the financing tool that drives everyday commerce for American businesses. The Treasury Department deposited $50 billion with the Fed to begin the program, which opened Oct. 27. The maximum amount of commercial paper that can be financed is $1.8 trillion. A separate Fed report earlier today showed U.S. commercial paper outstanding rose by a record $100.5 billion, or 6.9 percent, to a seasonally adjusted $1.55 trillion for the week ended Oct. 29. The market plunged 20 percent over the previous six weeks.
American International Group Inc. drew down $83.5 billion of its $123 billion rescue credit line from the Fed, down from $90.3 billion last week. The insurer may need to borrow more if capital markets fail to improve, Chief Executive Officer Edward Liddy said Oct. 22. The Fed first provided an $85 billion loan Sept. 16, then authorized another $37.8 billion on Oct. 8.
Central bankers are flooding financial institutions with temporary loans in an effort to overcome cash hoarding by banks. The loans have enlarged the Fed's balance sheet to $1.97 trillion, compared with $1.8 trillion last week and $887 billion a year earlier. The weekly release now runs eight pages, up from four last year. Two days ago, Fed policy makers cut the benchmark interest rate, the federal funds rate, by a half-point to 1 percent, matching a 50-year low. The discount rate was reduced to 1.25 percent, the lowest since 2002.
Average daily discount window borrowing was $111.9 billion during the week ended Oct. 29, up $6.19 billion from a week earlier. Average daily borrowing by securities firms fell $23.9 billion to $87.4 billion. The Fed's holdings of U.S. Treasury securities fell $43 million to a daily average of $476.5 billion. The central bank had about $791 billion of Treasuries at the start of the credit crisis in August 2007.
In addition to the new Commercial Paper Funding Facility, the Fed started a separate program in September to lend to banks to buy asset-backed commercial paper from money-market mutual funds. Loans under that program totaled $96 billion as of yesterday, down from $107.9 billion a week earlier. A third Fed program involving commercial-paper purchases, the Money Market Investor Funding Facility, will be up and running within a few weeks. Under that program, the Fed will lend up to $540 billion to five special funds to buy certificates of deposit, bank notes and commercial paper with a remaining maturity of 90 days or fewer.
For the CPFF, the Fed began providing a breakdown of holdings and loans. The $143.9 billion paid to buy the debt by the Fed's private Delaware-incorporated company, Commercial Paper Funding Facility LLC, includes fees payable to the program's manager, Pacific Investment Management Co. An item for "other investments" includes securities purchased with cash fees from participating companies. The Fed isn't disclosing those investments, which totaled $894 million as of yesterday.
That and the debt's book value comprise the net portfolio holdings of Commercial Paper Funding Facility LLC, which joins the Fed's balance sheet. Another Fed unit, Maiden Lane LLC, holds the $26.8 billion of assets the central bank took on in its rescue of Bear Stearns Cos. The Fed also reported that the M2 money supply rose by $54.3 billion in the week ended Oct. 20. That left M2 growing at an annual rate of 6.1 percent for the past 52 weeks, above the target of 5 percent the Fed once set for maximum growth. The Fed no longer has a formal target.
The Fed reports two measures of the money supply each week. M1 includes all currency held by consumers and companies for spending, money held in checking accounts and travelers checks. M2, the more widely followed figure, adds savings and private holdings in money market mutual funds. During the latest reporting week, M1 fell by $1.3 billion. Over the past 52 weeks, M1 increased 4.5 percent. The Fed no longer publishes figures for M3.
Fed Opens Up Another Pocket For AIG: Total Loans Hit $144 Billion
American International Group is borrowing from Peter to pay, um, Peter. The government-controlled insurer is replacing the expensive credit line it received when it was rescued by the federal government last month with a cheaper one, also from Uncle Sam.
Four American International Group affiliates registered to borrow up to $20.9 billion through the Federal Reserve Bank of New York’s Commercial Paper Funding Facility according to a regulatory filing on Thursday. Tapping the U.S. government for cash has become a habit for AIG’s since it was nationalized in September. Shares in the New York-based insurer gained 5.2%, or 8 cents, to $1.63 off of the news. Stock in the company now trades at a 97.4% discount from what it changed hands a year ago. The Fed, which provided the initial financing, will end up with a 79.9% stake in the company.
The most recent bout of just-to-get-by borrowing is at much sweeter terms than the draconian 12.0% or so interest AIG pays on its original $85.0 billion credit facility from the Federal Reserve. The plan is for the insurer to pare down its business and use the proceeds to settle its debt to America. But staying solvent while the deals get done is proving to be the hard part.
Nick Ashooh, a spokesperson for AIG, said some of the cash the insurer has borrowed through the commerical paper facility has been used to pay down AIG’s original borrowing from the government. As of Thursday afternoon, the balance on the initial loan had fallen by $6.5 billion, to $65.5 billion, from $72.0 billion a week ago. Meaning, government-owned AIG is essentially paying off one government loan with another.
Ashooh said he did not know if AIG would need any more money in the short-term and acknowledged that this is a government loan, albeit one that any big insurer might need. “It’s a liquidity issue. It’s hard for everybody,” he said. The Fed will allow AIG Funding, International Lease Finance, Curzon Funding and Nightingale Finance to borrow up to $6.9 billion, $5.7 billion, $7.2 billion and $1.1 billion, respectively. The latter two are funds within AIG’s loss-ridden financial products group.
In mid-October, the New York Fed announced it would be advancing AIG an additional $37.8 billion via a securities lending facility; of that amount, $17.7 billion has been drawn down. This loan allows the insurer to pay back parties that have given it cash collateral in exchange for borrowing AIG’s illiquid (largely residential mortgage-backed) securities. “They are only taking highly rated stuff,” Ashooh said.
That kind of program was a popular method for insurers to earn money before the subprime crisis upended the credit markets.
Ashooh said he wasn’t sure of the rate of the commercial paper loans but said “it would be the same as anyone else.” On Monday, the New York Fed announced 90-day asset-backed borrowing rates would be 3.9% through its commercial paper program. AIG has to keep tapping the Fed for money because it still hasn't managed to sell any of its parts. “We haven’t made any announcements, but there is a lot of activity,” Ashooh said. AIG will report third-quarter earnings before Nov. 10, Ashooh said.
The Shipping News Suggests World Economy Is Toast
In the third quarter of 2007, Volvo AB booked 41,970 European orders for new trucks. Guess how many prospective purchases Volvo, the world's second-biggest maker of heavy rigs, received in the third quarter of this year? Here's a clue. Picture a highway gridlocked by 41,815 abandoned trucks -- because Volvo's order book got destroyed to the tune of 99.63 percent, with customers signing up for just 155 vehicles in the three-month period, the Gothenburg, Sweden-based company said last week.
The pathogen that has fatally infected swathes of the banking industry is now contaminating non-financial companies. "We're heading toward the sharpest downturn I've ever seen in Europe," said Chief Executive Officer Leif Johansson. Volvo has company. Daimler AG, the world's biggest truckmaker, said earlier this month that its U.S. deliveries slumped by a third in the first half of the year.
After months of money-market madness, slumping stock markets, collapsing currencies and bank bailouts, the headlines from the broader economy are starting to roll in -- and the news is all bad and getting worse, fast.
Let's begin with the shipping news. If nobody is buying your trucks, you don't need to rent a vessel to carry that shiny new 18-wheeler to its new owner. Hence the Baltic Dry Index, which tracks the cost of shipping goods and commodities, fell below 1,000 this week for the first time in six years. Put another way, it is now almost 90 percent cheaper to ship goods over the oceans than it was at the beginning of the year. And because the huge vessels known as capesize ships can't currently charge much more than their daily operating cost of about $6,000 per day, their captains have slowed down to economize on fuel and save money, to about 8.68 knots from 10.33 knots in July, according to data compiled by Bloomberg.
It isn't just the oceans that are emptying. Air freight traffic dropped 7.7 percent in September, according to the latest figures from the International Air Transport Association. That's the steepest decline since the trade group began compiling the data in January 2003. Figures this week showed U.S. consumer confidence collapsed to a record low in October; retail therapy probably isn't the cure. With Christmas looking like it might be canceled, why bother fighting with your bankers for the letters of credit you need to export the stocking-stuffers you make in the factory?
"The October reading signals the deepening concern about the marked deterioration in the overall economy as well as the growing anxiety arising from the continued travails in the financial markets," David Resler, chief economist at Nomura Securities in New York, wrote in a research report. "Confidence declined across all regions, all age groups and all income categories." One way in which the current recession/depression/meltdown (take your pick) will differ from previous economic collapses is the granularity of information now available. The world is awash with more data than ever before, generating a plethora of ways to scare yourself silly.
The Bank of England, for example, produces what it calls a Financial Market Liquidity Index, a global measure of stress that gauges how far a basket of nine indicators strays from its historical mean. The index gets updated twice a year; this week's bulletin, which recalculates the level up to Oct. 17, showed liquidity at its lowest level in at least 17 years.
The next wave of headlines to scare shoppers out of the mall is likely to come when companies find they can't pay their debts. Credit-rating company Moody's Investors Service predicts that the default rate among sub-investment grade borrowers will surge to 7.9 percent in a year, from 2.8 percent at the end of the second quarter of 2008 and from just 1.3 percent 12 months ago. "With the global credit crisis intensifying and credit spreads widening, it is increasingly likely that corporate default rates will spike sharply in the next 12 months," Kenneth Emery, the director of default research at Moody's, said in a research report published earlier this month.
The Markit iTraxx Crossover index of credit-default swaps on mostly speculative-grade companies traded as high as 920 basis points this week. That level suggests investors and traders are anticipating more than half of the companies in the index will default, based on bondholders recouping 40 percent of their money from companies that fail to keep up their debt payments. At a recovery rate of 20 percent, the implied default level is about 45 percent.
At a salvage percentage of just 10 percent, the index is still suggesting about 40 percent of its members will renege on their commitments. It is hard to see how consumer confidence will recover when companies start going bust. "Worries about defaults are mounting as liquidity is strained," Guy Stear and Claudia Panseri, analysts at Societe Generale SA, wrote in a research note this week. "Earnings expectations still look optimistic, with analysts projecting 2009 earnings for the S&P 500 rising by 19 percent."
There's a great scene in the film version of Annie Proulx's Pulitzer Prize-winning novel "The Shipping News." A grizzled journalist explains to rookie hack Kevin Spacey how dark clouds on the horizon justify the hyperbolic headline "Imminent Storm Threatens Village." "But what if no storm comes?" Spacey asks. The veteran replies with a second-day headline: "Village Spared From Deadly Storm." Unfortunately, the global village we live in is unlikely to survive unscathed.
Gordon Brown gets tough with banks over lending freeze
Gordon Brown and Alistair Darling last night began piling the pressure on British banks to start lending again, telling them to honour the commitments they made as part of the £37 billion bailout. Government directors on the boards of the three banks that the taxpayer has helped to recapitalise will use their influence to ensure that they make lending to British individuals and businesses their top priority, officials disclosed.
The Times understands that Mr Brown regards the current reluctance of the banks to lend, after a period when they have been riskily liberal in handing out loans, to be the greatest threat to recovery from the recession. The Government will insist, as a shareholder in the Royal Bank of Scotland, HBOS and Lloyds TSB, that they carry out their agreements to make ample lending available through mortgages and loans to small companies.
The banks will shortly publish their prospectuses for raising new capital. The Government will underwrite the fundraising. Ministers are saying that while the Government will not exercise control of the day-to-day business of the banks, its directors on the boards will use their influence to see that the agreements are implemented. The calculation appears to be that if the three part-nationalised banks start lending properly again, rivals will follow suit or lose business.
Mr Brown and Mr Darling yesterday welcomed a commitment by the European Investment Bank (EIB) to make £4 billion available to provide finance to companies in the UK. However, they were criticised by MPs on all sides for failing to guarantee that money would be passed on by British banks. Small businesses also gave warning that they may not receive anything near the loans that the Government has promised will come from the EIB. John Wright, chairman of the Federation of Small Businesses, told a meeting that despite the promises from the Government and banks, “the evidence contradicts the good intentions”.
Mr Wright said that small businesses were still finding it hard to borrow and were facing punitive charges despite creation of a forum set up by the Government to help to alleviate the cash problems they face. Philippe Maystadt, president of the EIB, told the same meeting, at Guildhall in London, that UK banks do not take very much of the money that is already available through the not-for-profit European bank. Mr Maystadt said that of the €5.2 billion (£4 billion) that was lent by the EIB to small companies through national banks last year, the UK took only €100 million. He said that only one of the four big high street banks – Barclays – works with the EIB on the loans, along with Alliance & Leicester and Close Brothers.
The Forum of Private Business provided further evidence that banks did not yet seem to be responding to the conditions of the UK Government’s £37 billion bailout, which stipulated that they had to lend to small businesses at the levels they lent at last year. The forum highlighted the plight of one of its members, whose application to increase a mortgage to develop a site was turned down because its bank said that it was not lending for property development at that time.
After talks in Downing Street with Angela Merkel, the German Chancellor, Mr Brown said that it was now up to the banks in Britain to honour their commitments. “Having recapitalised the banks, we must ensure that the money is used to sustain credit lines on normal terms to solvent businesses,” he said. “I urge banks not to change the terms and charges for existing lending to small and medium-sized enterprises.”
Wall Street Bonus Backlash Brewing
Bonuses? For Wall Street? At first I thought it was an early Halloween prank, but no, it's for real: Wall Street firms actually may pay out big bonuses this year. The very people who brought us the global financial crisis are now getting ready to reward themselves for a job well done. Believe me, if I were clever enough to make this up, I'd be writing screenplays in Hollywood.
Forbes.com found that seven big-name investment banks (including extinct Lehman Brothers had racked up $97 billion in compensation expenses this year, only 7% below last year's totals. Their combined revenues are down 27%. As for their earnings and share prices, don't ask. The Associated Press reported that nine financial companies it surveyed--Citigroup, Bank of America, Goldman Sachs, Morgan Stanley, JPMorgan Chase, Merrill Lynch, Bank of New York Mellon, State Street, and Wells Fargo --had compensation-related expenses of $108 billion in the first three quarters of the year. That's 3% higher than in the first nine months of 2007, says the AP.
These nine banks, incidentally, have just accepted capital infusions of $125 billion from the U.S. Treasury courtesy of the Troubled Asset Relief Plan (TARP), the government's messy bailout of the financial system. That's ultimately you and me, of course. In early 2008, Wall Street firms awarded a near-record $33.2 billion in bonuses, weeks before Bear Stearns went under and many firms had already taken tens of billions of dollars in write-downs. Amazingly, when bonuses are paid out early next year, they may total $20 billion or so, a third lower than payments in 2008 but hardly chump change.
Unfortunately, pocket change is about all that shareholders of these firms have left. Lehman Brothers and Bear Stearns were wiped out. Merrill (which has agreed to be acquired by Bank of America) has seen its stock plunge by roughly 80% from its early 2007 high, and Morgan Stanley is off by a similar amount. Even Goldman has lost better than 60% of its value in the past year. Here's my favorite story: while Lehman was going under, someone was shrewd enough to set aside $2.5 billion to pay bonuses to its New York employees. (Barclays, which scooped up Lehman's U.S. broker-dealer network for under $2 billion, has said it is not required to pay out the bonuses.)
Whoever pulled this off managed to keep the money separate from Lehman's bankruptcy filing and hence out of the reach of creditors and bondholders, who were left holding the bag when that venerable firm failed. It's like filling a lifeboat with champagne and caviar just before the Titanic sank beneath the North Atlantic's waves. Now, there are some people on Wall Street who actually defend big bonuses, though none of them is running for office this year. They say that bonuses traditionally make up nearly half of employees' total compensation, which varies from department to department. Brokers, for instance, earn bonuses based on their "production," determined by a combination of revenues brought in, assets managed and trades executed. And, of course, there's the inevitable argument, "If we don't overpay them, our competitors will."
But can anyone tell me one area of the market that's not doing horribly this year? Stocks are having their worst year since 1931. Emerging markets and commodities are tanking. Investment banking is nonexistent. And don't even mention derivatives. So where exactly is the "performance" that's supposed to be rewarded with bonuses? And with financial services companies expected to shed tens of thousands of jobs, where are all these "top performers" expected to go if they don't get their fat bonuses? Is Bear Stearns hiring?
Meanwhile, of course, there's another wrinkle: American taxpayers now have stakes in all these firms, which we got for saving many of them from collapse. So, it's no surprise that politicians are getting involved. U.S. Rep. Henry Waxman, chairman of the House Committee on Oversight and Government Reform, wrote letters to the heads of nine financial firms asking about their compensation plans in light of the bailout. (TARP does have some restrictions on top executive pay.) And New York Attorney General Andrew Cuomo followed suit with letters of his own asking for similar information.
The last thing I want is for Congress or governments to set executive pay. But all across America, workers and managers are losing their jobs, seeing their salaries cut and forgoing bonuses this year. They're scared about the future and furious about the bailout. They will go ballistic at any hint that their hard-earned dollars are helping keep Wall Streeters in Maseratis.
TARP, bonuses, dividends and Waxman’s letter
The bitter political divisions between middle America and Wall Street on display when the House of Representatives first rejected the Emergency Economic Stabilization Act last month look set to be re-opened in even more dramatic form in the remaining months of the year.
Rep Henry Waxman, chairman of the powerful House Committee on Oversight and Government Reform, on Tuesday sent identical letters to the chief executives of nine major banks receiving $125 billion of capital injections under the Troubled Assets Relief Program (TARP) demanding details of total bonus payments for 2006, 2007 and 2008. The issue of bonuses and dividend payouts from banks that accepted the TARP injection looks set to become highly charged.
It is going to be hard for the banks and Treasury to explain why so much taxpayer funding needs to go in through the front door, only for it to flow out again as staff bonuses and dividend payments to ordinary shareholders. Bonus and dividend payments could quickly absorb all the TARP capital funding. The issue of responsibility for the credit crisis will intensify during the quarterly dividend and annual bonus payout period in Dec-Feb, just when a new administration will be taking office and Democrats are likely to extend their control over both houses of Congress.
The equation between bonus and dividend payments on the one hand and capitalization and TARP funding is a false one. But it will stoke fury in middle America about the cost of bailing out banks while homeowners continue to be foreclosed. By heightening the political temperature at a key time, it will make a more radical solution to the crisis more likely. For example, buying off political hostility to the continued bonus and dividend payments will almost certainly force Congress and the incoming administration to consider widespread restructuring, loan guarantees and other financial support to homeowners and troubled companies (eg GM) which in turn will intensify the upward pressure on the budget deficit.
The toxic cocktail of TARP, compensation and dividends will complicate budget planning and makes it almost certain there will be significant slippage on the federal government’s budget deficit. Even before the crisis struck, the Congressional Budget Office (CBO) and White House Office of Management and Budget (OMB) were projecting deficits of around $450 billion in 2009.
TARP will add at least another $250 billion to the deficit — because CBO has already reportedly decided capital injections into banks will be counted as 100 pct spending (and 100% revenue when they are finally cashed in) rather than just counting the subsidy element of the credits and estimates of likely losses (which is what would have happened if the TARP had been utilized only to buy troubled assets, as the Treasury originally proposed).
OMB is likely to take a similar view. There is already speculation the Treasury could use TARP funds to help smooth a merger between General Motors and Chrysler. The more of TARP is used for equity injections rather than troubled asset purchases, the higher the deficit will be. In addition, the worsening downturn may well cut income tax and corporation tax revenues, while boosting expenditure on unemployment insurance and aid to families with dependent children in the form of food stamps.
This is before Congress considers tax cuts, homeowner bailouts or extra spending to stem the tide of foreclosures and stimulate the economy. Using conservative estimates, the budget deficit for fiscal 2009 could easily hit a record $900 billion — $450 billion originally projected plus $250 billion of TARP equity capitalization plus $100 billion in underlying deterioration from the automatic stabilizers of lower tax receipts and higher welfare spending plus $100 billion of stimulus from extra tax cuts and spending.
The US government will therefore need to borrow about $900 billion to finance new deficits as well as around $2.3 trillion to roll over existing debt maturing within the next twelve months. The cocktail of TARP, compensation, dividends and record debt issuance promises to be very bitter indeed.
Japan's desperate $260 billion bid to kick-start economy
Japan is to give emergency cash hand-outs to every household in the country regardless of whether they are rich or poor as a part of $260bn (£159bn) blitz to kick-start the world's second-largest economy and prevent a slide back into deflation.
The raft of measures comes amid reports in the Japanese press that the Bank of Japan is mulling a cut in interest rates from 0.5pc to 0.25pc as soon as today, chiefly aimed at curbing any further rise in the yen exchange rate after its spectacular increase since the summer. The futures markets are pricing in a 50pc chance of a cut. "A harsh storm seen only once in 100 years is raging," said Japan's premier Taro Aso as he unveiled the spending plans in Tokyo.
The package includes payments of $600 for a typical family of four, as well as tax relief on mortgages, in the raft of measures worth $50bn, or roughly 1.2pc of Japan's GDP. It is the second fiscal package in two months. The government is extending a further $210bn in loan guarantees targeted at small and medium-sized firms struggling to rasie money or roll over debts as the credit crisis bites deeper.
The talk of combined fiscal and monetary stimulus helped lift Tokyo's Nikkei stock index above 9,000, ending its seemingly unstoppable slide. The bourse is still trading at levels first reached in 1983 – a warning to the rest of the world of what can happen to equities once a country succumbs to debt deflation. Japan held rates at zero for nearly six years in its decade-long struggle against deflation. When that was not enough it resorted to "quantitative easing", a technical term for what amounts to printing money on huge scale.
The Bank of Japan had hoped to nudge the country to normal rates over time but the violence of the global credit crisis has now brought the fragile recovery to a standstill. The economy began to contract in the second quarter. The trade ministry said industrial output is likely to fall 2.3pc in October, and 2.2pc in November. Leading exporters Toyota, Honda, Sony and Canon have all slashed earnings forecasts, while the electronics companies Hitachi and Toshiba both reported a loss over the last three months.
"We think that Japanese rates will be cut all the way to zero again, most likely in January," said Mark Williams from Capital Economics. "We expect a return to deflation next year in the wake of the collapse in global commodity prices." Japan remains the world's top creditor nation by far with a $15 trillion pool of savings and some $3 trillion in net overseas investments. The ups and down in Japanese sentiment can have a powerful effect on world markets.
A mixed army of life insurers, pension funds, and housewives with margin trading accounts, as well as foreign hedge funds, borrowed at near zero rates during the credit bubble to chase higher yields across the world, pushing up asset prices from Australia to South Africa, Brazil and Britain. This yen carry trade – estimated at $1.4 trillion in all its forms – has now reversed violently as flight from global markets leads to yen repatriation. This has forced up the currency by almost 40pc against the euro and sterling since August, and by almost 50pc against the Australian dollar
Those playing the carry trade with high leverage have been caught in a brutal squeeze as margin calls force investors to liquidate assets. This in turn has pushed the yen even higher, setting off a vicious circle. The yen has fallen back this week as US rate cuts and swap agreements with emerging market economies help restore a degree of global confidence, but few in Japan are yet convinced the coast is clear.
Michael Taylor, from Lombard Street Research, said Japan had enough leeway to "turn on the fiscal tap" after pursuing a tight budgetary policy in recent years, but doubted whether the latest spending package will achieve much over time. "Japan is clearly in recession so this will help," he said. "But you need continual, increasing doses to keep things going, otherwise its just a one-shot gain."
'Panic' Strikes Eastern Europe as Banks Cut Foreign Currency Loans
Imre Apostagi says the hospital upgrade he's overseeing has stalled because his employer in Budapest can't get a foreign-currency loan. The company borrows in foreign currencies to avoid domestic interest rates as much as double those linked to dollars, euros and Swiss francs. Now banks are curtailing the loans as investors pull money out of eastern Europe's developing markets and local currencies plunge.
"There's no money out there," said Apostagi, a project manager who asked that the medical-equipment seller he works for not be identified to avoid alarming international backers. "We won't collapse, but everything's slowing to a crawl. The whole world is scared and everyone's going a bit mad." Foreign-denominated loans helped fuel eastern European economies including Poland, Romania and Ukraine, funding home purchases and entrepreneurship after the region emerged from communism. The elimination of such lending is magnifying the global credit crunch and threatening to stall the expansion of some of Europe's fastest-growing economies.
"What has been a factor of strength in recent years has now become a social weakness," said Tom Fallon, emerging-markets head in Paris at La Francaise des Placements, which manages $11 billion. Since the end of August, the forint has fallen 16 percent against the Swiss franc, the currency of choice for Hungarian homebuyers, and more than 8 percent versus the euro. Foreign- currency loans make up 62 percent of all household debt in the country, up from 33 percent three years ago.
Romania's leu dropped more than 14 percent against the dollar and 3.2 percent against the euro. Poland's zloty declined more than 17 percent against the dollar and 6.8 percent versus the euro, and Ukraine's hryvnia plunged 22 percent to the dollar and 11.5 percent to the euro. That's even after a boost this week from an International Monetary Fund emergency loan program for emerging markets and the U.S. Federal Reserve's decision to pump as much as $120 billion into Brazil, Mexico, South Korea and Singapore. The Fed said yesterday that it aims to "mitigate the spread of difficulties in obtaining U.S. dollar funding."
Plunging domestic currencies mean higher monthly payments for businesses and households repaying foreign-denominated loans, forcing them to scale back spending. In Kiev, Ukraine, Yuriy Voloshyn, who works at a real-estate company, says he's forgoing a new television because of his dollar-based mortgage. His monthly payments have risen by 18 percent, or 1,000 hryvnias ($167), since he took out the loan seven months ago. "I only have money to pay for food and my monthly fee to the bank," Voloshyn, 25, said. "I can't even dream about anything else." Rafal Mrowka, a driver from Ostrow Wielkopolski in western Poland, says he became addicted to checking foreign-currency rates as monthly installments on his Swiss-franc mortgage jumped 25 percent. "I've even stopped getting nervous, now I can only laugh," the 32-year-old, first-time property owner said.
The bulk of eastern Europe's credit boom was denominated in foreign currencies because they provided for cheaper financing.
Before the current financial turmoil, Romanian banks typically charged 7 percent interest on a euro loan, compared with about 9.5 percent for those in leu. Romanians had about $36 billion of foreign-currency loans at the end of September, almost triple the figure two years earlier. In Hungary, rates on Swiss franc loans were about half the forint rates. Consumers borrowed five times as much in foreign currencies as in forint in the three months through June.
Now banks including Munich-based Bayerische Landesbank and Austria's Raiffeisen International Bank Holding AG are curbing foreign-currency loans in Hungary. In Poland, where 80 percent of mortgages are denominated in Swiss francs, Bank Millennium SA, Getin Bank SA and PKO Bank Polski SA have either boosted fees or stopped lending in the currency. The extra burden on borrowers is making a bad economic outlook worse, said Matthias Siller, who focuses on emerging markets at Baring Asset Management in London, where he manages about $4 billion.
If borrowers believe local interest rates are prohibitive and foreign currency lending dries up, it means "a sharp deceleration in consumer spending," Siller said. "That will bring serious problems for the economy." The east has been the fastest-growing part of Europe, with Romania's economy expanding 9.3 percent in the year through June, Ukraine 6.5 percent and Poland 5.8 percent. The combined economy of the countries sharing the euro grew 1.4 percent in the period. Governments are seeking to ease the pain as recession concerns sweep across eastern Europe's emerging markets. Ukraine, facing financial meltdown as the hryvnia drops and prices for exports such as steel tumble, on Oct. 26 agreed to a $16.5 billion loan from the IMF.
Hungary on Oct. 28 secured $26 billion in loans from the IMF, the EU and the World Bank. The government forecast a 1 percent economic contraction next year, the first since 1993. The Hungarian central bank raised its benchmark interest rate by 3 percentage points to 11.5 percent on Oct. 22 to defend the forint. nThe same day, Prime Minister Ferenc Gyurcsany said the government was seeking an accord with banks to "prevent the burdens of debtors from reaching the sky." It's considering granting borrowers extended payment periods or the ability to convert foreign-exchange debts into forint. "Panicked customers are calling to say they're afraid the interest on their mortgages will go up or that they won't be able to secure mortgages," said Nikolett Gurubi, director of lending at Otthon Centrum Belvaros, the downtown Budapest branch of a real estate agency.
Project manager Apostagi, 58, said he hopes the crisis will be over in a few months, blaming U.S. banks for creating such distrust between lenders. For now, "it looks like our signed contracts were for naught," he said. Romanian central bank Governor Mugur Isarescu sounded the alarm in June, saying the growth of foreign-currency loans was "excessively high and risky," especially because Romanians with their communist past aren't used to the discipline of debt. "It's not that we're bad," Isarescu said. "It's that, culturally, we need to prepare for the moment of repayment."
At the other end of the spectrum, Turkish consumers have proved more cautious after living through their own currency crises in 2001 and 1994. The government, the IMF's biggest customer in recent years, is resisting new loans from the fund, arguing that its economy can weather the credit crunch and a 22 percent slump in the lira since the start of September. Turkish savings in foreign currencies exceeded loans by about 30 percent as of the end of 2007, according to a January Fitch report. In Poland foreign exchange loans were double deposits, and in Hungary they were triple. Mert Sevinc borrowed the equivalent of $100,000 in Turkish liras to buy an Istanbul apartment in 2006, paying an annual rate of 13.5 percent. The marketing consultant didn't even look at the foreign exchange loans at less than half that price. "Of course it would have been cheaper to borrow in dollars or euros, but it's a fairly basic principle of finance: Things that are cheaper are riskier," he said. That reasoning may soon be part of the eastern European psyche too.
"We've been observing a return to a good old banking rule to lend in a currency in which people earn," said Jan Krzysztof Bielecki, chief executive officer of Poland's biggest lender, Bank Pekao SA. It stopped non-zloty lending in 2003. "Earlier, banks competed on the Swiss franc market watching only sales levels and not looking at keeping an acceptable risk level." The problem is a "good lesson to all of us," Polish President Lech Kaczynski said at an Oct. 24 press conference in Warsaw, where he urged Poles to stick to zloty lending.
British house prices fall by more than average annual pay
House prices have fallen in the past 12 months by more than the average Briton earns in a year, new figures show. The average home is now valued at £27,000 less than in October last year, while the national average salary is about £25,000. House prices fell by 1.4 per cent in October, pushing the annual decline to 14.6 per cent, figures from Nationwide show. This is the biggest annual fall since comparable records began in 1991 and the number of home sales looks likely to fall to the lowest level since 1974.
An average home is now worth £158,872, down from £186,044 in October last year when the market peaked, Nationwide said. The pain for homeowners is unlikely to be over as economists forecast that prices could fall by as much as 35 per cent from the peak, which would cut the value of an average property by £65,000. The fall in prices has thrown nearly half a million homeowners into negative equity but there are fears that nearly two million more households will suffer the same fate.
The mortgage drought caused by the financial crisis has dragged down prices as buyers struggle to secure a home loan. Mortgage lenders are demanding hefty deposits from all new borrowers, preventing many would-be buyers from getting on the property ladder. Sellers are being forced to reduce their prices to attract the attention of the dwindling number of buyers. Fionnula Earley, chief economist at Nationwide, said: “Consumers still expect house prices to continue to fall into 2009 and will, therefore, be reluctant to trade without some discount on the asking price.”
The number of first-time buyers has fallen by 55 per cent in the past year, recent figures show, and Ms Earley said that unless there were a sharp increase in activity, the number of transactions this year would descend to a 34-year low. Economists warned homeowners against pinning their hopes on expected interest rate cuts to refuel the property market. Ed Stansfield, of the consultancy Capital Economics, said that there would be no recovery in prices even if rates fell to as low as 1 per cent. “With unemployment rising and expectations that house prices have much further to fall still widespread, lower interest rates will not stimulate housing demand.”
As homeowners grapple with the twin blows of tumbling house prices and rising household expenses, there is mounting evidence that increasing numbers are finding it difficult to make ends meet. People are now less likely to buy items such as furniture or expensive electrical goods than at any time since 1982, figures from the market researchers Gfk NOP show, and more people are running into difficulties with mortgage repayments. The number of repossessions rose by more than 70 per cent between April and June compared with the same period last year, figures from the Financial Services Authority showed this week.
Gulf Citizens Beg for Bailout as Stock Rout Signals End of Boom
Abdullah Hajeri led a march on the Emir's palace in Kuwait this week, demanding the oil-rich nation's ruler stop stocks from plunging. Adnan Mohammed Saleh, down the Persian Gulf coast in Dubai, said he wants more government protection from the global financial crisis. "Every day the market is crashing," said Saleh, a 42-year- old trader, staring dumbfounded last Tuesday as company names scrolled across the Dubai Stock Exchange's outdoor ticker in red.
The region's rulers are under pressure from citizens to shore up investors, not just banks, as they try to fend off what may be the worst economic crisis since December 1998, when oil at $10.35 a barrel forced them to slash spending. Crude prices have fallen 50 percent from a record $147.27 in July, and stock indexes in Dubai and Saudi Arabia are down by as much this year. Gulf economies are more susceptible to financial turmoil than in the past because of their greater dependency on international expertise, investment and tourists to diversify away from oil. While Dubai, home to the world's tallest building and the man-made Palm Island, is considered most at risk, no part of the Persian Gulf will go untouched.
"There is no way you can say that any trouble in Dubai is going to be isolated," Georges Makhoul, Morgan Stanley's president for the Middle East and North Africa, said in an interview in London. "The biggest threat is going to be local confidence in the local economy, whether it's in Dubai or Abu Dhabi or anywhere else." There aren't many international investors left in the region, he added. Regional competition to attract investors and tourists from around the world led to a surge in record-breaking projects.
Dubai is racing against Saudi billionaire Prince Alwaleed bin Talal's investment company to build the world's first kilometer-tall tower. Saudi Arabia has turned a spot on its Red Sea coast into the biggest property development in the Middle East. Now little more than sand and construction cranes, the $120 billion King Abdullah Economic City is meant to create 1 million jobs and be home to 2 million residents. Projects risk going unfinished or becoming white elephants if economies around the world go into recession, keeping international investors and tourists closer to home. Dubai's plans, including the Disneyland-style "Dubailand" that will be three times the size of Manhattan, are predicated on doubling the number of tourists annually to reach 15 million visitors by 2015. "Many of the projects being marketed in the Gulf today will get shelved," Kamel Lazaar, chairman of Riyadh-based financial advisory firm Swicorp, said Oct. 7. "The price of land has been inflated. It will have to correct."
Kuwait on Wednesday became the third Gulf state to prop up its banking system. It did so after losses on currency derivatives at Gulf Bank KSC, the country's second-largest lender by assets, sparked a surge in customer withdrawals from the bank. The United Arab Emirates said Oct. 12 it would guarantee deposits of all local lenders and large foreign banks. It also set up a $19 billion facility to help banks make loans. Saudi Arabia, the world's largest oil exporter, put $2.7 billion into a government-run bank in Riyadh to provide no-fee loans to low- income citizens. "We are going to be impacted, but we are better suited than anyone else to deal with the problems," Hareb Al-Darmaki, executive director of the Abu Dhabi Investment Authority, said Oct. 28 at a London conference for companies from the United Arab Emirates' richest member. "We have the ammunition."
The emirate has almost 8 percent of the world's oil reserves and a sovereign wealth fund with assets between $250 billion and $875 billion, according to a range of estimates compiled by the International Monetary Fund. Even with its decline, oil still averages $110 a barrel for the year. Residents of the region are used to government intervention. All Gulf countries are run by unelected rulers who maintain political power through tribal allegiances and marriages. Generous state welfare programs have traditionally damped demands for more political participation. How the region's rulers cope with the turmoil may define relations with their people in the future, as they try to wean their subjects off state handouts and encourage them to find jobs and embrace market capitalism.
"There's no question that it sets back the move from socialist, paternalistic societies toward more modern capitalist states," said Gabriel Stein, a director at London's Lombard Street Research, which provides economic analysis to investors and companies. "It is a trend that we have seen all over the world. The immediate reaction is that you told us to do this, so now things are going wrong it's up to you to help us out." On Oct. 27, Hajeri, an independent equity trader, and 20 peers marched from the Kuwait Stock Exchange's trading floor to the emir's office to demand that the government close the exchange. Rebuffed, Hajeri said it meant "destruction to the market and the Kuwait people."
All capital markets in the Gulf Cooperation Council, which includes Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates, have declined and interest rates have increased since Lehman Brothers Holdings Inc. sought bankruptcy protection on Sept. 15. Foreign investors were net sellers of more than 5 billion dirhams ($1.4 billion) of shares on the Dubai Stock Exchange since the beginning of August, more than 1 percent of its current market value, according to bourse data. "The U.S. financial crisis has ramifications for all countries, including the Gulf," U.S. Deputy Secretary of Treasury Robert Kimmitt said this week during a speech in Dubai, where he met representatives of sovereign wealth funds. "Our capital markets are more integrated than ever before, allowing opportunities, but also financial difficulties, to spread rapidly across borders."
Of the Gulf states, Dubai may be hardest hit by a global economic slowdown because it has borrowed more to finance its transformation from a Persian Gulf trading post to a financial and tourist hub, and has only 4 billion barrels of oil reserves.
Government-controlled companies owe at least $47 billion, more than Dubai's gross domestic product, and they will continue to accumulate debt faster than the economy grows, Moody's Investors Service estimated in an Oct. 13 report. It concluded that Dubai may need financing help from Abu Dhabi.
Dubai-based Emaar Properties PJSC has shed more than 26 percent since Sept. 15 as investors lost confidence in the ability of the Middle East's biggest publicly traded real-estate developer to finance projects by borrowing through local and international banks. Dubai property prices will likely remain unchanged through 2010 after quadrupling in the past five years, Colliers CRE Plc said Oct. 5.
"There is a liquidity and credit crunch and now oil prices have fallen from $140 to $70," said Nouriel Roubini, a professor at New York University. "I see the risk of a real-estate bust throughout the Gulf, but specifically in Dubai, and there's a huge amount of excess capacity being built."
That's not keeping investors from betting on pain across the region. The cost of protecting debt from default has jumped more than fivefold since July for Abu Dhabi and Dubai, according to trading in credit default swaps. The cost of insuring Saudi Arabian government debt has risen 51 percent since Sept. 18. The price of oil may determine whether governments can maintain government spending and support economic growth. "If prices drop by $15 a barrel from the $60 to $70 mark, then they will probably not break even in terms of their budgets," said John Sfakianakis, chief economist at Saudi British Bank in Riyadh.
Wall Street Banks Owe $40 Billion to Executives
Financial giants getting injections of federal cash owed their executives more than $40 billion for past years' pay and pensions as of the end of 2007, a Wall Street Journal analysis shows. The government is seeking to rein in executive pay at banks getting federal money, and a leading congressman and a state official have demanded that some of them make clear how much they intend to pay in bonuses this year.
But overlooked in these efforts is the total size of debts that financial firms receiving taxpayer assistance previously incurred to their executives, which at some firms exceed what they owe in pensions to their entire work forces. The sums are mostly for special executive pensions and deferred compensation, including bonuses, for prior years. Because the liabilities include stock, they are subject to market fluctuation. Given the stock-market decline of this year, some may have fallen substantially. Some examples: $11.8 billion at Goldman Sachs Group Inc., $8.5 billion at J.P. Morgan Chase & Co., and $10 billion to $12 billion at Morgan Stanley.
Few firms report the size of these debts to their executives. (Goldman is an exception.) In most cases, the Journal calculated them by extrapolating from figures that the firms do have to disclose. Most firms haven't set aside cash or stock for these IOUs. They are a drag on current earnings and when the executives depart, employers have to pay them out of corporate coffers. The practice of incurring corporate IOUs for executives' pensions and past pay is perfectly legal and is common in big business, not limited to financial firms. But liabilities grew especially high in the financial industry, with its tradition of lavish pay.
Deferring compensation appeals both to employers, which save cash in the near term, and to executives, who delay taxes and see their deferred-pay accounts grow, sometimes aided by matching contributions. In some cases, firms give top executives high guaranteed returns on these accounts. The liabilities are an essentially hidden obligation. Even when the debts to their executives total in the billions, most companies lump them into "other liabilities"; only a few then identify amounts attributable to deferred pay. The Journal was able to approximate companies' IOUs, in some cases, by looking at an amount they report as deferred tax assets for "deferred compensation" or "employee benefits and compensation." This figure shows how much a company expects to reap in tax benefits when it ultimately pays the executives what it owes them.
J.P. Morgan, for instance, reported a $3.4 billion deferred tax asset for employee benefits in 2007. Assuming a 40% combined federal and state tax rate -- and backing out obligations for retiree health and other items -- implies the bank owed about $8.2 billion to its own executives. A person familiar with the matter confirmed the estimate. Applying the same technique to Citigroup Inc. yields roughly a $5 billion IOU, primarily for restricted stock of executives and eligible employees. Someone familiar with the matter confirmed the estimate.
The Treasury is infusing $25 billion apiece into J.P. Morgan and Citigroup as it seeks to get credit flowing. In return, the federal government is getting preferred stock in the banks and warrants to buy common shares. The Treasury is injecting $125 billion into nine big banks and making a like amount available for other banks that apply.
It's imposing some restrictions on how they pay top executives in the future, such as curtailing new "golden parachutes" and barring a tax deduction for any one person's pay above $500,000. But the rules won't affect what the banks already owe their executives or make these opaque debts more transparent. Asked about the Journal's calculation, the Treasury said, "Every bank that accepts money through the Capital Purchase Program must first agree to the compensation restrictions passed by Congress just last month -- and every bank that is receiving money has done so." Bear Stearns Cos., the first financial firm the U.S. backstopped, owed its executives $1.7 billion for accrued employee compensation and benefits at the start of the year, according to regulatory filings. When Bear Stearns ran into trouble after investing heavily in risky mortgage-backed securities, the government stepped in, arranging a sale of the firm and taking responsibility for up to $29 billion of its losses.
The buyer, J.P. Morgan, says it will honor the debt to Bear Stearns executives, which it said is shrunken because much of it was in stock that sank in value. J.P. Morgan will also honor deferred-pay accounts at another institution it took over, Washington Mutual Inc. It couldn't be determined how big this IOU is. J.P. Morgan's move will leave the WaMu executives better off than holders of that ailing thrift's debt and preferred stock, who are expected to see little recovery. J.P. Morgan's share of the federal capital injection is $25 billion.
Obligations for executive pay are large for a number of reasons. Even as companies have complained about the cost of retiree benefits, they have been awarding larger pay and pensions to executives. At Goldman, for example, the $11.8 billion obligation primarily for deferred executive compensation dwarfed the liability for its broad-based pension plan for all employees. That was just $399 million, and fully funded with set-aside assets.
The deferred-compensation programs for executives are like 401(k) plans on steroids. They create hypothetical "accounts" into which executives can defer salaries, bonuses and restricted stock awards. For top officers, employers often enhance the deferred pay with matching contributions, and even assign an interest rate at which the hypothetical account grows. Often, it is a generous rate. At Freddie Mac, executives earned 9.25% on their deferred-pay accounts in 2007, regulatory filings show -- a better deal than regular employees of the mortgage buyer could get in a 401(k). Since all this money is tax-deferred, the Treasury, and by extension the U.S. taxpayer, subsidizes the accounts.
In addition, because assets are rarely set aside for executive IOUs, they have a greater impact on firms' earnings than rank-and-file pension plans, which by law must be funded. Bank of America Corp.'s $1.3 billion liability for supplemental executive pensions reduced earnings by $104 million in 2007, filings show. By contrast, the bank's regular pension plan is overfunded, and the surplus helped the plan contribute $32 million to earnings last year. While disclosing its liability for executive pensions, the bank doesn't disclose its IOU executives' deferred compensation, and it couldn't be calculated. The bank's share of the federal capital injection is $25 billion. Bank of America has agreed to acquire Merrill Lynch & Co. Merrill is a rare example of a firm that has set aside assets for its deferred-pay obligation: $2.2 billion, matching the liability. Morgan Stanley also says its liability for executives' deferred pay is largely funded.
To be sure, deferred-compensation accounts can shrink. Those of lower-level executives usually track a mutual fund, and decline if it does. Often the accounts include restricted shares, which also may lose value, especially this year. To the extent financial-firm executives were being paid in restricted stock, many have lost huge amounts of wealth in this year's stock-market plunge. The value of Morgan Stanley Chief Executive John Mack's deferred-compensation account declined by $1.3 million in fiscal 2007, to $19.9 million; much of it was in company shares. Mr. Mack didn't accept a bonus in 2007.
Executives can even lose their deferred pay altogether if their employer ends up in bankruptcy court. When Lehman Brothers Holdings Inc. filed for bankruptcy last month, most executives became unsecured creditors. The government didn't come to Lehman's aid. In assessing liabilities, the Journal examined federal year-end 2007 filings by the first nine banks to get capital injections, plus six other banks and financial firms embroiled in the financial crisis. In many cases, the firms didn't report enough data to estimate their obligations to executives. As for identifying amounts due individual executives, company filings provided a look at only the top few, and not a full picture of what they were owed.
Just as banks aren't the only financial firms getting federal aid amid the crisis, they aren't the only ones facing scrutiny of their compensation programs. Struggling insurer American International Group Inc. agreed to suspend payment of deferred pay for some former top executives pending a review by New York state Attorney General Andrew Cuomo. Mr. Cuomo is also demanding to know this year's bonus plans for the first nine banks getting federal cash, as is House Oversight Committee Chairman Henry Waxman.
Among the payouts AIG agreed not to make are disbursements from a $600 million bonus pool for executives of a unit that ran up huge losses with complex financial products. AIG also is suspending $19 million of deferred compensation for Martin Sullivan, whom AIG ousted as chief executive in June. His successor as CEO, Robert Willumstad, who left when the U.S. stepped in to rescue AIG in September, has said he's forgoing $22 million in severance because he wasn't there long enough to execute his strategy for AIG. However, the giant insurer -- whose total liability for its executives' deferred pay couldn't be calculated -- says most of the managers will receive the compensation. "Of course, we'll be looking at all these to make sure they're consistent with the requirement of the program," said spokesman Nicholas Ashooh.
AIG isn't eligible for the government's capital-injection plan, since it's not a bank, but it's getting plenty of U.S. aid of another sort. The Treasury has made $123 billion of credit available, a little more than two-thirds of which AIG has borrowed so far. Fannie Mae and Freddie Mac also don't get in on the capital-injection plan for banks. But under a federal "conservatorship," the Treasury agreed to provide each with up to $100 billion of capital if needed. In return, the government got preferred shares in the firms and the right to acquire nearly 80% of them. Their regulator, the Federal Housing Finance Agency, says it will bar golden-parachute severance payouts to the mortgage buyers' ousted chief executives. The executives remain eligible for their pensions.
Fannie Mae had a liability of roughly $500 million for executive pensions and deferred compensation at the end of 2007, judging by the size of its deferred tax assets. A spokesman for the firm wouldn't discuss the estimate or whether the executives would get the assets.
At Freddie Mac, most will. "Deferred compensation belongs to the officers who earned it," said Shawn Flaherty, a spokeswoman. Indeed, in September Freddie Mac made its deferred-compensation plan more flexible, allowing executives to receive their money earlier than initially spelled out. "Officers were nervous about market changes," said Ms. Flaherty. "We wanted a retention tool for top talent."
Ilargi: Yes, GM asks for taxpayers’ funds to help employees lose jobs. The new economy.
”... $15 billion in aid to help keep the company going and possibly to make the Chrysler deal work. GM could use some of the money to shut down redundant Chrysler operations.
6 governors ask feds for help for US automakers
The governors of six states have asked the treasury secretary and Federal Reserve chairman to take "immediate action" to help the troubled domestic automakers.
General Motors Corp. and Chrysler LLC are in talks to combine in order to survive, but financing is one of the biggest obstacles.
GM is lobbying the Bush administration and some members of Congress for $10 billion to $15 billion in aid to help keep the company going and possibly to make the Chrysler deal work. GM could use some of the money to shut down redundant Chrysler operations.
In their letter, the governors of Michigan, Delaware, Kentucky, New York, Ohio and South Dakota reminded Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke that the domestic automakers are "particularly challenged" in the down economy and warn that, "as a result, the financial well-being of other major industries and millions of American citizens are at risk."
"The auto industry; their network of suppliers, vendors, dealers and other businesses; and the communities that rely on those businesses face unimaginable challenges — challenges we urge you to help address," the governors wrote. The letter, sent Wednesday, was released Thursday by Democratic Michigan Gov. Jennifer Granholm's office. White House spokeswoman Dana Perino said Thursday that the secretaries of the Treasury, Commerce and Energy departments are talking with the automakers.
"We understand that they've been facing tough times for a while. They've made business decisions that unfortunately have put them in this position. But we also recognize how big the companies are, how many families rely on these companies, and what it would mean for the overall economy," Perino said. Democratic presidential candidate Barack Obama said if he's elected, he wants to meet immediately with the heads of the domestic automakers and the United Auto Workers union to craft a strategy that will make the U.S. industry competitive in the world again. He made the remarks Thursday in an interview on NBC's "Nightly News with Brian Williams."
Some industry analysts have said a GM acquisition of Chrysler could cost up to 35,000 jobs nationally and up to 25,000 in Michigan. A separate analysis released Thursday by Grant Thornton LLP predicted that a GM-Chrysler combination would likely lead to the closure of seven of Chrysler's 14 manufacturing plants, plus the loss of 12,000 factory jobs and 12,000 administrative ones, some of which already have been announced. An additional 50,000 auto supplier jobs could be lost, it added.
Still, it sees GM's acquisition of Chrysler as the least painful option, since "if one or the other company were to fail, we would face a much bigger calamity — the collapse of the North American supply base and the potential endangerment of all three Detroit automakers and businesses that depend on them." Michigan's governor and senior U.S. senator, speaking at separate events Thursday, said job losses from a merger would hurt the area but would be far worse if Chrysler is auctioned off in pieces or allowed to go bankrupt. "I certainly support the efforts of trying to get Secretary Paulson to give some federal loans to General Motors so that they can survive," Granholm said.
Sen. Carl Levin said money from the $700 billion set aside to help the financial and credit crunch could help foster a GM-Chrysler deal. The Democrat told reporters Thursday after a meeting with veterans in Port Huron that the purpose of any federal funding is to help a domestic auto industry that's been battered by the swooning economy. "Even without these merger discussions going on, the industry needs an infusion of capital given this economic downturn," Levin said.
Separately, the National Automobile Dealers Association sent President Bush a letter Wednesday asking him to consider refundable consumer tax credits for car and truck buyers or programs that encourage consumers to upgrade their old cars. GM, Chrysler and Ford Motor Co. are all having cash troubles amid a sales decline and the slowing global economy, but industry analysts consider Chrysler and GM to be in the worst shape.
GM is burning through more than $1 billion per month and is working to cut $10 billion in costs and raise another $5 billion through asset sales and borrowing, but analysts have said the company could reach the minimum cash levels required to operate sometime next year. Chrysler is in such bad shape, analysts say, that it could go into bankruptcy next year if it doesn't take on a partner or isn't acquired by another automaker. The mayor of Warren, Michigan's third-largest city and home to the GM Technical Center, worries what consolidation will mean for Michigan, particularly southeast Michigan.
"If they merge it's bad. If they don't, it could be equally bad," Jim Fouts said, noting that the job losses "could have a catastrophic, devastating, potential tsunami effect upon the whole area. ... It would be like a 10 on the Richter scale if that thing happens." Fouts is among the local officials invited to a Friday morning meeting with state economic development officials to continue discussions on what the possible combination of two of the three domestic automakers, all headquartered in Michigan, would have on the state.
"We've already had discussions with county officials, education officials, those involved in economic development and work force development," Granholm spokeswoman Liz Boyd said Thursday. "This is all part of that effort to make sure everyone is at the table." Additional tax breaks for the automakers may be among the options discussed. Warren gets $8 million a year in property taxes from GM and $4 million from Chrysler because the GM Tech Center, a GM powertrain factory and a Chrysler plant that makes the Dodge Ram pickup truck are within its boundaries. Combined, that represents around 15 percent of the Warren city budget. Fouts is open to additional concessions.
"If ... we have to give them additional financial inducements, then so be it," he said. Fouts said Michigan Economic Development Corp. officials wanted to meet as soon as possible with local leaders, which led him to conclude that a development may be coming soon. But Boyd said the governor and her administration don't have any indication that a deal is imminent. "We have no more information than we had yesterday ... or the day before," Boyd said. Speaking to reporters Thursday morning, Granholm mentioned the letter but spoke mostly about preparing state and local officials to help laid off workers with job training and other assistance.
"The question is, can we, as a state, support a smaller auto industry, but a healthier auto industry. And ultimately, we will. We're going to be all right as a state," the governor said. "But we've got to deal with the fallout from people who have been laid off." The prospect of more lost jobs is bad news for Michigan, which had the nation's highest average annual unemployment rate in 2006 and 2007 and leads the way so far in 2008. The state's September unemployment rate of 8.7 percent was second only to Rhode Island's 8.8 percent.
GM-Chrysler Merger May Cost 74,000 Jobs
A merger of General Motors Corp., the largest U.S. automaker, and Chrysler LLC may cost 74,000 jobs and close half of the smaller company's plants, according to a report from an accounting firm. The combination may eliminate all but seven of Chrysler's car and truck models, Grant Thornton LLP said.
Chrysler, the No. 3 U.S. automaker, would keep the Dodge Ram pickup, minivans and some Jeep models, the report said. GM and Chrysler owner Cerberus Capital Management LP are studying a merger, people familiar with the plans have said. The automakers will probably have a tentative agreement before the Nov. 4 U.S. presidential election, said Kim Rodriguez, who leads Grant Thornton's automotive restructuring group. Still, a tie-up will be impossible without an infusion of cash to bolster the balance sheet of the new company, she said.
"It's probably not the optimal solution, but unfortunately it's the optimal solution given the facts in which we find ourselves," Rodriguez said in a presentation today in Southfield, Michigan. The combined company would have to cut 24,000 Chrysler jobs, split evenly between administrative and manufacturing employees, Rodriguez said. That figure includes the already- announced 25 percent reduction in salaried workers by Chrysler. A study released yesterday by Anderson Economic Group of East Lansing, Michigan, said the merger may cost 25,000 to 35,000 jobs.
Automakers are grappling this year with what may be the worst U.S. market since 1993 as elevated fuel prices sap light- truck sales and the global credit crunch curbs access to loans. Governors from Michigan, Delaware, Kentucky, Ohio, South Dakota and New York sent a letter dated yesterday to Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke urging "immediate action" to help boost liquidity for the U.S. auto industry.
Ford Motor Co. is having an "ongoing dialogue" with U.S. officials and wants to ensure parity should competitors receive aid, Executive Vice President Mark Fields said in an interview today. A GM-Chrysler merger could take on several forms, including a so-called prepackaged bankruptcy by Chrysler where GM agrees to buy certain assets and creditors agree to a preset payout before a filing, Grant Thornton's Rodriguez said.
An additional 50,000 jobs may be lost in the auto-parts industry, which would be buffeted by fewer car models and closed plants. Along with positions in shipping, advertising and other indirect services, job losses could be 100,000 to 200,000, Rodriguez estimated. A "free fall" by Chrysler in which the company runs out of money, enters bankruptcy and stops producing cars would almost destroy the U.S. industry and cause massive supplier failures, she said. While that scenario is unlikely, it would mean "significant" job losses.
"It's a bitter medicine for this area," she said. Michigan had an 8.7 percent unemployment rate in September, compared with 6.1 percent for the U.S. Cerberus's stake in the GMAC LLC finance company may rise to at least 75 percent from 51 percent under a merger, said Lars Luedeman, a co-author of the Grant Thornton report. GM owns 49 percent of GMAC.
Barclays close to sealing a deal with Qatar over big cash injection
Barclays is on the verge of securing a capital injection of at least £6.5 billion from investors including Qatar in what would be a coup for the bank, which has shunned the option of taking cash from the Government. The Qatar Investment Authority (QIA), an existing shareholder has been in negotiations for several weeks with Barclays. The bank also held talks with the Libyan Investment Authority and Russia’s VTB banking group and Sberbank, although sources last night claimed that these had not led to any investment.
Last night, the parties were attempting to complete the deal. If things go according to plan, an annoucement could be made as soon as today, although those involved said that talks may continue into next week. The plan will help Barclays’s chief executive, John Varley, to recapitalise the bank without Government help. Although the exact sum of the injection is not known, it is understood to be enough to meet Barclays’s promise to raise £6.5 billion in fresh capital.
The QIA already has a substantial stake in Barclays after taking part in the bank’s £4.5 billion capital increase earlier this year.
Barclays, along with Royal Bank of Scotland, Lloyds TSB and HBOS, was recently involved in talks with the Government over a multibillion-pound taxpayer bailout. However, while the other three institutions collectively accepted £37 billion of emergency funding in exchange for giving up significant stakes to the Government, Barclays decided to go it alone, announcing plans to raise £6.5 billion from investors to help to shore up its balance sheet.
Barclays also said it would not pay a final dividend for 2008, saving it £2 billion. The bank is also expected to try to raise another £3 billion through a rights issue, which will be announced after it has published its full-year results in February.
Gordon Brown is to visit the UAE, Qatar and Saudi Arabia this weekend and is expected to urge the Gulf states to put more money into the International Monetary Fund (IMF). Barclays is expected to issue a range of complex capital instruments to its new investors. It also may give existing shareholders the opportunity to participate in the fundraising. Barclays has until the end of the year to raise its money or it will be forced to turn to the Government.
In February the QIA, a sovereign wealth fund set up to invest profits from the world’s largest gasfield, said it had $15 billion to spend on overseas financial institutions over the next two years. The £30 billion fund itself is expected to double in size by 2010. In February when QIA took its first stake in Barclays, Mr Varley said: “The participation of players such as these is one of the most positive manifestations of globalisation. It’s highly positive that there are pools of money that can be put to work in this way. That’s very different to the world of five or ten years ago.”
Mortgage Plan May Irk Those It Doesn’t Help
As the Treasury Department prepares a $40 billion program to help delinquent homeowners avoid foreclosure, it confronts a difficult challenge: not making the plan too tempting to people like Todd Lawrence. An airline pilot who lives outside Norwich, Conn., Mr. Lawrence has a traditional 30-year mortgage that he has no trouble paying every month. But, thanks to the plunging real estate market, he owes more on his house than it is worth, like millions of other people.
If the banks, which frequently lent irresponsibly, and many homeowners, who often borrowed irresponsibly, are getting government assistance, Mr. Lawrence says he believes sober souls like himself are also due a break. “Why am I being punished for having bought a house I could afford?” he asked. “I am beginning to think I would have rocks in my head if I keep paying my mortgage.” The plan, still under development by Treasury, is part of the economic rescue package passed by Congress earlier this month. It is aimed at aiding up to three million beleaguered homeowners by reducing their monthly payments.
Washington and Wall Street are frantically seeking to stabilize markets by curtailing the onslaught of foreclosures. There are now at least four major plans to aid homeowners. But experts say it is difficult to design these programs in ways that reduce the indebtedness of the distressed without giving everyone else a reason to mail the keys back to their lenders.
“If the lunch truly is free, the demand for free lunches will be large,” said Paul McCulley, a managing director with the investment firm Pimco.
More than 10 million homeowners are underwater like Mr. Lawrence, and their ranks are swelling. In theory, Mr. McCulley points out, underwater homeowners benefit when a neighbor is bailed out instead of surrendering his house to foreclosure. With a foreclosure, the owner becomes the bank, which will care for the house minimally. When the bank finally manages to unload the house months later, the fire-sale price will establish a new floor for the remaining neighbors. But the benefits of a bailout for his neighbors seem ephemeral to the 45-year-old Mr. Lawrence, especially because he figures the cost of helping them will come, one way or another, out of his pocket as a taxpayer. “I’m basically financing my own financial destruction,” he said.
Government officials say that homeowner bailouts are not a gift. For one thing, they assert, most mortgages will simply be revamped so the monthly payments become affordable for the next few years. Reductions in loan balances, which are drawing the most attention, will generally be a last resort. “This is not about trying to create fairness,” said Michael H. Krimminger, special adviser for policy at the Federal Deposit Insurance Corporation, which is working with Treasury on the latest plan. “The goal is to keep people in their houses.” Still, he acknowledged, “a lot of people are angry because they feel some people are getting something they don’t deserve.”
Going into default, whether as a gambit to get a loan modification or to get rid of a burdensome house payment, carries risks. Under some conditions, lenders have the right to sue a borrower for assets beyond the house itself. Then there is the inevitable blot on the borrower’s credit record. Other factors are intangible: Many owners like their houses and neighborhoods and do not want to leave them. And many people, even as their retirement funds vaporize, consider paying their debts a moral obligation. Against those considerations must be measured the burden of paying a $500,000 mortgage on a property now worth $350,000.
“From a purely economic standpoint, there’s not a whole lot to be gained from staying,” said Rich Toscano, a San Diego financial adviser whose popular blog, Piggington.com, predicted the collapse. Homeowners are not the only ones weighing their options. Real estate investors are also wondering if they will be left behind. “We told our lenders that if you’re writing down 90 percent of your portfolio, we want to be in on it,” said Jason Luker, a principal at Cardinal Group Investments in San Diego. Cardinal owns homes that it rents out. “If all of our neighbors are getting bailed out despite their own bad decisions, arrogance or ignorance, and we’re asked to keep playing by the rules for the sake of the greater good, I don’t want to participate,” Mr. Luker said.
Peter Schiff, the president of Euro Pacific Capital in Darien, Conn., who prophesied doom before it became fashionable, says he thinks just about everyone who is underwater and has few other assets should stop paying. “If the government says, ‘Prove that you can’t afford your house and we’ll redo your mortgage,’ then people are going to try to qualify,” Mr. Schiff said. In that situation, those who will benefit the most are the ones who, unlike Mr. Lawrence, spent far beyond their means — who refinanced their houses and used the cash to buy toys and lavish vacations, or sometimes just to pay the bills. “You put something down, you have something to lose,” Mr. Schiff said. “You put nothing down, you’ve got nothing to lose.”
Though hard numbers are scarce, estimates are that foreclosures will surpass one million this year. Losses on home loans are piling up faster than banks can deal with them. First Federal Bank of California said this week that as of June 30 it owned 380 foreclosed houses. It managed to sell 329 of them during the third quarter but acquired another 450. This sense of rapidly losing ground underlies the urgency behind the Treasury’s new plan, which is being developed even as various homeowner bailouts that were announced earlier are just getting under way.
A White House spokeswoman, Dana M. Perino, said on Thursday that the plan was not “imminent” and that several different proposals were being considered. “If we find one that we think strikes the right notes and could meet all of those standards that we want to protect taxpayers, make sure that it’s also fair and that it would actually have an impact, then we would move forward and we would announce it,” Ms. Perino said. The Federal Housing Administration began Hope for Homeowners on Oct. 1, aimed at making as many as 400,000 mortgages affordable. Under the program, lenders will refinance loans to 90 percent of a house’s current value, automatically giving the owner 10 percent equity.
The loans will be insured by the government, which will take a share of any gain when the house is sold. If a sale occurs in the first year, the government takes it all. The second year, it takes 90 percent; and so on down a sliding scale. After five years, it takes half the gain. To guard against fraud, an F.H.A. spokesman said, borrowers will have to certify they did not “intentionally” default. The Hope Now Alliance, an initiative by a range of lenders, trade groups and counseling agencies, says it has aided 2.3 million borrowers in the last year. Nearly half of Hope Now’s most recent workouts involved modifications of the original loan, including reducing the principal or the interest rate.
Countrywide Financial says it will help 400,000 of its customers through the Nationwide Homeownership Retention Program, slated to begin in December. Countrywide, an aggressive lender during the boom, is now a division of Bank of America. The $8.4 billion program arose out of a legal settlement, but a Countrywide spokesman, Rick Simon, said the lender now realized that it was cheaper to keep owners in their homes than to let them go into foreclosure. But not every owner. The program, aimed at those spending more than a third of their household income on a mortgage, property taxes and insurance, is limited to borrowers with subprime and pay-option adjustable-rate mortgages — the worst of the many exotic loan types that proliferated during the boom.
“Confusion or misrepresentation went into the marketing of these loans,” Mr. Simon said. By contrast, a buyer with a standard 30-year mortgage “probably understood the terms.” Countrywide says it will write down pay-option mortgages to as low as 95 percent of the current value of the home. The borrowers must either be in default or “reasonably likely” to default. “I guess they are forcing me to deliberately stop paying to look worse than I am,” said one borrower with a Countrywide pay-option loan. “Crazy, don’t you think?”
The borrower, who lives in suburban Los Angeles, took nearly $200,000 in cash out of his house and then paid less than the monthly interest due on his new loan. He now owes about $350,000 on a house that is worth only $150,000. He asked not to be identified for fear he would not get a modification, which could reduce his mortgage to $142,500.
White House Said to Want Limit on Loan-Guarantee Plan
The White House and Treasury Secretary Henry Paulson want to scale back a proposal by Federal Deposit Insurance Corp. Chairman Sheila Bair to guarantee mortgages to help stem foreclosures, according to two congressional aides briefed on the matter. The Bush administration is reluctant to sign off on the plan because of its cost, the two people indicated. Bair's idea to provide guarantees for modified loans could take as much as $50 billion from the $700 billion bailout package approved by Congress this month.
The tussle comes as Democrats intensify pressure on the administration to help more Americans keep their homes instead of focusing on a rescue for Wall Street firms. Senate Banking Committee Chairman Christopher Dodd today sent a letter to President George W. Bush urging him to have the Treasury create the program and let the FDIC design and implement it. The Treasury Department must use its authority under the financial-rescue law "to act decisively, aggressively and swiftly to reduce foreclosures," Dodd wrote in the letter also signed by Democrats on his committee.
"Given the FDIC's demonstrated commitment to the goal of foreclosure prevention, and its proven track record in achieving results, the FDIC is clearly the federal agency best suited to implementing this program quickly and efficiently," they wrote. House Financial Services Committee Chairman Barney Frank and Representative Maxine Waters, a California Democrat who serves on Frank's panel, urged Bush in an Oct. 20 letter to have Bair lead a "government-wide effort" to stem foreclosures.
"There's pressure to do something from everyone for homeowners," said Dean Baker, co-director of the Center for Economic and Policy Research in Washington. The FDIC plan is "the only thing on the table." Administration officials are concerned the program, intended to help as many as 3 million homeowners through $500 billion of mortgage guarantees, would give a windfall to banks that made bad loans. The White House is leading negotiations among the federal agencies, including the Department of Housing and Urban Development, and nothing has been completed, the people said.
"The administration, including the White House offices, HUD and Treasury, has been looking at ways to reduce foreclosures, and that process is ongoing," said Jennifer Zuccarelli, a Treasury spokeswoman in Washington.
Bair, a bank regulator who has pressed the mortgage industry to modify loans to reduce foreclosures, unveiled the idea during a Senate Banking Committee hearing last week. "Loan guarantees could be used as an incentive for servicers to modify loans," she said at the Oct. 23 hearing. "The FDIC is working closely and creatively with Treasury to realize the potential benefits of this authority."
The Treasury, which is overseeing the $700 billion bailout package, has focused on buying stakes in banks and setting up auctions for devalued securities. Bair told Congress the legislation gave the government authority to set mortgage modification standards and offer guarantees for loans that meet those standards. Dodd, a Connecticut Democrat, said at the hearing that he understood Paulson to be supporting the idea after speaking with him about it. "I'm understanding there's some details to be worked on, but I certainly was left with the impression that Treasury likes this idea, would like to get it going," Dodd said Oct. 23. Neel Kashkari, who was designated to run the Treasury's bailout office, told Dodd the department is "looking very hard" at the proposal.
The FDIC is already modifying mortgages held by IndyMac Federal Bank FSB, the successor to the failed lender that is being managed by the agency, to serve as an industry model. The modifications have cut borrowers' average monthly payments by more than $380, Bair said. Lawmakers are pressing for more action to forestall foreclosures days before U.S. presidential and congressional elections. Foreclosures rose to the highest on record in the third quarter, led by California, Arizona, Michigan and several pivotal states in the presidential contest -- Florida, Ohio and Nevada, according to data compiled by RealtyTrac.
Bair's proposal would require banks, savings and loans, hedge funds and other mortgage holders to restructure mortgages based on a borrower's ability to repay, according to people familiar with the matter. Under one option, the industry would reduce monthly payments on troubled loans for five years, they said. The government's partial guarantees for the loans would put taxpayers on the hook for potential losses if a homeowner defaulted.
Fed’s Yellen Says Benchmark Rate May Be Cut Close to Zero
Federal Reserve Bank of San Francisco President Janet Yellen said the central bank may cut the benchmark interest rate close to zero percent from the current 1 percent level should the economy remain weak. "We would do it because we are concerned about weakness in the economy," Yellen said today after a speech, responding to an audience question about the impact on the economy should the Fed reduce the main rate to as low as zero. "I think we could, potentially, go a little bit lower than" 1 percent, she said in Berkeley, California.
Recent data on the U.S. economy is "deeply worrisome" and the government should consider new ways to help homeowners and stem foreclosures, Yellen said in the speech. The central bank cut the benchmark interest rate yesterday for the sixth time this year, seeking to avert what may be the worst recession in a quarter century. U.S. consumer confidence fell this month to a record low and the government reported today that the economy shrank at a 0.3 percent annual pace in the third quarter for its biggest decline since 2001.
"Clearly, we have a long way to go before the credit crunch shows significant healing," she said. "We are in the grip of an adverse feedback loop," in which tighter credit conditions are exacerbating economic weakness. In the current quarter, "it appears likely that the economy is contracting significantly" and "inflation risks have diminished greatly," she said.
Yellen is the first Fed official to speak since the decision by the central bank to reduce the main rate by half a percentage point to 1 percent, matching a half-century low. Fed Chairman Ben S. Bernanke is set to speak, via satellite, to the same group tomorrow. "The reason to lower rates, and to lower them promptly and aggressively, as I think the Fed has done, is to get ahead of the curve" and support the economy "against the kind of weakness that Japan has experienced for over a decade," she said in response to an audience question.
The Conference Board's confidence index decreased in October to 38, the lowest reading since monthly records began in 1967, the New York-based research group said two days ago. "The effects of the growing credit crunch have outpaced the easing of policy, and, indeed, every major sector in the economy has been adversely affected by it," Yellen said. Home prices in 20 U.S. cities fell 16.6 percent in August from a year earlier, and have dropped every month since January 2007, the S&P/Case-Shiller home-price index also showed this week.
"Unfortunately, this is another case where the bottom is not yet in sight," Yellen said of home prices, adding that "direct assistance to homeowners and the housing market are worthy of serious consideration." With the dollar appreciating against other currencies, "exports will not provide as much of an impetus to growth as they did earlier in the year," the bank president said. Yellen, who has been the San Francisco Fed's president since June 2004, is a former Fed governor and ex-chairman of President Bill Clinton's Council of Economic Advisers. She votes on rates again next year.
Crisis Hammers Pensions
A trade group whose members include Lockheed Martin Corp., Dow Chemical Co. and General Motors Corp. is pressing Congress to help close a record $200 billion deficit in U.S. pensions created by this month's global stock-market collapse. The Committee on Investment of Employee Benefit Assets is kicking off a lobbying effort today to delay provisions of the Pension Protection Act that it says will force companies to drain cash flow to comply with funding rules set to take effect next year.
"This will be real money that companies will have to come up with," said Judy Schub, managing director of the Bethesda, Maryland-based group, which represents 110 of the nation's largest retirement plans holding almost half of U.S. assets. "The law will be forcing people to be taking money out of operations at the worst possible time." Aetna Inc., the third-largest U.S. health insurer, said today that pension expenses caused by stock market declines will lop 30 cents to 40 cents a share off next year's operating earnings.
Ryder System Inc.'s pension contributions will "significantly increase in 2009" and force "cost management" to protect profit, Chief Executive Officer Gregory Swienton told a conference call Oct. 22. The Miami-based, truck-leasing company's plan had $1.5 billion in assets in 2007 and was underfunded by $1 million, according to Standard & Poor's Corp.
Pension obligations at Lockheed, the world's biggest defense contractor, would also deplete cash and hurt earnings, Chief Financial Officer Bruce Tanner said last week. Lockheed, Bethesda, Maryland-based maker of F-22 Raptor stealth fighter jets, said on Oct. 21 that 2009 profit will be shaved by about 30 cents a share as it records a $60 million expense next year, compared with the projected $125 million gain on its pension this year.
Even companies that aren't necessarily anticipating an impact on earnings are suggesting better uses for the cash. "While we support the Pension Protection Act and improved funding for corporate pension plans, we are very concerned about the immediate impact to the overall economy if massive cash contributions are required due to the recent stock market declines," FedEx Corp. CFO Alan B. Graf Jr. said yesterday. "In the current liquidity crisis, that money would be better used to support immediate working capital needs, make capital investments and protect American jobs."
The value of so-called defined benefit plans fell to $1.1 trillion by Oct. 24 from $1.3 trillion at the end of September, according to Mercer, a pension consulting unit of Marsh & McLennan Cos., as the Standard & Poor's 500 index declined 36 percent this year. The $200 billion gap between U.S. retirement plan assets and liabilities indicates that pensions are about 85 percent funded, said Adrian Hartshorn, who advises corporate programs at New York-based Mercer.
The Pension Protection Act of 2006 compels companies to cover 94 percent of retirement-plan liabilities to be considered fully funded in 2009. The legislation was passed after funding dropped following the technology sector collapse in 2001. Plans covered 104 percent of obligations and posted a $60 billion surplus at the end of 2007, Mercer said. Companies must cut benefits if assets fall below 80 percent of liabilities and eliminate lump-sum payments below 60 percent, according to the law. At that level, companies must also freeze their plans and prevent participation by new hires.
The law "was unnecessarily conservative in its funding requirements and unnecessarily punitive in cases where companies make an unwise decision relative to plan funding," said North Dakota Representative Earl Pomeroy, a member of the House Ways and Means Committee, which will hold hearings on pensions and economic-recovery plans today. "Any stimulus package needs to address the pension issue," said Pomeroy, a Democrat and sponsor of legislation that would delay the pension act's "draconian" funding provisions. "The squeeze on cash may not happen tomorrow, but I can assure Congress that if it fails to act, this will be upon us before we know it."
The first deadline most companies will need to meet is Dec. 31, when they will have to calculate their funding ratio and develop budgets for contributions beginning in the second half of 2009. "Companies will be facing quite significant cash calls in 2009 and 2010 and more than a few will find it difficult to meet these," Hartshorn said. The impact of rising pension expense is making companies cut spending in areas including dividends, said Howard Silverblatt, an S&P analyst in New York. Dividends will fall 10 percent this quarter the worst year-over-year decline since 1958, he said. "The cash-flow hit is killer," Silverblatt said. "You look in your pocket and there is a hole all the way through to your socks."
Next year's pension costs will be determined by 2008 returns on plan assets and interest rate assumptions that won't be made until year-end, according to federal rules. "Like every other defined-benefit plan, we'll have suffered losses in line with what the markets have done, and we'll have to see what happens," Burlington Northern Santa Fe Corp. CFO Thomas Hund said in an Oct. 23 call. "We were fairly well funded, although not fully funded, prior to the disruption this year," said the second-biggest U.S. railroad's CFO. "And so, there will be funding required if the assets don't return back to previous levels." The Dec. 31 deadline to set next year's plan contributions gives Congress, which returns from recess Nov. 17, less than six weeks to resolve the issue.
Congress should push off the 94 percent funding requirement and compel the Treasury Department to redefine how companies deal with market volatility as they calculate assets and liabilities, according to the Committee on Investment of Employee Benefit Assets. The American Benefits Council, another pension-plan trade group, asked for similar action last month. Canadian companies are lobbying that country's federal Finance Department for temporary relief from their pension-fund obligations, including an extension of the time allowed to make up shortfalls, the Globe and Mail reported today. About 59 percent of the 100 largest U.S. pension plans will fall short of the required 2009 funding level, even if stocks pared their decline to 13 percent, Pomeroy said.
Wall Street ‘made rod for own back’
Wall Street unwittingly created one of the catalysts for the collapse of Bear Stearns, Lehman Brothers and American International Group by backing new bankruptcy rules that were aimed at insulating banks from the failure of a big client, lawyers and bankers say. The 2005 changes made clear that certain derivatives and financial transactions were exempt from provisions in the bankruptcy code that freeze a failed company’s assets until a court decides how to apportion them among creditors.
The new rules were intended to insulate financial companies from the collapse of a large counterparty, such as a hedge fund, by making it easier for them to unwind trades and retrieve collateral. However, experts say the new rules might have accelerated the demise of Bear, Lehman and AIG by removing legal obstacles for banks and hedge funds that wanted to close positions and demand extra collateral from the three companies.“The changes were introduced to promote the orderly unwinding of transactions but they ended up speeding up the bankruptcy process,” said William Goldman, a partner at DLA Piper, the law firm. “They wanted to protect the likes of Lehman and Bear Stearns from the domino effect that would have ensued had a counterparty gone under. They never thought the ones to go under would have been Lehman and Bear.”
The Securities Industry and Financial Markets Association, the trade body that lobbied for the changes, rejected the criticism, saying the 2005 rules “enhance legal certainty for contracts, [and] reduce legal risk ... and systemic risk”. The International Swaps and Derivatives Association added that the 2005 clarifications “provided legal certainty by clarifying existing federal policy”. The changes in the code expanded the scope and definition of financial transactions not covered by bankruptcy rules to include credit default swaps and mortgage repurchase agreements – products used widely by Lehman, Bear and AIG. Lawyers said under the old rules, creditors of companies facing financial difficulties were wary of settling trades or seeking extra collateral because they knew such demands could precipitate a bankruptcy filing and potentially freeze their claims.
However, when the financial health of Bear, Lehman and AIG took a sharp turn for the worse this year, their trading counterparties – mainly hedge funds and other banks – were not deterred from seeking to settle their trades or forcing the three companies to put up more collateral. Such pressure exacerbated the liquidity squeeze that ultimately forced the three companies to hoist the white flag. Bear was sold to JPMorgan in a cut-price deal in March, while Lehman filed for bankruptcy last month and AIG was rescued by a $120bn government loan.
Lawyers said the 2005 exemptions also could apply to non-financial companies, potentially complicating the bankruptcy process of any company that uses derivatives. Stephen Lubben, professor at Seton Hall University School of Law, said: “These provisions affect a non-financial firm, such as a car company or an airline, because they also engage in derivatives trading.”
The Fed as lender of first and only resort
The Federal Reserve has unveiled a dizzying array of new lending and liquidity support facilities over the last six weeks, but the diminishing law of marginal returns already looks to have set in. Each new lending and liquidity facility announced by the Fed is providing a smaller boost to confidence than the last.
The market is increasingly focused on how the Treasury and the Fed will fund the ever-expanding array of facilities, and the huge overhang of very short-term paper that needs to be rolled over into longer-term securities in a market that already looks queasy about the forthcoming flood of notes. Rather than multiplying the number of acronymned facilities further, restoring confidence now rests on solving two issues.
First, the market needs to see buyers for all this new Treasury paper that will have to be issued in the coming year. The government is under pressure to line up support from overseas central banks and other institutional investors to continue supporting the market by absorbing a large share of the new issuance that will be required. A much higher share may need to be in the form of Treasury Inflation Protected Securities (TIPS) to reassure buyers the government will not seek to inflate its way out of the problem. Additional commitments on exchange-rate stability may also need to be given, at least implicity, to solicit strong foreign participation.
Second, the market needs to see that the financial crisis can be contained by a stabilisation of home values, corporate cash flows and default rates. Until collateral values and default rates stabilise, the steady flow of losses will continue to eat into even the banking system’s supplemented capital base. The Federal Reserve System’s balance sheet has almost doubled since the start of Sep 2008, as the central bank has created or expanded a dizzying array of new lending facilities providing around $750 billion more support to the commercial banking system.
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The Fed is now providing extra credits through the Term Auction Facility ($263 billion); increased primary credits from the discount window ($106 billion); equivalent credits to other primary dealers and broker-dealers ($111 billion); liquidity support to money market mutual funds ($114 billion); and a variety of other uncategorised credit extensions including swap lines ($87 billion); as well as support for JPMorgan’s acquisition of Bear Stearns ($29 billion); and enhanced repo activity ($41 billion). The Fed has run down its portfolio of Treasury securities as a result of lending operations, swapping them for other less liquid mortgage-backed securities, and has lent out about half of those which remain to securities dealers to provide temporary liquidity.
Some of these extra credits have simply remained on deposit or flowed back into the Fed as member banks increased their reserve balances with the central bank. Excess reserves held with the central bank above the minimum required for operational purposes have risen by around $289 billion in the past twelve months. But the rest of the Fed’s balance sheet expansion has been funded from the proceeds of a massive US Treasury borrowing programme deposited into a special new account at the central bank. The Treasury has borrowed $876 billion since the end of Aug (net of refunding). In the first instance, most of the funding has been raised through the sale of an unprecedented volume of short-term cash management bills in Sep ($320 billion) and Oct ($520 billion).
Only a small proportion has so far been funded through the issue of bills, notes and bonds in the regular series to the public, leaving a massive overhang of debt that will need to be funded at longer maturities in the coming months. As a result of this huge borrowing programme, the US Treasury now has a staggering $715 billion of cold hard cash and near-equivalents on deposit in various accounts:
(1) Some $559 billion is on deposit in the Treasury’s new “special supplementary financing programs” account at the Fed to back increased Fed lending and credit facilities to the banking system.
(2) Another $137 billion is being held in the Treasury’s regular account at the Fed. Presumably this money will eventually be allocated to another account. In the meantime it is a general deposit against which the Fed can lend.
(3) The Treasury also has $20 billion in its Treasury Tax and Loan (TTL) accounts with commercial banks and had as much as $80 billion in recent days.
The TTL accounts are a holding facility used for surplus Treasury funds which are left with commercial banks for short but fixed maturities to earn commercial rates of interest. Normally, the Treasury tries to keep balances on both its regular account and the TTL loans to a minimum. Surpluses are withdrawn to finance spending and reduce borrowing. But in the current climate, the Treasury has no difficulty borrowing overnight. In fact, it is the only borrower able to do so effectively. So the Treasury is maximising its short term borrowing and depositing the money with the Fed and the commercial banks, in effect doing the borrowing they cannot do for themselves.
The higher than usual balance in the Treasury’s regular Fed account is a form of quiet supplementary support for the central bank. The higher than usual balances in the TTL facility are a quiet form of support for the banking system. The problem with all this borrowing is that it is now taking the Treasury perilously close to the statutory debt limit, which was only raised by Congress in July and then again in Oct, as part of the Emergency Economic Stabilisation Act. The statutory debt ceiling currently stands at $11.315 trillion. The Treasury has already borrowed $876 billion since the end of Aug. Total debt outstanding is now $10.457 trillion, just $858 billion below the revised ceiling.
But the Troubled Assets Recovery Programme (TARP) will require as much as $700 billion worth of borrowing. It is not clear from the Treasury and Fed accounts whether some of the borrowing already done and the money already deposited into the various accounts is to support the TARP in future. But it looks like those funds are already fully committed backing existing facilities — meaning the Treasury still has to borrow most or all of the TARP funding.
With just $858 billion of unused borrowing authority, and as much as $700 billion of that committed to TARP, the Treasury has just $158 billion of uncommitted borrowing authority left. A substantial rise in the debt limit is now both inevitable and urgent. The administration looks set to recall Congress for a special lame-duck session after the Nov elections to approve a further rise in the limit as part of a broader package of financial reform measures and help for homeowners and corporate borrowers designed to stem the rising tide of bankruptcies.
America must lead a rescue of emerging economies
By George Soros
The global financial system as it is currently constituted is characterised by a pernicious asymmetry. The financial authorities of the developed countries are in charge and they will do whatever it takes to prevent the system from collapsing. They are, however, less concerned with the fate of countries at the periphery. As a result, the system provides less stability and protection for those countries than for the countries at the centre. This asymmetry - which is enshrined in the veto rights the US enjoys in the International Monetary Fund, explains why the US has been able to run up an ever-increasing current account deficit over the past quarter of a century. The so-called Washington consensus imposed strict market discipline on other countries but the US was exempt from it.
The emerging market crisis of 1997 devastated the periphery such as Indonesia, Brazil, Korea and Russia but left America unscathed. Subsequently, many peripheral countries followed sound macroeconomic policies, once again attracting large capital inflows, and in recent years have enjoyed fast economic growth. Then came the financial crisis, which originated in the US. Until recently peripheral countries such as Brazil remained largely un-affected; indeed, they benefited from the commodity boom. But after the bankruptcy of Lehman Brothers, the financial system suffered a temporary cardiac arrest and the authorities in the US and Europe resorted to desperate measures to resuscitate it. In effect, they resolved that no other big financial institution would be allowed to default and also they guaranteed depositors against losses. This had un-intended adverse consequences for the peripheral countries and the authorities have been caught unawares.
In recent days there has been a general flight for safety from the periphery back to the centre. Currencies have dropped against the dollar and the yen, some precipitously. Interest rates and credit default premiums have soared and stock markets crashed. Margin calls have proliferated and spread to stock markets in the US and Europe, raising the spectre of renewed panic. The IMF is discussing a new credit facility for countries at the periphery, in contrast to the conditional credit lines that were never used because the conditions attached to them were too onerous. The new facility would carry no conditions and no stigma for countries following sound macroeconomic policies. In addition, the IMF stands ready to extend conditional credit to countries that are less well qualified. Iceland and Ukraine have already signed and Hungary is next.
The approach is right but it will be too little, too late. The maximum that could be drawn under this facility would be five times a country's quota. In the case of Brazil, for example, this would amount to $15bn, a pittance when compared with Brazil's own foreign currency reserves of more than $200bn. A much larger and more flex-ible package is needed to reassure markets. The central banks at the centre should open large swap lines with the central banks of qualifying countries at the periphery and countries with large foreign currency reserves, notably China, Japan, Abu Dhabi and Saudi Arabia, ought to put up a supplemental fund that could be dispersed more flexibly.
There is also an urgent need for short-term and longer-term credit to enable countries with sound fiscal positions to engage in Keynesian counter-cyclical policies. Only by stimulating domestic demand can the spectre of a world-wide depression be removed. Unfortunately the authorities are always lagging behind events; that is why the financial crisis is spinning out of control. Already it has enveloped the Gulf countries, and Saudi Arabia and Abu Dhabi may be too concerned with their own region to contribute to a global fund. It is time to start thinking about creating special drawing rights or some other form of international reserves on a large scale, but that is subject to American veto.
President George W. Bush has convened a G20 summit for November 15 but there is not much point in holding such a meeting unless the US is serious about supporting a global rescue effort. The US must show the way in protecting the peripheral countries against a storm that has originated in the US, if it does not want to forfeit its claim to the leadership position. Even if Mr Bush does not share this point of view, it is to be hoped the next president will - but by then the damage will be much greater.