Child of migratory packinghouse workers. Belle Glade, Florida.
Ilargi: You can safely leave it to governments to make a bad situation a whole lot worse. While that is not surprising, what is unfolding now is of an alarming magnitude.
Everybody has only one answer to the problems they are confronted with. When a lot of money disappears, they throw a lot of money around, expecting that this will somehow solve something. It’s like they are all living in a two-dimensional world. And that is starting to be extremely costly to all of us.
Throwing money at the mayhem does not help in any way, it merely postpones the body blow. This kind of time buying becomes more expensive by the minute. It may be hard to keep track of the hundreds of billions of dollars presently being coughed up, but make no mistake: a lot more disappears than is magically created.
Obviously, everybody is familiar with the saying "throwing good money after bad money", but hardly a soul seems to understand what it means. And that will lead to much deeper and far more dire levels of poverty looming in tomorrow’s world.
There is only one correct answer to what we face here, and instead of choosing that utterly simple path, everyone tries to run away from it. It makes no difference in the end, the gravity that lies beyond the event horizon will be unrelenting.
I am still hopeful that soon at least one country’s government will be bold enough to start down that path. One nation needs to be the first to demand a rigorous emptying of all its vaults, pull out all the paper inside, hold it up against the light and provide an open and public fair assessment of the real value.
As long as that doesn’t happen, we will not just keep swirling down the drain, we will do so at a rapidly increasing speed, all the while losing more and more of our constitutional rights to powergrabbers shouting Mayday.
The losses in the markets today are hard to oversee, but they are running in the -many- trillions. Trading was suspended in Brazil, Iceland, Russia. I would not in the least be surprised if we will start to see bank holidays declared in the immediate future.
A neverending number of smart-asses plead for bail-outs and rescues, in every corner of the planet. But none of them will improve matters one inch if all of the global casino’s toilet paper is not thoroughly and completely flushed out and down. If any one issue is worth of petitions and calls on politicians, it’s that. Instead of throwing good money in the black and blue holes, throw in the toxic paper.
Debt servitude is one thing, being enslaved on account of someone else’s debt is quite another.
Dow Industrial Average Falls Below 10,000
U.S. stocks dropped, driving the Dow Jones Industrial Average below 10,000 for the first time in four years, after bank bailouts in Europe widened and commodities companies tumbled on concern global growth is slowing.
Equities fell worldwide, with trading in Russia and Brazil halted. Goldman Sachs Group Inc., Morgan Stanley and Bank of America Corp. lost more than 6.3 percent after the German government led a bailout of Hypo Real Estate Holding AG and BNP Paribas SA bought Fortis's Belgium bank. ConocoPhillips slid 7.3 percent as oil traded below $90 a barrel, sending the Standard & Poor's 500 Energy Index to a 21-month low.
The S&P 500 lost 63.37 points, or 5.8 percent, to 1,035.86 at 10:48 a.m. in New York, the lowest since December 2003. The Dow Jones Industrial Average retreated 510.7, or 5 percent, to 9,814.68. The Chicago Board Options Exchange Volatility Index surged as much as 25 percent to 55.86, the highest in its 18-year history.
"It's a financial panic, total dislocation in the financial industry across the board," said Ralph Shive, chief investment officer at 1st Source Corp. Investment Advisors in South Bend, Indiana, which manages $3 billion. "It's blown up in our face." The S&P 500 tumbled 9.4 percent last week, the steepest slump since the September 2001 terrorist attacks, as concern the U.S. is headed for a recession overshadowed passage of a $700 billion bank bailout.
Stocks briefly pared their decline after the Federal Reserve doubled its emergency auctions of loans to commercial banks to as much as $900 billion. The central bank also will begin paying interest on bank deposits under authority it gained from financial-rescue legislation enacted last week. About 480 million shares had changed hands on the New York Stock Exchanges as of 10:47 a.m. in New York, compared with about 334 million at the same time a week ago.
Should the Dow average lose 1,100 points before 2 p.m., the New York Stock Exchange would halt trading for an hour. If it happened between 2 and 2:30 p.m., trading would be suspended for 30 minutes. After 2:30 p.m., there would be no halt.
Money-market interest rates remained elevated as lenders hoarded cash on speculation more financial institutions may collapse after governments in Europe and the U.S. intervened to salvage six in the past two weeks.
The difference between what banks and the Treasury pay to borrow money for three months widened to 3.89 percentage points, the biggest since Bloomberg began compiling the data in 1984. David Bianco, UBS AG's chief equity strategist, cut his 12- month forecast for the S&P 500 by 9.1 percent to 1,500 and abandoned his year-end target, citing deeper-than-expected recessions in the U.S. and Europe.
U.S. gross domestic product will drop the next two quarters, with unemployment reaching 8 percent by the end of 2009, Goldman Sachs wrote in a research note Oct. 3. Financial futures are pricing in 100 percent odds the Federal Reserve will cut the target rate for overnight loans between banks by at least 0.50 percentage point by Oct. 29. Goldman Sachs lost 9.6 percent to $115.78. Morgan Stanley sank 15 percent to $20.41. Bank of America declined 6.5 percent to $32.25. The S&P 500 Financials Index fell 6 percent.
National City Corp. decreased 29 percent to $2.47. Ohio's biggest bank had its long-term issuer default rating cut by Fitch Ratings. Energy companies fell the most among 10 industries in the S&P 500, losing 9.3 percent as a group. ConocoPhillips, the second-biggest U.S. refiner, slipped 9.4 percent to $59.91. Exxon Mobil, the largest energy company, fell 2.4 percent to $76.08. Crude oil sank below $90 a barrel in New York for the first time since February as the deepening credit crisis added to concern that slowing global economic growth will reduce demand for fuels.
The euro had its biggest one-day drop against the yen since its 1999 debut and the dollar plunged as the deepening credit crisis prompted European governments to pledge bailouts for troubled banks while stopping short of coordinated action.
Denmark and Germany said they will guarantee all their countries' bank deposits. French President Nicolas Sarkozy and Italian Prime Minister Silvio Berlusconi have made verbal pledges to do the same. Fortis was driven to the brink of collapse after pouring 24.2 billion euros ($32.9 billion) into the acquisition of ABN Amro Holding NV assets last year just as the U.S. subprime-mortgage market collapsed and credit markets froze.
Iceland halts trading in six major financial institutions
Iceland suspended trading the shares of six major financial institutions today as ministers worked on a plan to help them survive the global financial meltdown.
The stock exchange said that it had decided to temporarily suspend trading in the big three Icelandic banks — Kaupthing, Landsbanki and Glitnir — plus three other institutions — Exista, Straumur and SPRON — to protect equality between investors while waiting for a government announcement on its plans. Bjorgvin Sigurdsson, Business Affairs Minister, said today that a rescue plan was "well on its way" after the country’s banks agreed to sell some of their foreign assets. Mr Sigurdsson, Commerce and Banking Minister, said it was impossible to give further information.
All the major credit ratings agencies moved today to downgrade Iceland’s four big banks and its sovereign credit rating. Fitch cut Iceland's long-term foreign-currency IDR rating by two notches to A-, while Standard & Poor's cut Iceland's long-term foreign currency sovereign credit rating to A- from A and Moody's put its Aa1 rating on review. The Icelandic currency droped 30 per cent against the euro.
The Government has asked pension funds to repatriate cash to bring home desperately needed foreign currency. Iceland’s Government had said this morning that it will not offer an economic package to protect the country’s banks. Prime Minister Geir Haarde said that the Government decided no special action was necessary after being locked in meetings for most of the weekend.
Icelandic state radio reported over the weekend that the country’s association of pension funds had agreed to transfer 200 billion Icelandic kronur (£1 billion) to the state. He said that Iceland’s banks would sell some of their overseas assets, which will increase speculation that groups such as Baugur, which owns several British high street chains and is backed by Icelandic banks, may be forced to sell some of their stakes.
The country’s banking problems led to the nationalisation last week of Glitnir, one of its largest lenders, as depositors pulled their funds. Problems for the Icelandic banking system sparked concerns about the implications for the British high street, with Iceland’s banks providing the backing for groups including Baugur, which owns Hamleys and House of Fraser. However, Baugur has emphasised that it is unaffected by the present situation, and House of Fraser says that it is unaffected by the economic turmoil in Iceland.
Iceland’s banks have been under pressure for most of the year, struggling with rampant inflation, the collapsing value of the currency and the general fallout from an overheated economy. In an attempt to curb inflation, the country’s central bank raised interest rates to 15.5 per cent, making it even more difficult for the banks to fund themselves. The banks expanded rapidly after the deregulation of domestic financial market in the 1990s and now have combined foreign liabilities in excess of $100 billion, dwarfing the country’s gross domestic product of $14 billion.
Further speculation over the health of the country’s banking system will heighten concerns about Iceland’s other two big banks, Kaupthing and Landsbanki. The chief executive of Kaupthing, Iceland’s biggest bank, has tried to allay fears, claiming that there was no need for the Government to rescue it. Speaking on state television, Hreidar Mar Sigurdsson said that he had held discussions with Mr Haarde on how the bank could participate in the rescue package.
Europe Races to Shore Up Banks as Crisis Spreads
Germany issued a blanket guarantee of all its consumer bank deposits on Sunday, as a group of European countries adopted emergency measures to shore up the Continent's financial system against the widening international credit crisis.
On Monday, several other European governments moved to try and stem the crisis, with Denmark and Sweden bolstering protection of bank accounts and Iceland drafting a plan to deal with the situation. Austria also said it will lift the guarantee on private deposits, although the government hasn't yet decided how high the new limit will be.
In Copenhagen, the Economy Ministry said commercial lenders had agreed to contribute up to 35 billion kroner ($6.4 billion) over two years to a fund that will help insure account holders from losses. In neighboring Sweden, the government said it would raise the limit for deposit insurance to 500,000 kronor ($71,000) from 250,000 kronor. The Icelandic stock exchange, meanwhile, halted trading in shares in six major financial institutions while crisis talks among lawmakers, financial regulators, bank executives and union leaders continued.
Both Spanish Prime Minister Jose Luis Rodriguez Zapatero and French President Nicolas Sarkozy will meet separately Monday with the heads of their country's top banks to discuss the unfolding global financial crisis. Meanwhile, U.K. Prime Minister Gordon Brown will ask German Chancellor Angela Merkel in a telephone conversation to clarify her government's pledge to guarantee personal bank accounts in Germany, British government spokesman Michael Ellam said.
In the U.S., the Federal Reserve has taken aggressive actions in recent weeks to try to alleviate the severe pressures weighing on damaged short-term funding markets. New measures from the central bank are likely in the days ahead. It is not yet clear exactly what steps the Fed will take, but it could be aimed at commercial-paper markets, which have been damaged by skittishness among money-market funds, a big investor in this asset class.
In tandem with its surprise move to protect deposits, the government of Germany, Europe's largest economy, arranged a bailout for Hypo Real Estate Holding AG, a giant property lender that came close to collapsing after private lenders pulled out of an earlier €35 billion ($48.2 billion) aid plan last week.
Also Sunday, the governments of Belgium and Luxembourg arranged a deal under which French lender BNP Paribas SA will take over the Belgian and Luxembourg operations of Fortis NV for roughly €15 billion in cash and stock. The deal for the Dutch-Belgian-Luxembourg insurance-and-banking giant came after a previous rescue plan last week failed to prevent an exodus of customers, and the Netherlands nationalized the Dutch wing of the company.
In Italy, meanwhile, the board of banking giant UniCredit announced that it would launch a €3 billion emergency capital increase. Sunday's meeting was a surprise; just days earlier, UniCredit's chief executive had gone on national television to say that the bank was solid. But executives decided to call the meeting after the bank's stock was pummeled last week, as investors fretted about the credibility of the bank's reassurances and persistent worries over its cash levels. At one point UniCredit's stock reached a 10-year low before rebounding.
The patchwork of measures on Sunday all came less than 24 hours after the leaders of Europe's four largest countries pledged after a meeting in Paris to protect their financial system. "We are taking a solemn commitment to back banking and financial institutions," French President Nicolas Sarkozy said at a news conference after Saturday's summit.
The crisis in Europe now has broadened from the implosion of U.S. mortgage-related assets to a mounting unwillingness among European banks to lend to one another and a growing loss of confidence among investors and in some cases depositors. Adding to the predicament, governments from Ireland to Germany are trying to reassure their increasingly anxious voters.
Other European banks could face similar funding strains to those of Fortis and Hypo, requiring public or private financial aid, as investors avoid making the kind of short-term loans that banks depend on for funding. In a sign that banks' borrowing costs are rising, the euro London interbank offered rate, or Libor, a measure of the rates at which banks lend to one another, hit 5.33% Friday, compared with 4.95% on Sept. 1.
The recent frantic and disparate moves raise questions about whether European governments, regulators and bankers have a comprehensive approach to addressing the deepening financial crisis. Some of Europe's largest economies are already flirting with recession.
"It's been a shocking reality check for everyone, and the specter of a vicious downward spiral of financial conditions and economic growth has now taken a very definite and concrete shape in everyone's mind," UniCredit global chief economist Marco Annunziata told clients in a note. Mr. Annunziata's note wasn't directly referring to UniCredit's situation. Ms. Merkel insisted that the banking system as a whole remained healthy and that problems were confined to individual cases such as Hypo. "We won't allow the distress of one financial institution to become the distress of the whole system," she said.
Though European governments have tried to seem united in their quest for solutions to the credit crunch, divisions are rife. Last week, Ireland was criticized by several European Union governments when it decided to unilaterally guarantee all deposits held in the country's six largest financial institutions. The British Bankers Association called Ireland's moves anticompetitive, and the Central Bank and Financial Services Authority of Ireland said it has seen an increase in deposit inflows since the measures were passed last week.
Yet, so far, proposals for unified rules for coping with the crisis -- such as a multibillion-euro banking bailout fund like the U.S.'s $700 billion plan -- have been abandoned for fear they would be impossible to govern. To fight the lack of bank funding, banks at some point could ask the European Central Bank to take on a role as clearing bank. The ECB would then operate as a middleman, matching deposit-rich institutions with banks that need to borrow.
The ECB, along with other central banks around the world, has been injecting funds into the financial system, but banks have remained unwilling to lend to each other beyond periods of a few days. As a result, the leaders of France, Germany, the U.K. and Italy didn't discuss concrete actions at Saturday's meeting, but instead agreed on a set of principles. Among them: keeping each other informed of measures to bail out banks, including slapping sanctions on the chiefs of failed banks.
They also said they would consider ways to amend international accounting standards and lobby for a softening of European rules that ban state aid and monopolies, according to a statement released after the summit. The leaders also said EU budget rules regarding the deficit and debt limits allowed for members of the euro common currency could be loosened.
As the crisis spreads, some observers are also beginning to ask whether European regulators have been tough enough in assessing both banks' exposure to souring assets and weaknesses in banks' ability to avoid liquidity shortfalls. Investor confidence in the ability of bank chiefs to correctly predict troubles is also waning.
Questions about UniCredit's need to raise capital, for example, first surfaced earlier this spring and then again last week, when the bank repeatedly denied them. And German officials were angered to discover during the weekend that Hypo had greater financial needs than they were told a week ago.
Ms. Merkel said Sunday that bankers at Hypo who had made irresponsible decisions would face consequences. The latest Hypo rescue package was a second emergency loan of €15 billion by German banks and insurers, on top of the €35 billion loan facility for the bank that was agreed a week ago by German lenders and the government.
The deposit guarantee is aimed purely at shoring up public confidence rather than Hypo, which isn't a retail bank. Ms. Merkel's spokesman Ulrich Wilhelm said the unlimited consumer-deposit guarantee meant the government would step in if Germany's existing deposit-insurance plans couldn't fully compensate savers.
German banks already guarantee 90% of customer deposits up to €20,000, and a voluntary fund protects sums above that. But Lehman Brothers Holdings Inc.'s failure means those funds are already largely depleted, German officials say. German banks had to cover deposits at Lehman's German operations.
Hypo was on the verge of collapse because its Ireland-based unit Depfa Bank PLC can't refinance its debts. Its original package fell apart after banks participating in its bailout saw an analysis by Deutsche Bank AG that found that Hypo needed far more money than previously thought, according to people familiar with the analysis. Deutsche Bank said Hypo needed €50 billion in funds this year and possibly further tens of billions next year, these people said. A Deutsche Bank spokesman
Hypo spokesman Hans Obermeier said the bank's estimate last week -- that it needed €15 billion in the short term and another €20 billion until next year -- was correct at the time. But, he said, "suggestions that Hypo Real Estate needed to be wound down caused additional uncertainty in already jittery markets, making it even more difficult for Depfa to get liquidity."
BNP late Sunday agreed to a rescue deal for Fortis, the Dutch-Belgian bank that just a year ago took part in the biggest bank deal yet, the $101 billion acquisition of ABN Amro Holding NV. Fortis has operations in more than 50 countries and about 85,000 employees. It thought ABN would transform it from a midtier institution into one of Europe's largest private banking operations. Instead, the acquisition strained its finances, leading to its current need for a bailout.
As part of a complicated deal, Belgium, which had agreed to buy 49% of Fortis's banking unit in the country as part of the earlier bailout plan, said it also will buy the rest. It will then sell 75% of that unit to BNP for €8.25 billion of new BNP shares. The French bank will also buy Fortis's Belgian insurance operations. A portfolio of €10.4 billion of Fortis's structured products will also be created. Minority stakes in that will be held by Belgium and BNP. Fortis will continue to hold 66% of that portfolio and Fortis's international insurance operations.
This is the second weekend in a row that the governments have discussed rescuing Fortis, which ran into trouble earlier this year after the ABN acquisition stretched its finances just as the credit crisis hit. It marks a return for BNP which, along with other potential buyer ING Groep NV, walked away last weekend from a potential deal for Fortis, prompting government intervention. Late Friday, the Netherlands stepped in again to nationalize Fortis's operations in the Netherlands.
After its emergency meeting, UniCredit said it was cutting its 2008 earnings per share target to 39 European cents, before the €3 billion capital increase, from the previous 52 cents. The bank said the total amount of its capital strengthening measures was €6.6 billion. Also included is the placement of a €3 billion core Tier 1 convertible bond that has mostly already been sold to a group of institutional investors and some core shareholders of the bank.
The overall aim is to strengthen the bank's capital ratios to 6.7% at the end of 2008 from previous 6.2% under so-called Basel II international capital requirements. "Finally, management addressed the key problem which is capital," said Marcello Zanardo, a banking analyst with Keefe, Bruyette & Woods Ltd. "This should have been addressed earlier, and it comes at the expense of management credibility."
Germany guarantees all private bank accounts
Germany announced Sunday that it would guarantee all private bank accounts, joining Ireland and Greece in taking drastic independent action to ward off financial crisis in Europe's biggest economy. Finance Ministry spokesman Torsten Albig said the unlimited guarantee covered some euro568 billion ($785 billion) in savings and checking accounts as well as time deposits, or CDs.
The announcement came as business leaders and lawmakers met in the capital for feverish talks to keep an embattled real-estate giant afloat. Hypo Real Estate AG had been banking on a euro35 billion ($48.42 billion) bailout package financed by the government and private banks, but the deal fell apart on Saturday evening. Chancellor Angela Merkel vowed that she would not let the failure of any company disrupt the German economy.
"We will not allow the distress of one financial institution to distress the entire system," she told reporters while talks between government and business leaders continued in the capital. "For that reason, we are working hard to secure Hypo Real Estate."
Merkel said the plan would ensure that anyone who made reckless market decisions would be made to answer for their actions. "The federal government will make sure of that," she said. "That is our debt to the taxpayers."
The talks at the Finance Ministry came a day after the rescue plan for the blue-chip company approved by the European Union on Thursday unraveled at the seams after German private lenders withdrew their support. Under the terms of the original bailout, a consortium of German banks was to provide a line of liquidity worth some euro10 billion ($13.8 billion).
"The intended rescue package involved a liquidity line to be provided by a consortium of several financial institutions," the company said in a statement released Saturday. "The consortium has now declined to provide the line." Finance Minister Peer Steinbrueck, who spoke at the press conference with Merkel, said the government was working on an "institution-specific solution" to Hypo's problems. "We have to start again where, at the end of last week, we thought we had a solution," he said.
It was not known if the government, which planned to inject nearly euro27 billion ($37.4 billion), would raise its stake in the bailout package. Hypo was the first German blue chip to seek a government rescue after running into trouble in mid-September as credit froze on international markets after its Dublin-based unit Depfa Bank PLC failed to attract needed short-term funding amid the widening credit crunch.
German media reported that the consortium apparently got cold feet after an examination of Hypo showed that losses could be as much as euro50 billion ($69.2 billion) by the end of 2008. The emergency meeting came a day after Europe's four major economic powers called for tighter regulation in a bid to stop the fiscal bleeding wrought by turmoil on Wall Street - though Germany, France, Britain and Italy shied away from advocating a massive bailout akin to that in the United States, where Congress approved a $700 billion (euro506 billion) plan last week.
The EU's failure during the past week to pull together on dealing with the crisis has caused worry.European states have pumped billions of euros into banks to keep them afloat over the last week, trying to assure savers their money was safe and avert a panic that has frozen lending across the world. Banks from Iceland to Germany to the Nordic nations have felt the sting of the meltdown since Lehman Brothers Holdings Inc. filed for bankruptcy last month.
Germany takes hot seat as Europe falls into the abyss
We face extreme danger. Unless there is immediate intervention on every front by all the major powers acting in concert, we risk a disintegration of global finance within days. Nobody will be spared, unless they own gold bars.
Investors will learn today whether the Paulson bail-out - fattened to $850bn (£480bn) by Congress - can begin to halt the death spiral in the credit system. So far, the response looks terrible. Germany is now in the hot seat. The collapse of a rescue deal for Hypo Real Estate on Saturday threatens a €400bn (£311bn) bankruptcy that nearly matches the Lehman Brothers debacle for sheer scale.
Chancellor Angela Merkel has been forced to pull her head out of the sand, guaranteeing all German savings, a day after she rebuked Ireland for doing much the same thing. Reality intrudes. During the past week, we have tipped over the edge, into the middle of the abyss. Systemic collapse is in full train. The Netherlands has just rushed through a second, more sweeping nationalisation of Fortis. Ireland and Greece have had to rescue all their banks. Iceland is facing an Argentine denouement.
The US commercial paper market is closed. It shrank $95bn last week, and has lost $208bn in three weeks. The interbank lending market has seized up. There are almost no bids. It is a ghost market. Healthy companies cannot roll over debt. Some will have to sack staff today to stave off default. As the unflappable Warren Buffett puts it, the credit freeze is “sucking blood” out of the economy. “In my adult lifetime, I don’t think I’ve ever seen people as fearful,” he said.
We are fast approaching the point of no return. The only way out of this calamitous descent is “shock and awe” on a global scale, and even that may not be enough. Drastic rate cuts would be a good start. Central bankers still paralysed by a misplaced fear of inflation – whether in Europe, Britain, or the US – have become a public menace and should be held to severe account by our democracies. The imminent and massive danger is now self-feeding debt deflation.
The lesson of the 1930s is that any country trying to reflate in isolation will be punished. The crisis will ricochet from one economy to another until every one is crippled. We are seeing it play again in this drama as our leaders fail to rise above their narrow, parochial agendas.
The European Central Bank – which raised rates into the teeth of the crisis in July – has played a shockingly destructive role in this enveloping slump. Its growth predictions this year have been, and still are, delusional. Neglecting its global role, it has vastly complicated the fire-fighting efforts of Washington. It could have offered “cover” to the US Federal Reserve this spring when Ben Bernanke was forced by events to slash rates to 2pc. It could at least have signalled an end to monetary tightening. That is how an ally ought to behave.
Instead, it stuck maniacally to its Gothic script, with equally unhappy consequences for both sides of the Atlantic, as well as for China, Japan, and India. The euro rocketed yet further, which it turn set off an oil shock as crude metamorphosed into an anti-dollar with leverage. The ECB policy was self-defeating, even on its own terms. It merely drove headline inflation even higher, while deeper forces of underlying debt deflation pulled the real economies of Germany, Italy, France, and Spain into a recessionary vortex.
Far from offering reassurance, the weekend mini-summit of EU leaders served only to highlight that nobody is in charge of this runaway train. There is still no lender of last resort in euroland. The £12bn stimulus package is risible. Angela Merkel has revealed her deep limitations. It was she who vetoed French efforts to launch a pan-EU rescue package, suspecting that any lifeboat fund would prove to be Trojan Horse – a way of co-opting German taxpayers into colossal transfers of wealth to Latin Europe.
In that she is right, but it is too late now for dysfunctional EU political games. By demanding that those who caused the damage should pay for it, she crossed the line into caricature, or worse. Her comments echo word for word the “we’re alright Jack” attitudes of Euro-pols during the first US banking crises in 1930-1931, until the storm hit Europe and the entire cast was swept away by furious electorates, or simply shot. Thankfully, this EU stupidity is at last drawing serious criticism.
“We have to make sure Europe takes its responsibilities, like the US: action must be taken quickly and in a concerted manner,” said IMF chief Dominique Strauss-Kahn. As for the US itself, it has not yet exhausted its policy arsenal. It can escalate further up the nuclear ladder. The Fed can cut interest rates from 2pc to zero. If that fails, it can let rip with the mass purchase of US debt.
“The US government has a technology, called a printing press,” said Fed chief Ben Bernanke in November 2002. (His helicopter speech). In extremis, the Treasury/Fed can swoop into any market to shore up asset prices. They can buy Florida property. They can even buy SUV guzzlers from the car lots in Detroit, and mangle them in scrap yards. As Bernanke put it, the Fed can “expand the menu of assets that it buys.” There is a devilish catch to this ploy, of course. It assumes that foreign creditors will tolerate such action.
Japan entered its Lost Decade as the world’s top creditor, with a vast pool of household savings to cushion the slump. America starts its purge with net external liabilities of $3 trillion, and a savings rate near zero. Foreigners own over half the US Treasury debt, and two thirds of all Fannie, Freddie, and other US agency bonds. But the risk of a dollar collapse is one for the distant future. Right now the world faces the opposite problem. There is a wild scramble for dollars as a $10 trillion pyramid of global lending based on dollar balance sheets “delevers” with a vengeance.
This is a “short squeeze” on those who have used the dollar for a vast global carry trade. International banks are facing margin calls on their dollar leverage. It is why the Fed is having to provide $1.25 trillion in dollar liquidity for the entire global system, according to estimates by Brad Setser from the Center for Geoeconomic Studies.
The crisis engulfing Europe, Asia and emerging markets, makes life easier for Washington. The United States is becoming a safe-haven again. The Fed can now hope to pursue monetary stimulus “a l’outrance” without being slapped down by the currency, debt, and commodity markets. Take comfort where you can.
Money-Market Rates Climb as Banks Hoard Cash; Euribor Rises to Record High
Money-market rates climbed worldwide as banks hoarded cash on speculation the seizure in credit markets is deepening and may prompt more financial institutions to collapse.
The London interbank offered rate, or Libor, that banks charge each other for overnight dollar loans rose 37 basis points to 2.37 percent today, the British Bankers' Association said. The three-month rate stayed near the highest level since January. Asian rates increased and the Libor-OIS spread, a gauge of cash scarcity among banks, held near a record.
"The situation remains very tight and we probably need more action from central banks," said Cyril Beuzit, head of interest- rate strategy in London at BNP Paribas SA. "There's a strong will from governments to get on top of the situation, but for the moment it hasn't worked. We're still left in a risk-averse environment."
Interbank rates have jumped as banks store cash to meet anticipated funding needs after governments in Europe and the U.S. intervened to prevent the collapse of six financial institutions in the past two weeks. The Libor-OIS spread, the difference between the three-month dollar rate and the overnight indexed swap rate, rose to 298 basis points today, before retreating to 293 basis points. It was at 129 basis points two weeks ago and 81 basis points a month ago.
BNP Paribas, France's biggest lender, agreed to take control of Fortis in Belgium and Luxembourg, completing a breakup of the lender after a government rescue failed. UniCredit SpA Chief Executive Officer Alessandro Profumo said Italy's biggest bank underestimated the severity of the global financial crisis, forcing him to cut profit forecasts and propose raising capital.
The Federal Reserve will double its auctions of cash to banks to as much as $900 billion and is considering further steps, the central bank said today in a statement. The Fed will increase its auctions under the 28-day and 84-day Term Auction Facility operations to $150 billion each. The two forward TAF auctions in November will be increased to $150 billion each. The central bank will also begin paying interest on bank reserves.
President George W. Bush signed a $700 billion U.S. bailout bill into law last week to help stem the crisis, which has claimed financial companies including Bear Stearns Cos. and Lehman Brothers Holdings Inc. The legislation enables the government to purchase tainted assets from institutions. European leaders meeting in Paris two days ago pledged to bail out their own nations' banks, while stopping short of a regional rescue effort.
The difference between what banks and the Treasury pay to borrow money for three months, the so-called TED spread, widened today to 393 basis points, the most since Bloomberg began compiling the data in 1984, before falling back to 385 after the Fed TAF statement. Writedowns and losses worldwide tied to the U.S. mortgage market have reached $586 billion since the start of last year, according to data compiled by Bloomberg.
Banks borrowed the most since February 2001 from the European Central Bank at its emergency rate as the credit crunch worsened. Financial institutions borrowed 24.6 billion euros ($33.4 billion) for overnight on Oct. 3 at the central bank's marginal lending rate of 5.25 percent, which is one percentage point above its benchmark rate. At the same time, banks deposited 38.9 billion euros with the ECB, the Frankfurt-based central bank said in a statement today. The deposit rate is 3.25 percent.
"Money-market conditions will continue to be very tight and this will not improve in the short term," said Dwyfor Evans, a foreign-exchange strategist at State Street Global Markets in Hong Kong. "There's an absence of trust." The increase in the overnight dollar Libor was the first in four days. The three-month rate was within 4 basis points of the highest since Jan. 10.
The euro interbank offered rate, or Euribor, for three-month euro loans advanced 1 basis point to 5.35 percent today, a seventh straight all-time high, European Banking Federation data showed. The Euribor for one-month loans in euros advanced 2 basis points to 5.15 percent today, reaching a record for a fifth day, according to the EBF.
Government bonds around the world climbed as stocks slid, driving investors to the safest assets. U.S. Treasuries rose for a fourth day, sending two-year notes to their longest winning streak in six weeks, and gains for German two-year notes drove yields to their lowest levels since March. Japanese 10-year bonds advanced for a second day. The MSCI World Index, a global equity benchmark, dropped for a third consecutive day, falling to its lowest level since November 2004.
Hong Kong's three-month interbank offered rate, or Hibor, increased 4 basis points to 3.85 percent, the highest since Dec. 10. The corresponding rate in Tokyo held at a nine-month high. Philippine money-market rates rose for a third day. The one- month interbank rate climbed to 5.125 percent, according to the Bankers Association of the Philippines. "Philippine banks are liquid but they still want to borrow for safety so they'd have enough in case the crisis continues," said Marcelo Ayes, senior vice president for Treasury at Rizal Commercial Banking Corp. in Manila.
Borrowing costs between banks in Singapore fell today, with the benchmark three-month rate for dollar loans easing more than 3 basis points to 4.23 percent, according to the Association of Banks in Singapore. "Euro and dollar funding has shot up due to the bank failures in those places," said Irene Cheung, a currency strategist at ABN Amro Bank NV in Singapore. "Asia's situation is not so scary." The Bank of Japan added 1 trillion yen ($9.7 billion) to the financial system. Australia is closed for a public holiday.
Commodities R.I.P. as Leverage Vanishes, Growth Slows
Commodities markets are heading for the biggest annual decline since 2001 as investors exit leveraged bets and slowing economic growth erodes demand for raw materials.
The value of the 19 commodities in the Reuters-Jefferies CRB Index fell $280.6 billion, or 43 percent, from its July 3 peak, a loss larger than their total worth two years ago, data compiled by Bloomberg show. UBS AG, the Zurich-based bank that bought Enron Corp.'s energy unit in 2002, plans to exit most commodity trading. About 15 percent of investors in Boone Pickens's BP Capital LLC hedge fund may want their money back.
The same credit-market seizure that led to last month's bankruptcy of New York-based Lehman Brothers Holdings Inc. and the forced sale of Merrill Lynch & Co. is squeezing speculators who drove commodities to record highs. Slower expansion in the U.S., China and India is also undermining prices of crude oil, which fell 39 percent, and corn, down 46 percent.
"The day of steadily rising commodity prices is over," said Chris Rupkey, the New York-based chief financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd. "A lot of the demand for commodities has been speculation, and now that demand is falling away because of fear taking hold in the market."
The CRB, which doubled from 2001 to a record 473.97 on July 3, may drop 15 percent this year, said William O'Neill, a partner at Logic Advisors in Upper Saddle River, New Jersey. The last time the index lost that much was 2001, when the U.S. sank into a recession. It's down 11 percent for the year.
A global slowdown may cause crude oil to plunge another 45 percent to $50 a barrel next year, New York-based Merrill Lynch said in an Oct. 2 report. Goldman Sachs Group Inc. cut its forecast for copper next year by 12 percent to $8,265 a metric ton and aluminum by 18 percent to $2,920 a ton.
Corn may tumble as much as 10 percent to $3.87 a bushel in the next six months, and soybeans by 4.5 percent to $8.85 a bushel, said Don Roose, president of U.S. Commodities Inc. in West Des Moines, Iowa. Investors who embraced commodities as an investment class like stocks and bonds, while demand from China and India eroded supplies faster than they were replaced, are now in retreat. Copper fell by as much as 6.9 percent today to a 20-month low, soybeans dropped as much as 6.8 percent and palm oil by 11 percent as the rout deepened.
Outstanding contracts for 17 commodity futures traded in New York and Chicago fell 26 percent since a peak on Feb. 29 to the fewest in two years, data compiled by Bloomberg show. Net-long positions, or bets prices will rise, held by hedge funds and other large speculators fell to 7 percent of total open interest for futures on Sept. 23 from 14 percent on March 25, according to an Oct. 2 report to clients by Barclays Capital in London.
The decline follows an unprecedented rally as the UBS- Bloomberg Constant Maturity Commodity Index of 26 raw materials rose every year since 2001. About 450 commodity hedge funds held $80 billion of assets as of Sept. 1, up from $55 billion last year, said Brad Cole, president of Cole Partners Asset Management in Chicago. Hedge funds are private, largely unregulated pools of capital whose managers can buy or sell any assets, bet on falling as well as rising asset prices, and participate substantially in profits from money invested. They typically use borrowed money, or leverage, to amplify investments.
Frankfurt-based Deutsche Bank AG, Newport Beach, California-based Pacific Investment Management Co. and Jersey- based ETF Securities Ltd. led Wall Street in creating funds linked to commodities indexes such as the Dow Jones-AIG Commodity Index or so-called exchange-traded funds that trade like stocks and buy raw materials such as gold, oil or cotton.
Futures, where a $12.50 deposit can control a $100 barrel of oil, allowed Dallas-based Pickens to earn $1.4 billion in 2005, Institutional Investor's Alpha magazine estimated. Michael Farmer and David Lilley at RK Capital Management LLP saw their Red Kite Metals fund in London gain 145 percent from inception in 2005 through the end of last year. Chris Levett, who founded London-based Clive Capital LLP, returned 17.6 percent in the first quarter on energy and metals bets.
Investments in commodity indexes reached a record $175 billion at the end of June, Barclays Capital said. Saudi Arabian Oil Minister Ali al-Naimi and Michael Masters of Atlanta-based hedge fund Masters Capital Management said speculation, not supply and demand, was responsible for increasing prices.
Crude oil quintupled from July 2002 to a record $147.27 a barrel on July 11, corn more than tripled from June 2006 to the highest ever, $7.9925 a bushel, on June 27. Gold more than doubled in the three years to March 17, when it reached a record $1,033.90 an ounce.
Prices dropped since June as the U.S. Dollar Index strengthened 9.6 percent in the third quarter, the most since 1992, economic growth slowed and bank losses from the collapse of subprime mortgages swelled to $586.6 billion, according to data compiled by Bloomberg. While President George W. Bush signed into law a $700 billion bank rescue plan Oct. 3, the leverage that pumped up commodities is unlikely to return.
"Easy credit is done, it's finished," said Robbert Van Batenburg, head of research at Louis Capital Markets LP in New York, a broker to institutional investors and hedge funds. "I don't think there's going to be a quick end to this situation."
The three-month London interbank offered rate, or Libor, that banks charge each other for 90-day loans in dollars, increased to 4.33 percent on Oct. 3, the most since January, the British Bankers' Association said.
Some investors and analysts expect commodities to rebound after the worst quarter for the CRB Index since at least 1956. The U.S. bailout may revive speculation as the government buys troubled assets, and record swings in prices may lure investors. The 10-week volatility in the CRB Index last month was the highest since 1973.
While economic growth is slowing, demand for food and fuel will continue to increase even if producers cut back supplies.
"I'm not bearish on softs," said Christoph Kampitsch, who helps oversee $1.5 billion in hedge funds at Erste Group Bank AG in Vienna. "In nine to 12 months, soybeans, cocoa, sugar and wheat will recover. For agricultural products, there could be supply disruptions very easily. People also need to eat."
The drop in prices may lead to lower production and create shortages as soon as next year. "It's a wholesale liquidation of all assets as people became concerned about the economic outlook," said Angus Murray, founder and joint chief executive officer of New York- based Castlestone Management Ltd., with about $1 billion in assets. "If this liquidation continues, commodities producers will stop producing. We'd end up with a severe shortage of commodities that would eventually boost prices back up again."
Economists say U.S. growth will slow to 1.5 percent next year from 1.7 percent in 2008, according to surveys compiled by Bloomberg. China expanded 10.1 percent in the second quarter, down from 12.6 percent a year earlier, and India grew 7.9 percent, compared with 9.2 percent.
Institutional investors withdrew $5 billion from commodity indexes during the third quarter, according to Barclays Capital. The combination of outflows and dropping prices pushed assets under management in indexes down 31 percent to about $120 billion, the bank said.
Every commodity in the CRB Index fell in the third quarter, led by a 44 percent drop in natural gas. The value of the 19 commodities fell to $374.8 billion on Oct. 1 from $655.4 billion on July 3, according to data compiled by Bloomberg. The total value of those futures contracts on Oct. 1, 2006, was $271.9 billion.
Fed Boosts Cash Auctions to $900 Billion, May Do More
The Federal Reserve will double its auctions of cash to banks to as much as $900 billion and is considering further steps to unfreeze short-term lending markets as the credit crunch deepens. "The Federal Reserve stands ready to take additional measures as necessary to foster liquid money-market conditions," the central bank said in a statement released in Washington today.
Fed and Treasury officials are "consulting with market participants on ways to provide additional support for term unsecured funding markets," the statement said. As part of today's steps, the Fed will increase its auctions under the 28-day and 84-day Term Auction Facility operations to $150 billion each. The two forward TAF auctions in November will be increased to $150 billion each, the Fed said.
The central bank will also begin paying interest on bank reserves. Payments on required reserves will be made at the average targeted federal funds rate established by the Federal Open Market Committee over each reserve maintenance period less 10 basis points. The Fed gained the authority to pay interest on reserves under the $700 billion financial-rescue legislation approved last week.
In a separate statement, the U.S. Treasury said it is considering changes to its debt issuance, including a reintroduction of three-year notes. Any changes will be released at the department's quarterly refunding announcement Nov. 5. The Treasury also said today that some cash-management bills may be "longer-dated."
The expansion in debt sales is needed to "allow Treasury to adequately respond to the near-term increase in borrowing requirements," the department said in the statement released in Washington. Treasury officials last month started a special program of bill auctions to help the Fed expand its balance sheet.
Fed, Treasury move again to help financial markets
The Bush Administration and the Federal Reserve said Monday they are moving "with substantial force on a number of fronts" to shore up confidence in, and protect, the financial system.
The aggressive posture comes as global stock markets suffered fresh losses amid fear that the turmoil in financial markets and the squeeze on credit will spread to the broader economy. In an overall statement, the President's Working Group on Financial Markets, which includes the top officials of all regulatory agencies and the Fed, said that it was working with the industry and regulators around the world to address the current challenges.
The Fed said it would double the size of its emergency loan program to banks to a potential $900 billion by the end of the year.
The announcement came as the central bank announced that it will begin to pay interest on bank reserves. This will give the Fed "greater scope" to address conditions in credit market. The Treasury announced steps to clarify to the market how it plans to coordinate the massive borrowing needs that will be required to fund the new emergency mortgage financing plan approved by Congress last week.
Treasury said it will make adjustments to its auction calendar by increasing the size of bill and note auctions and continuing to issue cash management bills, some of longer-duration. In addition, the department said it was considering bringing back the three-year note in November and taking other steps. The Fed and Treasury said that they are consulting with market participants on ways to support term unsecured funding markets.
"Together these actions should encourage term lending across a range of financial markets in a manner that eases pressures and promotes the ability of firms and households to obtain credit," the Fed said. "The Federal Reserve stands ready to take additional measures as necessary to foster liquid money market conditions," the statement said. The Fed will increase the size of its term auction facility auctions to $150 billion beginning later Monday.
Anthony Ryan, the acting under secretary for domestic finance, went on television to stress that top-level officials are working rapidly to implement the mortgage rescue plan hatched by Treasury Secretary Henry Paulson. "We're moving as quickly as we can," Ryan said in an interview on CNBC. But Marc Chandler, currency analyst with Brown Brothers Harriman, said he was worried that the markets were moving much more rapidly than regulators and that Washington's efforts ultimately may be too small to stem the crisis
Yen Unbeatable as Credit Seizure Kills Carry Trades
The same credit market collapse that drove Lehman Brothers Holdings Inc. into bankruptcy and sent bank borrowing costs in Europe to record highs is making the yen unbeatable.
Japan's currency was the best-performer in September and the only currency to appreciate against the dollar. Deutsche Bank AG, the biggest trader of foreign exchange, says the yen will rise 5 percent in coming months. New York-based Morgan Stanley is telling clients to buy the currency versus the euro and pound.
After seven years of providing the cheapest source of funds for investors buying higher-yielding New Zealand dollars, Australian dollars and Brazil reais, the yen is appreciating as $584 billion of subprime mortgage-related losses force banks to restrict credit. It strengthened 4.4 percent on a trade-weighted basis in September, according to the Bank of Japan's effective exchange rate, the most since August 2007, when the seizure in capital markets began.
"We are in a multi-year trend reversal," said Paresh Upadhyaya, a senior vice president at Putnam Investment LLC in Boston who helps manage $50 billion in currency assets. "We are going to see a global central bank easing cycle. The yen is the place to be in this environment of economic slowdown and heightened volatility."
This year will be the first since 2002 that the economies of the U.S., euro-region and Japan all expand less than 2 percent, according to data compiled by Bloomberg. The BOJ's effective exchange rate rose 5 percent from April through September of that year, the best six-month performance since the end of 1999.
Strategists are turning more bullish, forecasting the yen will end the year at 107 to the dollar, compared with an expectation of 109.15 on Sept. 12, according to the median of 40 estimates compiled by Bloomberg. The currency rose 4 percent to 101.21 per dollar as of 10:53 a.m. in New York from 105.32 late on Oct. 3. Japan's currency also climbed 9 percent to 63.92 per New Zealand dollar and gained 11 percent to 72.45 against the Australian dollar. It advanced 9 percent to 46.88 versus the Brazilian real from 51.5240.
"The yen is a counter-cyclical currency," said Richard Benson, who oversees $14 billion of currency funds at Millennium Asset Management in London. "When the global economy looks bad, the yen should do well." The currency lost 60 percent against the Australian and New Zealand dollars in the seven years ended June 30, and depreciated 24 percent versus the real and 20 percent to the British pound. The main cause was the so-called carry trade, where investors took out loans in Japan to take advantage of the lowest benchmark interest rates among the Group of 10 industrialized nations. They then sold the yen and invested the proceeds in high-yielding assets outside the country.
Investors who used the strategy to buy the New Zealand and Australian dollars, euro and pound, would have generated a return of 211 percent on average in the past seven years, according to data compiled by Bloomberg. The trades would have lost 13 percent this year. The collapse of Lehman, the government takeovers of Fannie Mae, Freddie Mac, American International Group Inc. and Washington Mutual Inc. and the forced sales of Merrill Lynch & Co. and Wachovia Corp. reduced confidence in the world's financial system.
That in turn has made banks wary of lending to each other, pushing the three-month London interbank offered rate in dollars to 4.33 percent from 2.81 percent on Sept. 15, the day New York- based Lehman filed for bankruptcy protection, according to the British Bankers' Association in London. The increase in rates and drop in credit is forcing speculators to close out carry trades and pay back yen-denominated loans. The currency's biggest gain the past month has come against the real, rising 20 percent.
The slowing world economy is also helping the yen by boosting expectations that central banks will lower borrowing costs. Policy makers in Europe, Australia, New Zealand and Brazil will cut interest rates next year, according to the median estimates of economists surveyed by Bloomberg.
Futures on the Chicago Board of Trade showed an 100 percent probability yesterday the U.S. Federal Reserve will lower its 2 percent target rate for overnight lending between banks by a half-percentage point at its Oct. 29 meeting. Traders saw no chance of a cut a month earlier.
"The carry trade is dead," said Derek Halpenny, European head of global currency research at Bank of Tokyo-Mitsubishi in London. "The world is deleveraging." The yen rose to 135.58 per euro today, the highest level since its 1999 introduction, and 176.06 versus the pound, the strongest since November 2001.
Hedge funds and speculators increased bets that the yen will appreciate versus the dollar to the highest level since July 18, data from the U.S. Commodity Futures Trading Commission show. Wagers on an advance in the yen outnumbered those on a drop by 43,022 on Sep. 30. As recently as Sept. 2 they were betting on a decline in the yen.
Morgan Stanley strategists turned bullish last week, saying in an Oct. 2 report to clients thy yen may strengthen to 135 per euro and to 165 per pound from 188.10. Frankfurt-based Deutsche Bank expects it to rally to 100 to the dollar. Bank of Tokyo- Mitsubishi UFJ Ltd, Japan's largest bank by market value, raised its forecast last week to 100 per dollar by March from 102. It predicts the yen will gain 11 percent versus the pound in a year.
Further gains may depend on whether U.S. Treasury Secretary Henry Paulson's $700 billion plan to revive credit markets by purchasing depreciated assets from banks boosts investor confidence. The carry trade "is a strategy that has a good track record," said Pablo Frei, a money manager at Quaesta Capital in Switzerland, which oversees $1.2 billion in currency funds. "You have to unwind carry during times of high risk. There will be a day that it will be put on again. The question is when."
Quaesta Capital's currency funds have reduced the amount of money in carry trades to less than 5 percent of assets, from about 30 percent a year ago, Frei said. Investors in Japan will continue to invest internationally to diversify their holdings as risk appetites return, capping the yen's strength, said Rebecca Patterson, global head of foreign exchange in New York for the private wealth management unit of JPMorgan Chase & Co.
Japanese mutual funds increased purchases of overseas assets to 36.89 trillion yen ($369 billion) by the end of last year, from 3.06 trillion yen in 2000, according to Japan's Investment Trust Association. "What's happened in Japan in the last two, three years has been a structural shift of the Japanese mindset," said Patterson. "They view these as long term investments. The yen negative flows will slow in times of trouble like this. But I don't see a lot of this is a longer-term shift."
Carry trades became popular as swings in exchange rates fell to record lows because there was less risk that rapid changes would wipe out profits.
Now, that is changing. Implied volatility on major currencies rose to 16.69 percent on Sept. 17, the highest level since 1998, according to the JPMorgan G7 Volatility Index. The gauge of price swings touched 5.76 percent in June 2007, the lowest since the index's inception in 1992. The percentage of currency reserves held in yen by foreign central banks increased for a third straight quarter through June, according to the International Monetary Fund.
Yen now accounts for 3.4 percent of global reserves, compared with 2.8 percent a year earlier, the lowest amount since at least 1999. The dollar is the world's largest reserve currency at 62.5 percent, IMF figures show. Morgan Stanley strategists said in their Oct. 2 report that the yen may overtake the pound, which is No. 3 at 4.7 percent, in "coming quarters."
"There are many risks in the United States and Europe," said Satoshi Okumoto, a general manager at Fukoku Mutual Life Insurance Co. in Tokyo, which has $54.1 billion in assets and is Japan's eighth-biggest life insurance company. "Fund managers are starting to shift their money to yen. They are starting to overweight yen in terms of currency allocation."
Lehman failed to convince Fed on survival plan
Lehman Brothers lobbied the US Federal Reserve this summer to be given access to much-needed liquidity, but was unable to convince the regulators, just two months before the Fed endorsed similar proposals from Goldman Sachs and Morgan Stanley, the Financial Times has learnt. Lehman held talks with regulators over a plan to convert to a traditional bank holding company in July.
At the same time it asked the Fed to loosen the rules by which it extends credit in order to include more types of collateral, according to sources close to the firm’s discussions with the Fed. Lehman also held a round of meetings that month with Bank of America over a potential takeover, and considered selling itself to other banks including Morgan Stanley, HSBC and Nomura before it eventually filed for bankruptcy.
It held extensive merger talks with AIG in 2006, and solicited potential minority investors ranging from General Electric to the Abu Dhabi Investment Authority, other Middle Eastern and Asian partners and private equity firms. According to people involved in Lehman’s efforts, Dick Fuld, Lehman’s former chief executive, quickly embraced the idea of becoming a bank holding company this summer. “We were working that hard as one of the angles for a while,” said one source close to the matter. “We had an application in front of them.”
Becoming a bank holding company would have subjected Lehman, which had been an independent investment bank, to regulation by the Fed. But it could also have helped to keep Lehman’s wholesale funding model from collapsing before the bank was able to metamorphose into a more deposit-based institution. The Fed, however, was not willing to change the rules over which types of collateral it would accept in exchange for credit, according to sources close to the talks.
It was also concerned that Lehman could be stigmatised if it converted to a bank holding company on its own. Without the Fed’s encouragement, Lehman felt it had to abandon the plan. Last month, Morgan Stanley and Goldman received quick Fed approval for their own conversions, after Lehman’s collapse reverberated through the markets with unanticipated severity.
The high degree of co-ordination between Morgan Stanley and Goldman helped convince regulators that the proposal could work, people close to those talks said. To provide Goldman and Morgan Stanley with additional liquidity, the Fed agreed to loosen its collateral arrangements when it approved their conversions. Goldman and Morgan Stanley have since been able to attract significant capital infusions from billionaire investor Warren Buffett and Mitsubishi UFJ, the Japanese bank, respectively.
While it is far from certain that Lehman could have recruited similar help after converting to a bank holding company, Wall Street’s top minds are now debating whether the bank’s disintegration should have been prevented. “Rehabilitation, rather than failure, is much more consistent with controlling systemic risk,” said Rodgin Cohen, chairman of law firm Sullivan & Cromwell, who helped advise Lehman in the days leading up to its bankruptcy.
U.S. Treasury's Kashkari (ex-Goldman) to Lead Bank Bailout Office
The U.S. Treasury will name Neel Kashkari, assistant secretary at the department, to run the $700 billion Wall Street rescue program on an interim basis, according to a Treasury official.
Kashkari will be designated the interim head of the new office of financial stability, created in the bailout legislation Congress passed last week. The Treasury aims to buy troubled assets such as home loans and mortgage-backed securities from banks and other financial institutions in an effort to shore up global credit markets. The Treasury said specifics on how the debt-buying office will operate are still being worked out.
"We need to think through what's the best for securities, for loans, to help strengthen the balance sheet of the institutions." Anthony Ryan, the Treasury's acting undersecretary for domestic finance, said in an interview today on CNBC. "We are focusing on the broader issues, the mortgage- related assets."
Senate confirmation is required to fill the position for which Kashkari will be nominated. The Treasury hasn't specified the length of Kashkari's tenure, or whether the White House would nominate him officially. The Bush administration remains in office until January.
For now, Kashkari will play a lead role in setting up the new office and organizing its first operations. The Treasury has said it plans to hire about two dozen staff to manage the program, along with five to 10 asset management firms. The first asset-buying operations are not expected for at least four weeks.
Kashkari, a former vice president at Goldman Sachs Group Inc., is currently assistant secretary for international economics and development. He has been one of Treasury Secretary Henry Paulson's key advisers on housing issues.
Now Wall Street may shun $700 billion bail-out
Fears are mounting that many Wall Street banks and financial firms will refuse to participate in the US government's $700bn bail-out package, leaving global markets and world economies in a perilous state for months to come.
'There is a growing feeling that banks ... might instead decide to tough it out,' said Thomas Caldwell, chairman and CEO of Caldwell Financial, a $1bn-plus fund manager. For the past two weeks all eyes in the market have been focused on US Congress and its attempts to pass Treasury Secretary Henry Paulson's bail-out package - a bill to allow the US government to buy up to $700bn of toxic mortgage-related assets from American banks, which would in theory free the credit markets and set the gears of global commerce spinning once more.
Last Monday, after the bill was thrown out by the House of Representatives, more than $1 trillion was wiped off the value of US stocks as the market was gripped by panic. The bill was passed on Friday afternoon, however, after the inclusion of $149bn of tax breaks and strict rules for participating banks. But Wall Street analysts, believe the addition of so many terms to the bill might deter potential participants.
One of the least attractive elements is a section designed to curb executive pay at banks that participate in the bail-out package. These include limiting stock-related pay and banning 'golden parachutes' for executives. 'I think this hodge-podge of regulations and rules will be enough to put many [chief executives] off participating,' Caldwell said.
Sources close to Goldman Sachs and Merrill Lynch indicated the banks might choose not to participate in the bail-out as there is a growing view on Wall Street that the market may be bottoming out.
Analysts also believe that the mere presence of the government as buyer of last resort will be enough to get credit markets moving again, and that a large number of banks would not need to take part for the legislation to succeed.
Wells Fargo wins court rulings, insists Wachovia deal will go forward
Wells Fargo appeared to have the upper hand Monday in its battle with Citigroup for the chance to take over Wachovia Corp. thanks to two court rulings in its favor.
Wells Fargo & Co. said Sunday that its takeover agreement with Wachovia will go forward, as an appellate court overturned an earlier decision to block its acquisition of Wachovia Corp. And, in a separate ruling reported by the Wall Street Journal, a North Carolina court issued a temporary restraining order also preventing Citi from enforcing a claimed exclusivity agreement.
According to the Journal report, the North Carolina court ruled that there was evidence that Citigroup, "has taken and continues to take actions designed to cause the seizure or collapse of Wachovia." One of the plaintiffs in the North Carolina suit was Leslie "Bud" Baker, former Wachovia CEO. On Saturday Justice Charles Ramos of New York State Supreme Court had halted the $15 billion transaction by extending an exclusivity agreement that Citigroup had for a merger.
Wells Fargo issued a statement late Sunday saying: "The appellate court has entered an order vacating Judge Ramos's order of yesterday. We are pleased that the unfounded order entered yesterday has been vacated. Wells Fargo will continue working toward the completion of its firm, binding merger agreement with Wachovia Corporation." Citi had said that the exclusivity agreement -- which Judge Ramos had extended over Wachovia's objection -- "unconditionally bars Wachovia from negotiating or entering into a merger/acquisition agreement with any party other than Citi."
However, according to a report in the Wall Street Journal Monday, a provision in the financial system bailout legislation passed Friday affects things like exclusivity agreements, and can make unenforceable certain agreements that restrict bank merger talks.
In pre-open trading Monday, shares of Citigroup fell 6.7%, Wachovia shares fell 7.4% and Wells Fargo shares fell 3.7%.
The deal between Wachovia and Citi was unveiled a week ago. But late on Thursday, Wachovia agreed to be acquired by Wells Fargo.
Following the latest court ruling, The Wall Street Journal also reported Sunday that the U.S. Federal Reserve was attempting to broker a deal between the rival suitors to allow each to acquire a portion of Wachovia. The report cited persons familiar with the situation as saying that the leading plan being discussed Sunday night would have Citi and Wells Fargo divide Wachovia's network of 3,346 branches along geographic lines.
Citigroup would get branches in the Northeast and mid-Atlantic regions, and Wells Fargo taking those in the Southeast and California, it said, adding Wells Fargo would also take over Wachovia's asset-management and brokerage units. Unlike Citigroup's original agreement to take over Wachovia's banking assets, in which the Federal Deposit Insurance Corp. agreed to shoulder potentially hundreds of billions of dollars in toxic loans, the plans being discussed Sunday night don't entail either buyer receiving financial assistance from the U.S. government, the report said.
Citi had earlier claimed a right to acquire Wachovia as it said it had been providing liquidity support to the troubled bank last week, since the two banks had agreed on a deal. Citi had said Friday that it had nearly completed the definitive agreements required to complete the deal. It demanded that Wachovia, based in Charlotte, N.C., and Wells Fargo, based in San Francisco, terminate their agreement. "Citi has substantial legal rights regarding Wachovia and this transaction," it said on Friday. Wells Fargo's "conduct constitutes tortious interference" with the exclusivity agreement, Citi said on Friday.
The New York Times, citing a person briefed on the situation, reported on Saturday that Citi was seeking $60 billion of damages from Wells Fargo for interfering with the transaction. On Saturday, Citi had said that it is "prepared to resume negotiating in good faith to complete the transaction contemplated by the agreement in principle" that it and Wachovia announced on Monday.
That deal would have seen Citi buy Wachovia's banking operations. Citi would have received FDIC protection against losses on $312 billion of Wachovia's more troubled assets. Wachovia is one of the largest holders of option adjustable-rate mortgages. Citi also has released the Exclusivity Agreement.
In a conference call Friday morning, Robert Steel, chief executive officer at Wachovia, addressed claims about a binding agreement with Citigroup by saying, "The controversy on this issue will be addressed in the appropriate way." He declined further comment. One lawyer said on Friday that while the agreement shows that Citi has a case, it's unlikely that it would be able to persuade a court to overturn the Wells-Wachovia deal.
"If Citi goes to court, how could they show lost profits in this market and with all those toxic assets [involved in the deal]?" said Roger Cominsky, partner at law firm Hiscock & Barclay. "Talk about a pyrrhic victory. The court could say, 'Yes the agreement was violated, but your deal is dead and you don't have any lost profits.'" Citi said when the deal was announced that it could have been exposed to potential losses of $42 billion as a result of the acquisition.
In a move that reflects how Citi was blindsided by the Wells-Wachovia deal, Citi placed a full-page ad touting its deal with Wachovia in newspapers across the country on Friday, including USA Today. "Citibank is honored to enter into a partnership with Wachovia," said the ad. "Together we will be part of the largest financial-services company in the world."
Citi's acquisition would have seen it pay $2.16 billion in stock to Wachovia, plus the $12 billion in preferred securities and warrants it gave to the FDIC. In return, Citi would have received $448 billion of bank deposits -- a large source of stable funding. At the time, Citigroup CEO Vikram Pandit said the acquisition offered a rare combination of potentially high returns and low risk.
But that deal was trumped, with Wachovia agreeing late Thursday to a deal in which it would be folded into Wells Fargo. The new deal will not require any FDIC support, Wachovia said. A source familiar with the situation said the Citigroup deal did not include a breakup fee, which would have made it more costly for Wachovia to break off discussions on a deal with Citi.
Bank of America blows billions on Countrywide litigation
Given the continued deterioration in the financial markets and mortgage industry, it seems likely that Bank of America badly overpaid for Countrywide Financial -- if the company's equity was worth anything at all.
This latest bit of news won't help. Attorneys general offices in California and Illinois have negotiated a settlement with the lender that will require Countrywide to modify terms on tens of thousands of loans. The settlement will offer strapped California borrowers $3.5 billion in relief, and if all 50 states sign on the total price could soar as high as $8.7 billion, according to the Illinois Attorney General's office. So far, Arizona, Connecticut, Florida, Iowa, Michigan, North Carolina, Ohio, Texas and Washington have joined Illinois and California in the deal.
In a statement, California Attorney General Jerry Brown Jr. said that "Countrywide's lending practices turned the American dream into a nightmare for tens of thousands of families by putting them into loans they couldn't understand and ultimately couldn't afford."
Of course, Bank of America knew going into the deal that it would have billions in litigation expenses to deal with but the downward spiraling of the economy has given CEO Ken Lewis a lot less margin for error. There are still shareholder class-action lawsuits and piles of consumer litigation to be sorted through, and, at a minimum, he has to be wishing he'd saved his ammunition to acquire cheaper assets in the midst of the carnage.
Long-term, it seems doubtful to me that the Countrywide Financial brand has any value at all. Why would anyone go to the poster child for the biggest real estate meltdown in history for a loan?
EU caricature of disunity
"The dollar may be our currency, but it's your problem." Europeans remember with a shudder the jibe used by John Connally, President Richard Nixon's free-speaking Treasury secretary.
This was when the Americans sent another shock wave through the world -- maybe small beer compared with today, but it seemed like a big thing at the time -- by abandoning the dollar's link to gold in 1971. Quite a landmark: the beginning of the break-up of the post-war Bretton Woods system of fixed exchange rates. Henry Paulson, Treasury secretary 37 years later under another beleaguered Republican president, is more polite in his dealings with the Europeans (that is, when he cares to take note of their existence). But fundamentally his message is the same: "Our crisis, your problem."
American financial upheaval is now washing over with full force on to the shores of the Old Continent. The rescue operations for European banks -- from the U.K. to Greece, from Ireland to Germany and Belgium -- underline the scope of the disorder. Assuming Armageddon is averted and some sort of recovery starts in the U.S. next year, Europe will probably take longer than America to emerge from its trough -- reflecting innate economic flexibility in the U.S. economy and the rigidities still present in Europe.
There are some colossal ironies here. In particular they surround the setting up of Economic and Monetary Union 10 years ago, now linking 15 countries including all the important European economies except Britain and Sweden. An important motive behind the creation of the single currency was to fulfill a vision first put forward nearly half a century ago: to lower Europe's economic dependence on those craven, myopic, ill-starred and selfish Americans running craven, myopic, ill-starred and selfish fiscal and monetary policies.
Great idea. And what has happened in the meantime? Because of the multitude of connections on globalized markets, interactions between the U.S. and Europe have multiplied. Far from being cut off from developments in America by the magic curtain of the euro, Europe is more exposed to U.S. than in the past. At no other time in the past half century have we seen greater truth in the old adage, "When America sneezes, Europe catches a cold."
But surely the Europeans have risen to the challenges with a consummate display of unity. Isn't that what European Union is all about? You could be excused for thinking that Europe, with an intact monetary policy edifice such as EMU, would be in a better position to withstand crises with a show of solidarity and common policies. You would think it's better equipped to repair immediate economic damage and enact longer-term changes in regulation and banking control.
You would be wrong. In fact, in response to the turbulence, Europe seems to be doing its best to serve up a caricature of disunity. The best example has been the response by the Irish government -- almost immediately copied by the Greeks -- to bring in state guarantees for all deposits at the country's top six banks. The move is certainly desperate, probably counter-productive and possibly extremely costly. Such measures, taken without any consultation with the other Europeans, are a throwback to beggar-thy-neighbor polices, which have no place in a cohesive grouping of economically advanced states.
But on Sunday, in response to worsening ravages at Germany's second-biggest mortgage lender Hypo Real Estate, the Berlin government went one better and offered state guarantees for savings deposits worth around Euro 560 billion -- roughly one quarter of German GDP (or equivalent to the combined GDPs of Belgium and Austria).
There is a reason for this, of course. Within the EMU, money is under supranational control. Governments can no longer bale out lackluster economies through currency devaluations or interest-rate cuts. But, reaching beyond policies that are within the purview of the European Central Bank, they can still call upon a broad range of further-going fiscal and regulatory instruments in the best European spirit of "every man for himself."
The main reason for the parlous state of Irish banks is that, during a bubble-like boom especially in real estate, they lent too much money to individuals and companies benefiting from the sharp fall in Irish interest rates when EMU started in 1999. Since that time, Ireland's economy has performed very well -- but not well enough, it seems to build up sufficient resources and reserves to save the day when upswing turns into downturn.
So Dublin, no longer having the tools of devaluation or interest rate reductions at its disposal, turns to basically protectionist measures to try to resolve an intractable economic problem. Especially now that the Irish have been followed by the German heavyweight, other countries will follow suit.
Of course, under the unlikely leadership of President Nicolas Sarkozy of France, who holds the half-year presidency of the European Union, some may think unity will suddenly break out across Europe. Dream on. The four-nation summit in Paris hosted by Sarkozy on Saturday more or less gave carte blanche to the Europeans to do their own thing. The Irish episode marks a new and inglorious tilt to go-it-alone-ism taking hold in a not-so-united Europe.
U.K. Treasury Under Pressure to Take Stakes in Banks
Chancellor of the Exchequer Alistair Darling is under increasing pressure to take equity stakes in British banks and to extend a guarantee on deposits to stem the impact of the worldwide credit crisis.
David Cameron, the leader of the U.K.'s Conservative opposition, and former Bank of England Deputy Governor Howard Davies said the Treasury should take more action to firm up banks. The Treasury has repeatedly declined to rule out any action and didn't address what it termed speculation today.
"We will do whatever it takes to get Britain through this," Yvette Cooper, chief secretary to the Treasury, told BBC Radio 4 in London today. "We are prepared to take radical action where it is needed. Governments across the world have had to take unprecedented steps." Prime Minister Gordon Brown's government is reviewing the impact of Germany's decision over the weekend to guarantee bank deposits. Darling will make a statement to Parliament at 3:30 p.m.
Cameron wrote in today's Financial Times that he'd support steps to recapitalize banks if the crisis worsened. "It is possible to imagine the circumstances in which government injections of capital, with proper safeguards and strict conditions, may be the best way to safeguard the long- term interests of the taxpayer," Cameron wrote in the FT.
Davies, who also has served as head of Britain's Financial Services Authority, told the BBC that governments should consider following billionaire investor Warren Buffett's lead and take stakes in banks to bolster their funds. "Governments are going to have to do something like that in order to signal to wholesale markets that they stand behind the institutions and that governments have some skin in the game," Davies, who is currently director of the London School of Economics, said on BBC radio.
Yesterday, Darling said he was "looking at some pretty big steps which we would not take in ordinary times." He didn't give any details of what he was considering. Banks are pressing for the Treasury to create a "bad bank" that would take on distressed assets to clean up the industry's balance sheets.
More liquidity is needed "to get interbank lending going and money markets going," former Chancellor of the Exchequer Ken Clarke, a Conservative lawmaker, said on Bloomberg Television. "I hope he (Darling) is going to announce something to put fresh capital into the banks."
Goldman Sachs Group Inc. raised $5 billion in a stock offering on Sept. 24 and gained an endorsement and a $5 billion cash infusion from Buffett. "I don't think full nationalization should be necessary. Taking a 10 to 20 percent stake as a signal to the market that the government stands behind it may well mean you could get out of that stake once markets return to normal."
Britain nationalized Northern Rock Plc in February and seized the loan book of Bradford & Bingley Plc last month. For now, Treasury officials are looking harder at whether to extend their assurances over bank deposits after Ireland, Greece and Germany extended their guarantees.
"It now seems likely that most or all European governments will have to follow with complete guarantees for all or almost all private deposits," Michael Saunders, chief Western European economist at Citigroup Inc. in London, wrote in a note to clients. "Now that several countries have taken this route, it will be hard for any other government to claim they do not want to follow or cannot afford to."
Brown earlier today met with his new National Economic Council including Cabinet ministers and 17 executives who will meet government officials twice a week to offer advice on the crisis. Barclays Plc Chairman Marcus Agius is on the panel along with Vodafone Group Plc Chairman John Bond, Lloyds TSB Bank Plc Chairman Victor Blank and Dick Olver of BAE Systems Plc.
Chancellor Angela Merkel said private account holders will have their savings guaranteed as the German government yesterday sought to reinforce confidence in the banking system while salvaging a bailout of Hypo Real Estate Holding AG.
Merkel made her pledge as the government worked on a new bailout package for Hypo Real Estate after the property lender said commercial banks withdrew support for a 35 billion-euro ($48 billion) plan.
Brown's spokesman, Michael Ellam, said British officials understand from their German counterparts that the government in Berlin will not propose legislation covering that country's bank guarantee. "The government isn't going to speculate on possible policy options," Ellam said at his daily briefing with journalists.
"Our understanding is that the German government will not be brining forward legislation for a legally binding guarantee. We are in the process of seeking clarification." Brown spoke with the prime ministers of Denmark and Iceland and French President Nicolas Sarkozy along with the head of the International Monetary Fund and European Central Bank.
The case for a European rescue plan
This has been a week of self-congratulation in Europe. We have saved a handful of banks. We have, in effect, started to cut interest rates. We even had a summit of European leaders that produced warm words of solidarity. It looks as though the Europeans have reached substantive agreement that no systemically important bank should ever be allowed to fail.
European officials believe that it was a big mistake to let Lehman Brothers fail. It could not have happened here. The rescue of Fortis and Dexia last week, two large, but not too large, cross-border European banks, should be seen as a sign that our emergency procedures are working. Look, they say, we met quickly and decided what needed to be decided. It was fast and unbureaucratic. We do not need a European rescue fund, let alone any new institutional set-up to deal with this, they say. We can do it ourselves.
I agree that the few ad hoc rescues have worked. But do not fool yourself. They worked because they were the first wave of rescues and because they involved banks such as Fortis – of just the right size, based in just the right small- to medium-sized country where political leaders are sufficiently rational not to hold each other to ransom as midnight approaches on Sunday.
But what if this had been a bank with a name of a large European country, or an acronym that refers to a large European city, banks that are simultaneously too big to fail and too big to save? I shudder to think what would happen when Silvio Berlusconi, Angela Merkel, Lech Kaczynski and the next Austrian leader have to meet to discuss the future of a large cross-border European bank.
What worked for banking rescues numbers one to five may not work for rescues number six to 50 – the estimated number of systemically important banks in Europe. And that number does not include some banks we have already rescued, which politicians judged to be important for their domestic banking system, like Germany’s IKB Bank, but with no European relevance whatsoever. We have been squandering money.
Nor does it include the likes of Hypo Real Estate, which is not even a bank at all, just one of those large and obscure members of the global shadow banking system that could easily bring the house down. Over the weekend, the previous weekend’s €35bn ($48bn, £27bn) rescue package for Hypo Real Estate, most of it guaranteed by the German government, collapsed amid fears that the financial situation of the bank was a lot worse than originally assumed. As we wake up this morning, I bet that in Germany at least the complacency is over.
The Europeans are of course right in their overall ambition not to allow systemically important banks to fail. They are also right in their scepticism about their ability to distinguish between illiquidity and insolvency during an emergency. But I fear we are still well short of a strategy. We might be lucky, and scrape through what could well become the most dangerous month of the crisis so far. If, for example, the credit default swap market were to blow up in the next couple of weeks – a non-trivial probability – we have no plan.
Nicolas Sarkozy, the French president, was therefore right when he appeared to back a €300bn rescue fund. Regular readers of this column will probably recall my somewhat constrained enthusiasm for his economic policies. But this had the makings of a good plan. He ended up distancing himself from it, when it became clear that Angela Merkel, the German chancellor, would not support it. But he was right and she was wrong.
Of course, a European plan should not have been a copy of the bail-out that was finally adopted by Congress on Friday. The US plan failed to address the problem of an undercapitalised banking sector. That issue is even more important in Europe where many banks have an extremely weak capital base, with leverage ratios of 50 or more.
Europe does therefore not need any bail-out plan, but a plan that specifically addresses the capitalisation problem. Concretely, three things are needed: the first and most important is money. A sum of €300bn will not cover the EU in a worst-case scenario, but it is a sensible number to start with; secondly, you need a semi-permanent crisis committee empowered to take decisions; and finally you need a strategy to apply symmetrically and based on clear rules about when to recapitalise, and when not.
If you pursue a strategy of taking purely national decisions, you run the risk that at least one government will hit its own financial ceiling before this crisis is over, or that decisions have negative spillovers on the banking systems of other countries. Moreover, you end up with a beggar-thy-neighbour regulatory race, as we saw last week when Ireland and Greece unilaterally issued blanket guarantees for large parts of their banking sector. Last night, Germany was preparing a full deposit guarantee for its own banking system.
Last but not least is the risk of violent political setback against a process that lacks transparency. For Europe, this is more than just a banking crisis. Unlike in the US, it could develop into a monetary regime crisis. A systemic banking crisis is one of those few conceivable shocks with the potential to destroy Europe’s monetary union. The enthusiasm for creating a single currency was unfortunately never matched by an equal enthusiasm to provide the correspondingly effective institutions to handle financial crises. Most of the time, it does not matter. But it matters now. For that reason alone, the case for a European rescue plan is overwhelming.
BNP Paribas to Buy Fortis Units for $20 Billion
BNP Paribas SA agreed to take control of Fortis in Belgium and Luxembourg for 14.5 billion euros ($19.8 billion), completing a breakup of the largest Belgian financial- services company after a government rescue failed. France's biggest bank will pay 9 billion euros in stock and 5.5 billion euros in cash for 75 percent of Fortis Bank Belgium, all of the Belgian insurance operations and 67 percent of Fortis's bank in Luxembourg, Paris-based BNP Paribas said today. Fortis's risky assets will be split off into a separate entity.
"They're taking over a majority of the assets and a minority of the problems, but they're not protected," said Mamoun Tazi, a London-based analyst with MF Global Securities Ltd. who has a "buy" rating on BNP Paribas shares. "The execution risk of acquiring these operations is significant and management resources will be stretched."
Governments from Brussels to Berlin are racing to shore up Europe's faltering financial institutions as the global banking crisis escalates. In Germany, the government and the country's banks and insurers agreed yesterday on a 50 billion-euro rescue package for Hypo Real Estate Holding AG, after an earlier agreement fell apart. European leaders meeting in Paris this weekend pledged to bail out their own nations' banks, stopping short of a regional rescue effort.
"We set out to defend the interests of the bank and its depositors," Belgian Prime Minister Yves Leterme said at a press briefing in Brussels late yesterday. These measures "will provide the means for Fortis Banque to develop." The Belgian state will become BNP Paribas's largest investor with a 11.6 percent stake, and Luxembourg will own 1.1 percent of the Paris-based lender after the deal. Belgium will appoint two new members to the French bank's board. Chief Executive Officer Baudouin Prot, on a conference call with analysts today, said BNP will probably keep the Fortis brand in Belgium.
The French bank fell as much as 6 percent, and was down 3.5 percent at 68.84 euros by 4:09 p.m. in Paris, valuing the French bank at 62.8 billion euros. Fortis shares will be suspended until investors have had the opportunity to analyze the impact of the agreement, Belgium's stock market regulator said.
"Uncertain days are over for Fortis's saving-account holders," Prot said. "Bigger is better especially when you do it at attractive pricing," he said, adding that BNP Paribas doesn't plan any asset sales to finance the purchase. Nor is the Paris-based bank planning "big" acquisitions in corporate and investment banking, Prot said. "BNP Paribas will remain ready to seize small- or mid-size" acquisitions, he said.
The French bank will gain about 3.3 million retail clients in Belgium and Luxembourg, as well as 1,458 branches, including those in Poland, Turkey and France. BNP Paribas will also acquire Fortis's Belgian insurance business, and its investment management operations, private banking, merchant banking and consumer finance operations, all outside the Netherlands.
With about 586 billion euros in deposits, BNP Paribas will become the largest lender by that measure in the 15 countries sharing the euro, the bank said.
"Fortis was a model in combining banking and insurance," Prot said. "It was key for BNP Paribas to keep and master the unity of these activities," he said. The purchase of Fortis in Belgium and Luxemburg will probably be completed by December or January, Chief Financial Officer Philippe Bordenave said.
BNP Paribas has been able to make acquisitions after suffering smaller subprime losses than rivals such as Deutsche Bank AG and UBS AG. The French company agreed in June to buy Bank of America Corp.'s prime brokerage unit, which caters to hedge- fund customers, for as much as $300 million. Under the terms of the deal with Belgium, Fortis will split off a 10.4 billion-euro portfolio of structured products into a separate entity.
The remaining Fortis holding company will have a 66 percent stake in that portfolio, the Belgian government 24 percent, and BNP Paribas 10 percent. Fortis will also hold onto its international insurance operations. The products transferred to the vehicle, to be marked down on average by an estimated 30 percent, haven't been selected yet, Fortis Chief Financial Officer Lars Machenil said. The portfolio represents only a "small part" of Fortis's total structured credit portfolio, said Fortis CEO Filip Dierckx.
Fortis had 41.7 billion euros of structured investments at the end of June, including collateralized debt obligations and U.S. mortgage-backed securities. The portfolio is divided between the new entity, the Dutch insurance unit bought by the Netherlands and Fortis's Belgian banking division, Dierckx said. Selling the assets soon wouldn't be in the company's interest, he said. "The 10.4 billion-euro of assets will be chosen by us," Bordenave said. "We are going to select all the lines we dislike in this portfolio."
Fortis, formerly the largest Belgian financial-services firm, got an 11.2 billion-euro capital injection from Belgium, the Netherlands and Luxembourg last week. The Dutch government took control of Fortis's units in the Netherlands for 16.8 billion euros on Oct. 3 after deciding the rescue didn't go far enough. Fortis became a casualty of the global financial turmoil after pouring 24.2 billion euros into the acquisition of ABN Amro Holding NV assets last year just as the U.S. subprime-mortgage market collapsed and credit markets froze.
"Few people would have predicted what has taken place over the past week," Dierckx told reporters. "In the current market environment in which the whole financial sector has been hit, we didn't have any other choice." In the Sept. 28 rescue that went awry, the three Benelux governments agreed to put capital into Fortis by purchasing minority stakes in the banking units in each country. Fortis also planned to sell ABN Amro's private-banking and Dutch retail banking units, which hadn't been integrated.
As clients withdrew money and Fortis had trouble obtaining loans, the Dutch government decided to buy Fortis Bank Nederland Holding NV, Fortis Insurance Netherlands NV and Fortis Corporate Insurance NV, and the company's holding in ABN Amro. "The new alliance between Fortis and BNP Paribas is an important step in the further stabilization of the financial system," Dutch Prime Minister Jan Peter Balkenende and Finance Minister Wouter Bos said in a joint statement. "All in all, there's a win-win situation for all involved parties."
Governments are protecting banks as the financial crisis that drove Lehman Brothers Holdings Inc. and Seattle-based Washington Mutual Inc. into bankruptcy widens. Ireland's government is guaranteeing banks' deposits and debts for two years, seeking to restore confidence in the country's financial industry. Last week, Belgium and France threw Dexia SA a 6.4 billion- euro lifeline and Britain seized Bradford & Bingley Plc, the U.K.'s biggest lender to landlords.
The party's over for Iceland, the island that tried to buy the world
The snow has arrived early in Reykjavik after an unusually long and warm summer. The freeze has brought out the ghostly green haze of the aurora borealis - the Northern Lights - the shape of which shifts dramatically across the tiny city's black skies.
The bars and restaurants of Iceland's capital are packed, the Range Rovers and BMWs are parked nose to tail all along the streets of the central 101 district, and music is pumping from a black stretch Hummer limousine cruising by.
'What can we do? Its difficult times but we've spent all day talking about it, watching the news getting worse and worse. We had to go out and be with friends. Maybe it's like the party at the end of the world,' says Egill Tomasson, 32, sitting in the Kaffeebarinn bar.
Iceland is on the brink of collapse. Inflation and interest rates are raging upwards. The krona, Iceland's currency, is in freefall and is rated just above those of Zimbabwe and Turkmenistan. One of the country's three independent banks has been nationalised, another is asking customers for money, and the discredited government and officials from the central bank have been huddled behind closed doors for three days with still no sign of a plan. International banks won't send any more money and supplies of foreign currency are running out.
People talk about whether a new emergency unity government is needed and if the EU would fast-track the country to membership. On Friday the queues at the banks were huge, as people moved savings into the most secure accounts. Yesterday people were buying up supplies of olive oil and pasta after a supermarket spokesman announced on Friday night that they had no means of paying the foreign currency advances needed to import more foodstuffs.
This North Atlantic volcanic island, which is the size of Cuba, with a population of 320,000 - the size of Coventry's - is an unlikely player on the global financial stage. It is famous for its fish, geysers and for winning the UN's 2007 'best country to live in' poll. But Iceland built its extraordinary wealth on the crest of the worldwide credit boom and now the crunch is sweeping it away, bankrupting a people for whom the past eight years have been, for most of them and by their own admission, one long party.
The nation's celebrated rags-to-riches story began in the Nineties when free market reforms, fish quota cash and a stock market based on stable pension funds allowed Icelandic entrepreneurs to go out and sweep up international credit. Britain and Denmark were favourite shopping haunts, and in 2004 alone Icelanders spent £894m on shares in British companies. In just five years, the average Icelandic family saw its wealth increase by 45 per cent.
But, as a result of the international banking crisis, the billionaires who own everything from West Ham United football club to the Somerfield supermarket chain, Hamleys toy shops and the House of Fraser, are in trouble and the country is drowning in debt. Iceland's cheap labour force, the Poles and Lithuanians, have left already - there's little point in sending home such a worthless currency, and the tourist season is over. Iceland is on its own.
In the Kaffeebarinn, Egill Tomasson isn't drinking because he has a music festival to organise. Iceland Airwaves takes place in a fortnight, when more than 100 Icelandic bands and 50 foreign ones will play in venues around the city over four days. Most of the tickets have been sold in krona, but the international acts need to be paid in euros, which is going to cost the organisers dearly.
'People here are going to need this festival,' says Tomasson. 'This crisis has been a heavy blow. And many people should have a bad conscience for what has happened. Someone should be prosecuted, they have sucked Iceland dry, taken the money and ran, and left us totally in the shit. People I know who have gone to the UK or the US to study have found their grants worthless, they are stranded.'
Like many his age, Tomasson has only a vague memory of harder times, before the boom that brought Iceland the highest per capita wealth in the world. Older islanders call them the 'Krutt-kynslotin' - the cuddly generation. Eco-aware, earnest but pampered, they drift from organic café to bar, listening to the music of Björk and Sigur Rós, islanders who have made it big abroad. 'They will have to get their hands dirty now,' says chef Siggi Hall, Iceland's answer to Gordon Ramsay, with an effusive vocabulary to match.
'That's good though, they are the I-generation; iPods, iPhones, everything starts with I. Well, we will have to go back to the basics now. Icelanders are risk-takers, but hard working, they will have to downsize. We will have to eat haddock and Icelandic lamb and forget these imports of goose livers and Japanese soy sauce. When everyone was extremely rich in Iceland - you know, last month, it was with money that they never have earned. Now those who were extremely rich are just normally rich, but they think they are poor. They were spoilt, spending billions.'
Hall is due to open his new restaurant on 17 October, but insists the crisis is not worrying him. 'I had been losing customers because people were flying off to Copenhagen and London and New York for the weekend, to eat out. Now they will stay in Iceland, but they will still eat out. People need to eat.'
Outside the city's Hofdahollin car showroom, looking a little rumpled for men trying to sell new and used cars for £35,000 and up, owner Runar Olafsson and his top salesman are sharing a Marlboro. They are not expecting any customers today. 'A few years ago we couldn't get enough top-end cars and we started importing them. We were selling 120, 140, a month. But it turned around so fast,' says Olafsson. 'It's so dramatic, just in one month. We have already seen two dealers go down.
'Customers would come in and we would apply for credit online for them, a 100 per cent loan, and they can drive away in their new Range Rover. It took ten minutes, it was very easy. But 60 to 70 per cent of those loans were in foreign currency, Japanese yen or Swiss francs, and they have gone up 90 per cent as the krona burns. A car worth 5 million krona now has a 9 million loan on it; how are people going to make those payments?'
Foreign currency loans are a problem for homeowners, too. 'Loans have been very cheap, house prices rose and there was a lot of good-quality housebuilding. But the building has halted, nothing is being finished, nothing is selling. The interest rates are staggering. What people are doing now is swapping houses if they want to go bigger or smaller. That is what is keeping us afloat,' says estate agent Ingolfur Gissurarson. His mobile goes off - the ringtone is A Hard Day's Night by the Beatles. 'I changed it to suit the times,' he smiles.
Blame it on the Vikings. Icelanders like to hark back to their ancestors, the rebel Vikings who, as the nation's most revered daughter Björk once explained, 'couldn't deal with authority in Norway. So they flew off in this mad ocean in a wooden boat which is pretty hardcore, North Atlantic in the year 800. And they found this island full of snow ... yeeeah!'
'The Icelandic psyche is an important part of all of this,' says Hellgrimur Helgason, who writes an outspoken newspaper column which exposes feuds between Iceland's ruling class and its entrepreneurs. He is also the author of 101 Reykjavik, a popular novel populated by 'Krutt-kynslotin' characters.
'Before the market reforms the country had stagnated, no one thought Icelanders could be businessmen. We were poor fishermen or farmers, so it had an incredible effect on confidence when we saw these young men out buying up British and Danish companies. Everyone grabbed at the new opportunities like children. Really, it was no surprise that Hamleys toy shop was one of the first purchases.'
Gunnghilder Sveinbjarna and her friend, Anna Lara Magnusdottir, are ordering their second bottle of red wine in the Philippe Starck-designed interior of Reykjavik's Bar 5. Tonight the young women are feeling no pain. 'We come out at the weekend to forget our children and our problems, and this time we will drink extra hard to make sure we forget the economic crisis too,' says Gunnghilder, raising a glass. 'Tomorrow the sore head.'
In the Arabian Nights, the beautiful princess Scheherazade buys one day of life at a time by recounting fantastic fables that entrance the King who has condemned her to die. Investors and traders are currently telling each other fairy tales to buy one day at a time to stave off the inevitable.
The drama and tumult of recent events are not symptoms of the disease but the cure. The "disease" is the excessive debt and leverage in the financial system, especially in the US, Great Britain, Spain and Australia. In the lyrics of the Bruce Springsteen song - many have "debts that no honest man could pay". The "cure" is the reduction of the level of debt (the great "de-leveraging").
In 1931, Treasury Secretary Andrew Mellon explained the process to President Herbert Hoover: "Liquidate labour, liquidate stocks, liquidate the farmers, liquidate real estate. Purge the rottenness out of the system. High costs of living and high living will come down. … enterprising people will pick up the wrecks from less competent people."
The initial phase of the cure is the reduction in debt within the financial system. The overall losses to the financial institutions (net of re-capitalisation via new equity issues) are $400 to $600 billion and may well go higher. This requires reduction in financial sector balance sheets (assuming bank system leverage of around 10 times) of around $4 to $6 trillion through reduction in lending and asset sales.
For example, the bankruptcy of Lehman Brothers resulted in $600 billion of debt being eliminated. In turn, this inflicts losses on holders of Lehman debt that in turn flows through the chain of capital. The destruction of Lehman Brothers’ capital (around $20 billion) also permanently diminishes the capacity for further credit creation in the future.
The second phase of the cure is the higher cost and lower availability of debt to the real economy. This forces corporations to reduce leverage by selling assets, reducing investment and raising equity (for example, as GE have done). This also forces consumers to reduce debt by selling assets (where available) and reducing consumption.
Feedback loops mean reduction in investment and consumption lowers economic activity placing stresses on corporations and individuals setting off defaults that trigger losses for the financial system that further reduces lending capacity. De-leveraging continues through these iterations until overall levels of debt reach a sustainable level determined by lower asset prices and cash flows available to service the debt. The process of destruction echoes W.B.Yeats’ words: "All changed, changed utterly: A terrible beauty is born."
Within the financial sector, de-leveraging is well advanced. In the real economy it is in the early stages. Fairy tales in financial markets focus on the "superhuman" abilities of regulators and governments to avoid the de-leveraging under way.
Central banks and governments have aggressively supplied liquidity to the money markets accepting an increasing range of collateral. Central banks may soon accept baseball cards and Lehman, Bear Stearns and Washington Mutual ("WaMu"), Fortis and Dexia memorabilia (mugs, stress balls, desk-decoration cubes that open up to reveal Lehman Brothers’ key operating principles. - "demonstrating smart risk management").
Central banks are acting as "buyers of last resort" rather than "lenders of last resort". They are providing cheap (negative real interest rate) term funding. The loans will have to be rolled over, as the banks cannot repay them. They will only be repaid from the underlying cash flows of the assets lodged as collateral.
Government and central banks have also "bailed out" a number of financial institutions using a variety of strategies to limit contagion.
Lower interest rates and increased government spending has been used to try to reduce the effects of the financial crisis on economic activity. The US government’s $700 billion package is the latest magic potion. It is puzzling why this initiative is seen as the "silver bullet" that will "fix" the problems.
A cursory analysis of TARP (Troubled Asset Relief Program) reveals considerable confusion about even what problem it is addressing. The proposal to purchase up to $700 billion in "troubled" assets is not dissimilar to the existing liquidity support provisions in place. If assets are correctly valued in the books of the selling banks, then purchase at that fair value only provides funding to the bank. The difference is the risk of the securities is transferred to the government but so is any possible recovery in the price.
There are different views as to what price should be paid by the government for these assets. Under one approach, the government would pay a "hold-to-maturity" price that may be (perhaps significantly) higher than the "market" price or the value in the bank’s book. This would provide the bank with liquidity as well as capital (the gain between the price paid and the lower value to which the bank has written down the asset).
The alternative approach would be pay "market" values. This would provide liquidity to the selling banks but no capital. It may even trigger additional losses where the assets are carried at higher values creating incentives against participation. There is also a small problem that nobody, even the super bankers with super computers, seems to have a clear idea what the securities are worth in any case.
Purchases of troubled assets are also conditional on (correctly) protecting the taxpayers against losses. This requires banks to provide the government with equity or equity-like interests in exchange for participating in the program. Alternatively, the institutions selling the assets will need to enter into contingent arrangements to minimise the risk of loss to the taxpayer. Commentators have gone into rhapsodies about the ability of the taxpayer to "profit" from the program. This creates potential conflicts for financial institutions whose fiduciary duties require maximisation of returns for shareholders.
It is not clear what securities will be eligible for purchase and exactly who will be allowed to participate. Amusingly, the recent short selling ban on financial institution stocks saw a curious array of companies claim that they were financial institutions! Gaming of the system will be practically difficult to control.
In fairness, the final form of TARP has not been settled and may provide greater clarity on these points.
TARP and many of the other initiatives merely transfer the problem onto the US government and taxpayer balance sheet.
Government support for financial institutions in this financial crisis is already approaching 6% of GDP (compared to less than 4% for the Savings and Loans crisis). This will ultimately place increasing pressure on the US sovereign debt rating and vitally the ability of US to finance its requirements from foreign creditors.
Government and central bank initiatives to date have been ineffective. Money markets remain dysfunctional and inter-bank lending rates have reached record levels relative to government rates. The failures are unsurprising.
At the height of the boom, banks used a variety of techniques to increase the velocity of money. As the system de-leverages, the velocity of money has sharply decreased. Money being supplied to the banks is not being lent through. Banks are parking the money in short dated government securities in anticipation of their own funding requirements.
Around $2-3 trillion of assets are returning to bank balance sheets from the "shadow" banking system of off-balance sheet structures that can no longer finance themselves. In addition, banks have large amount of maturing debt (estimates suggest $1.5 trillion by the end of 2008) that they must fund. Fear of bank failure (especially after the bankruptcy of Lehman and restructuring of WaMu) and shortages of capital also limit ability of bank’s to on-lend.
The initiatives do not address the required re-capitalisation of banks to enable them to take on risk assets and also reduce fear of default allowing normal activity between institutions to resume. Ultimately, "all the king’s horses and king’s men" cannot prevent the de-leveraging of the financial system under way. At best, the actions can smooth the transition and reduce the disruption to economic activity. The risk is that well-intentioned steps prevent the required adjustments from taking place, delay recognition of problems and discourage action that must be taken by financial institutions, corporations and consumers.
The extent of de-leveraging is substantial and likely to take time. It is clear that all asset prices must adjust significantly. The key issues are availability of capital and liquidity. The perceived abundance of liquidity was, in reality, merely an illusion created by high levels of debt and leverage. As the system de-leverages, it is becoming clear unsurprisingly that available capital is more limited than previously estimated.
Central bank reserves and sovereign wealth funds are often cited as evidence of the amount of available capital. These reserves are invested in US dollar denominated US Treasury bonds, GSE paper and AAA rated asset-backed securities. It will be difficult to mobilise the funds and convert them into the home currencies of the investors without large losses.
Government and central bank actions need to be focused on managing the transition to a lower debt world. Actions should be directed to three areas. Banks must be forced to write-off bad loans without delay even if this means breaching minimum solvency capital requirements. Bank capital needs must be addressed by forced mergers and restructuring, new equity issues and (in the absence of other options) nationalisation or liquidation.
Central banks need to guarantee (for a fee) all major bank transactions to reduce counterparty risk enabling normal transactions between banks and other parties in the financial markets to resume. Elements of these actions are already in place but the absence of a co-ordinated global strategy reduces effectiveness.
A global conference (along the lines of Bretton Woods) under a respected chairman (Paul Volcker is the obvious choice) must be convened. It would bring together all the major players including the vital creditor nations – China, Japan etc – to develop a framework for the major economic reforms (currency policies, fiscal disciplines, trade barriers) to work towards a resolution of the crisis.
A principal objective of this conference would be ensuring supply of funding for the US in the transition period. Recent comments by China about US responsibility for the crisis and its resolution miss the point. As China’s Premier Wen Jiabao observed the U.S. financial may "affect the whole world". As Wen noted: "If anything goes wrong in the U.S. financial sector, we are anxious about the safety and security of Chinese capital…" All creditors have much to lose if the de-leveraging process becomes dis-orderly.
Like a giant forest fire the de-leveraging process cannot be extinguished. Thoughtful actions can create firebreaks that limit preventable damage to the economy and the international financial system until the fire burns itself out.
The Arabian Nights had a happy ending. The King after 1,001 night of enchantment and three sons pardons the beautiful Princess Scheherazade who becomes his queen. Despite the fairy tales that investors are putting their faith in currently, the de-leveraging that is at the heart of the current financial crisis may not have such a happy ending.