Houses and abandoned cars of migratory workers in Belle Glade, Florida
Ilargi: A little over a week ago, I compared the goings-on in the wild wanky world of finance with the theatre of the absurd. That comparison no longer holds. We have, in the space of a few days, moved from absurdity into outright insanity, from Waiting for Godot to One Flew over the Cuckoo’s Nest. This is a dangerous development.
We have seen "emergency" measures follow each other faster and faster, each time with -much- higher amounts of money involved, and each time with less impact on markets. Obviously, none of it has worked so far. The reason is not just that the tools are wrong; it’s also that the bigger the gesture becomes, the hollower it is. The more you try to exhibit strength, the easier it is to see your fear.
So far, central banks and governments have been exposed by the markets as naked emperors. To wit, a good example of the lunatics’ take-over today comes from the US, where the Fed proposes to buy unsecured debt. As the ban on (naked) short selling expires tomorrow, the Federal Reserve announces it will move into some sort of naked buying.
The idea seems to be that it will allow businesses to borrow more easily, this time directly from the Fed (which in turn borrows the funds from the Treasury, which borrows it from you). Yeah, and then what? Will companies become more solvent through loans? Uh... nope. They'll perhaps be able to prolong the suffering for a short while, but the American people, whose purchasing power is needed to keep companies healthy, will still get poorer.
I’ve also asked if a country can go bankrupt. We now see Iceland on the brink. It has in despair turned to Russia for loans, after somewhat puzzlingly being turned down by other western countries. It bought a second bank in a week, and pegged the kruna to the Euro, a move that is full-blown crazy. Iceland could soon be forced to do what Argentina did, absolve its currency, and confiscate its citizens’ deposits. That will not be pretty. It’s basically for sale to the highest bidder.
Continental Europe is like a house on fire, with nothing to fight the flames but bottled Evian water. No matter what they say, the European emperors, they can't fix their problems in a coordinated fashion. The legal tools are not there, and both conditions and interests are too diverse to make up the rules as they go along. It will be easier for the countries to face the fires separately. Who will be the first to go?
Another much talked-about cooperation that cannot possible work is an across-the-board global interest rate cut, For one thing, Japan’s rate is 0.5%. Where would they go from there? More importantly, low interest rates are perhaps the main underlying factor for the entire credit crisis in the first place. If you ask me, it’s superbly clear that you can't solve it by ... lowering interest rates. In fact, I'd say that's a sign of insanity. Sure, all involved would love to resurrect the yen carry trade, but that is not going to happen; not in this century.
A crucial part of the "fall-out of the downfall" looks set to be a plummeting commodities market. The consequences could be grave, in the short and medium term. We are already seeing Brazil and Russia being hit pretty badly, and next on the list might well be Canada. It has elections next week, and there is no telling where Canadian economy will stand by then.
Naked emperors with closets full of skeletons. Perhaps an idea for a Halloween costume. Then again, there's a fair chance that in three weeks the world will be such a scary place that you don't even need a costume.
Iceland Seeks Loan From Russia, Pegs Krona to Euro, Takes Over Another Bank
Iceland sought a 4 billion-euro ($5.43 billion) loan from Russia, pegged the slumping krona to a basket of currencies and took control of its second-biggest bank to stem a collapse of the financial system.
Central bank Governor David Oddsson said an announcement earlier today in Reykjavik that the Russian loan had been agreed was incorrect and talks were "ongoing." Russian Finance Minister Alexei Kudrin confirmed that "we have a request from the Icelandic government" and said Russia's reaction is "positive."
The global credit crunch has crippled Iceland's biggest banks, which racked up foreign debts equivalent to as much as 12 times the size of the economy. The nation's current account gap swelled to the equivalent of 34 percent of gross domestic product in the second quarter, mainly because of the cost of debt payments.
"The commercial bank model there has failed," said Sunil Kapadia, an economist at UBS Ltd. in London. "For such a leveraged economy as Iceland, it was clear this was going to happen, but the pace has been surprising." About 90 percent of the external debt was generated by the three biggest banks, Kaupthing Bank hf, Landsbanki Islands hf and Glitnir Bank hf. The government took control of Landsbanki today, following the nationalization of Glitnir on Sept. 29, loaned 500 million euros to Kaupthing and guaranteed domestic deposits.
Prime Minister Geir Haarde said at a press conference he was "disappointed" that "we have not received the kind of support we requested from our friends." He declined to name countries Iceland may have approached for a loan, adding that the nation "will absolutely not default on its foreign debt."
The central bank said it pegged the koruna against a basket of currencies at a rate equivalent to 130 per euro. Still, traders at UBS stopped trading the currency after markets became illiquid, Kapadia said. According to Nordea Bank AB, the krona traded at 200 to the euro as of 11:39 a.m. in Reykjavik. That's 53 percent weaker than the peg implies.
"I'm deeply surprised -- this peg is not credible at all," said Lars Christensen, senior currency strategist at Danske Bank A/S in Copenhagen. "A credible peg needs a credible set of measures to stabilize the economy and we haven't seen that yet."
The credit crunch intensified across the world today. In Europe, U.K. lenders held talks with the government on emergency funding, and in Asia, Japan and Australia's central banks pumped more than $11 billion into markets to revive lending. The Reserve Bank of Australia also slashed its benchmark interest rate by a percentage point, twice as much as economists forecast.
Iceland's oversized bank industry means it's "probably in the worst position in the developed world to cope with the ongoing credit crisis," Deutsche Bank AB economist Henrik Gullberg said before today's announcements. The Financial Supervisory Authority said earlier today it had taken control of Landsbanki, a move that reflected the "risk of default" at the lender, according to Chamber of Commerce spokesman, Finnur Oddson.
Kaupthing said today it received a 500 million-euro loan from the central bank and that it hasn't been approached by the FSA. "It seems they'll allow some banks to go bankrupt but that they've chosen Kaupthing to survive," Kapadia said.
The seizure in global credit markets is deepening on speculation central bank attempts to revive lending between financial institutions won't work, resulting in more bank failures.
The London interbank offered rate, or Libor, that banks charge each other for such loans rose 157 basis points to 3.94 percent today, the British Bankers' Association said.
Government urged to act as Royal Bank of Scotland leads plunge in UK banks
After a tumultuous morning's trading, CBI deputy director-general John Cridland urged the Government to deliver a "circuit-breaker" to stem plunging confidence in Britain's banking system.
"The UK Government has already provided a political guarantee that deposits are safe if a bank fails," Mr Cridland said. "The pressing need now is for coordinated and consistent statements from the governments of each leading economy, to prevent beggar-thy-neighbour reactions."
The CBI's call came after a morning during which Royal Bank of Scotland shares at one point crashed more than 50pc as fears for the health of the financial system intensified. Shares in RBS, the owner of mortgage lender Natwest, had recovered some of their losses by early afternoon in London, with the shares trading down 24pc at 113p.
Shares in HBOS, the owner of Halifax, dropped by as much as 18pc, Barclays fell by up to 16pc and Lloyds TSB fell 21pc after news that the banks had reportedly asked the Government for capital in order to support their businesses. HBOS also denied that they requested more capital.
The chief executives of RBS, Barclays, Lloyds TSB and HBOS met the chancellor, Alistair Darling, on Monday night and told him they support the Government's plan to take substantial shareholdings in return for an injection of billions of pounds.
However, a Barclays spokesman said it had "categorically not" requested any capital from the Government.
RBS initially declined to comment on its share price movement or the reports of a plea for a Government capital boost, except to confirm that Sir Fred Goodwin, the chief executive, was part of the team of banking bosses involved in last night's meeting with the Chancellor. However, just before 1pm, RBS issued a statement saying: "Contrary to press speculation, RBS did not make a request to government to capital."
Lloyds TSB reiterated that it is looking at raising more funds to boost its capital ratios. A spokesman said: "We have been and we are going to be taking a number of actions to improve our capital ratios to the band that we want. We will look at opportunities as they present themselves. We do believe we have a robust capital position, but in the current environment, we would like it to be a little stronger."
Analysts yesterday predicted the Government might need to pump between £30bn and £50bn into the banks. Sources said last night they expect a plan of action to be hammered out over the next couple of days. The cash injection would be in the form of preference shares, and it is possible the Government would hand over some cash now while also saying there would be a pot of cash available if banks need money several months down the line. "There is a realisation that some of the more radical options have to be put on the table," a senior banking source said.
Australia Slashes Rates, Central Banks Inject Cash
Australia slashed its benchmark interest rate by the most since 1992 and central banks pumped more than $480 billion into money markets as policy makers tried to staunch the worsening financial crisis. Australia's central bank lowered its key rate by one percentage point to 6 percent, twice as much as economists forecast.
The European Central Bank and its counterparts provided extra funds one day after the worldwide stock market slide wiped more than $2 trillion off investors' wealth. The moves failed to stem strains in credit markets that have pushed Iceland's financial system close to collapse and sent European money-market rates to records today. With financial conditions deteriorating, central banks are coming under pressure to follow Australia and cut interest rates.
"There seems a growing chance of emergency ECB and Bank of England easing in the next few days," said Michael Saunders, chief western European economist at Citigroup Inc. "To be sure, early easing, even 50 basis points or more, would not provide a full solution to the current economic and financial crisis." ECB President Jean-Claude Trichet is scheduled to speak in Evian, France at 3:30 p.m. local time today. Fed Chairman Ben S. Bernanke will discuss the economic outlook from 12:30 p.m. in Washington. They will meet Group of Seven counterparts in the U.S. capital on Oct. 10.
The ECB today loaned banks 250 billion euros ($339 billion) in seven-day funds, six times more than it initially estimated would be needed. It also lent banks $50 billion for one day at a marginal rate of 6.75 percent, more than three times the Federal Reserve's 2 percent benchmark interest rate. The Australian rate cut triggered a rebound in Asian stocks on speculation other countries will follow to unlock credit markets. The MSCI Asia Pacific Index pared a 3.2 percent loss and ended the day 1.2 percent lower.
"Rumors are now circulating that today's aggressive move by the Reserve Bank of Australia is the precursor for coordinated rate cuts by global central banks," said Katie Dean, a senior economist at Australia & New Zealand Banking Group Ltd. in Melbourne. So far, some central banks have been reluctant to move as fast as the Fed in lowering borrowing costs. Indonesia's central bank today raised its policy rate to slow inflation and boost the rupiah.
The ECB in July increased its benchmark rate to 4.25 percent and the Bank of England has left its key rate at 5 percent since April. The Fed by contrast has slashed its benchmark by 3.25 percentage points to 2 percent. As the credit squeeze worsens and spills over into Europe's economy, its central banks may nevertheless have to act. Trichet said Oct. 2 that the ECB considered easing policy last week. The Bank of England will cut its benchmark rate by at least quarter point on Oct. 9, according to 48 of 61 economists in a Bloomberg News survey.
The concern for governments and central banks is that their measures have so far failed to contain the financial crisis. The London interbank offered rate, or Libor, for overnight dollar loans rose to 3.94 percent from 2.37 percent. One-day rates for loans in pounds climbed to 5.84 percent from 5.08 percent. Earlier today the euro interbank offered rate, or Euribor, for three-month loans reached a record 5.38 percent.
"Despite central banks pumping liquidity into the system, banks are either hoarding cash or putting it into treasury bills," said Ong Hock Ann, a money-market dealer at ING Asia Private Bank Ltd. in Singapore. "It's a question of confidence and trust. There is money, but money is not flowing to the right channels."
Bernanke yesterday signaled he's preparing measures with Treasury Secretary Henry Paulson to unfreeze markets where loans aren't secured by assets. Russia may lend Iceland's central bank 4 billion euros ($5.43 billion) to inject liquidity into the financial system, the bank said today. Financial institutions have incurred more than $585 billion in writedowns and credit-market losses since the collapse of the U.S. subprime mortgage market in early 2007.
Governments in Europe and the U.S. arranged rescues for six financial institutions in the past two weeks. The ECB also added $50 billion in overnight dollar funds. The Bank of England provided $25.9 billion in overnight and weekly money and 31 billion pounds ($54 billion) in three-month funds. The Bank of Japan added 1 trillion yen ($9.8 billion) into money markets and the Reserve Bank of Australia provided A$1.82 billion ($1.3 billion) of funds. The Swiss National Bank today loaned $10 billion of overnight funds.
IMF Urges Coordinated Action, Sees U.S. Losses at $1.4 Trillion
With losses on bad U.S. assets alone expected to top $1.4 trillion, the International Monetary Fund urged global policy makers Tuesday to coordinate a response to an unprecedented financial crisis that continues to spread.
The latest estimate of losses in the Global Financial Stability Report is well above the figure of $945 billion the fund predicted in April, which was considered high at the time by some economists. It also tops the $1.3 trillion forecast given by IMF Managing Director Dominique Strauss-Kahn just two weeks ago.
"With financial markets worldwide facing growing turmoil, internationally coherent and decisive policy measures will be required to restore confidence in the global financial system," the IMF said in the report. "Failure to do so could usher in a period in which the ongoing deleveraging process becomes increasingly disorderly and costly for the real economy."
In its downbeat assessment, the IMF said "threats to systemic stability became manifest" last month, with the failure or near-collapse of major U.S. institutions. The fund estimates that write-downs on U.S. assets totaled $760 billion through September, suggesting the period of financial pain is only around the halfway mark a little over a year after the blowout in the U.S. subprime mortgage sector turned into a global credit crunch.
While European institutions are getting hit mostly by exposure to toxic U.S. assets, mortgage markets in the U.K. and Spain are also coming under increasing pressure. "Global losses could be higher should credit quality worsen and write-downs mount on non-U.S. loans," the report said. "Already, fundamentals are deteriorating in some European economies, where house price appreciation has slowed considerably or turned negative, lending standards have tightened, and mortgage rates have risen."
Emerging markets, which have so far proven resilient to the crisis, are now feeling the heat, as well. Some developing countries "face challenges as global growth slows and the lagged pass-through of domestic inflationary pressures continues -- and all this against the backdrop of lower confidence and the reversal of earlier flows into these markets," the report said. That raises the risk of a credit cycle downturn in their domestic markets.
The world economy is already hurting as its lifeblood of financial market liquidity dries up, and the IMF is poised once again to ratchet down its economic forecasts. On Wednesday, the fund will release its latest global economic estimates, and is expected to reverse at least part of July's upward revision in its 2008 forecast to 4.1% growth. "The strains afflicting the global financial system are expected to deepen the downturn in global growth and restrain the recovery," the report said.
The biggest concern is that the "adverse feedback loop" between the economy and financial system could accelerate, according to the IMF. Noting that the private sector is unlikely to be able to address the problems alone and that "piecemeal interventions" haven't eased market jitters, the IMF welcomed broader efforts to tackle the root causes.
"Such a comprehensive approach -- if well-coordinated among countries -- should be sufficient to restore confidence and the proper functioning of markets and avert a more protracted downturn in the global economy," the report said. Laying out an extensive menu of policy prescriptions, the fund recommended ways to make the necessary deleveraging process already underway more orderly by focusing on "insufficient capital, falling and uncertain asset valuations, and dysfunctional funding markets."
Estimating that major global banks will need about $675 billion in fresh capital just to support modest private-sector credit growth, the IMF said governments may need to provide increasingly scarce capital. "While there are many ways to accomplish this, it is preferable that the scheme provide some upside for the taxpayer, coupled with incentives for existing and new private shareholders to provide new capital," the report said.
On the other hand, the orderly resolution of nonviable banks would demonstrate a commitment to a healthy system, it said. To help prevent "fire-sale" asset liquidations, governments can offer the use of public balance sheets, or allow more flexible use of mark-to-market accounting rules to reduce pressure on valuations, according to the IMF. Meanwhile, the fund welcomed efforts by central banks to continue to inject liquidity into funding markets, which have remained "stressed for an unprecedented period."
The IMF also encouraged ongoing cooperation and coordination between central banks, adding that "continued convergence of their operational procedures would also aid in achieving this goal." Under "extreme circumstances," additional measures such as temporarily increasing insurance on retail bank deposits or guaranteeing debt liabilities may also be considered, the report said.
The private sector also must play a role, the IMF said. Financial firms should shore up balance sheets with new capital, strengthen risk-management practices, improve valuation techniques and create better clearing and settlement mechanisms for over-the-counter securities, it said.
EU raises savings guarantee to €50,000
EU finance ministers today agreed to raise the minimum guarantee for individuals' bank deposits to €50,000 — half the level demanded by the European commission and several countries. The 27 ministers, meeting in Luxembourg amid market mayhem, also gave the green light for national governments to bail out the big banks through injections of public equity.
As more EU countries raised the bar for deposit guarantees to prevent a run on banks, ministers fell out over setting a new EU-wide minimum. The current minimum, set in 1994, is €20,000. Christine Lagarde, the French finance minister, who chaired the "ecofin" talks, said small countries with smaller economies and financial institutions found it hard to meet the €100,000 threshold proposed by commission president Jose Manuel Barroso.
"To paraphrase what someone said: what looks big to you looks enormous to me," she said. The new €50,000 limit applies for "an initial period of at least one year". Sweden has raised the bar to €40,000, while other countries in eastern Europe already find the €20,000 minimum stretching.
Amid continuing recriminations over the scope of Germany's "political" decision to offer limitless guarantees for up to €1 trillion of deposits and Ireland's unilateral move to guarantee all Irish bank liabilities of around €400bn, the EC said it would swiftly produce guidelines on the guarantee schemes and recapitalisation.
Neelie Kroes, EU competition commissioner, said she would issue the guidelines about the compatibility of schemes with state aid rules later this week or early next week. But she signalled that the Danish scheme would be used as a model.
Her comments came as it emerged that Germans were moving millions of euros from commercial banks into state-owned savings banks. A Düsseldorf savings bank said it had received as much as €200m in the past two weeks — the same as for the whole of last year.
Lagarde said "systemically relevant" banks could be bailed out. "We're not going to tolerate a Lehman Brothers scenario. We will take measures, including recapitalisation, and be very specific in what we say," she said. "We'll talk about terms and conditions." These are also due to be set out by Kroes, who has rapidly approved bail-outs such as that of Bradford & Bingley but is under pressure from governments to relax state aid rules.
As Barroso warned in Lisbon of a "renationalisation" of Europe's financial system, the Luxembourg meeting adopted seven "common principles" to try to present a collective front. These include "timely" and "temporary" interventions to bail out banks and replace boardroom directors. But ministers failed to agree on measures to curb executive pay.
ECB injects additional $390 billion into markets to ease turmoil
The European Central Bank (ECB) Tuesday provided 250 billion euros (340 billion U.S. dollars) to commercial banks to ease turmoil stemming from the recent U.S. financial crisis.
The ECB provided the money in a regular one-week loan with interest rate of 4.99 percent. It provided a similar 190 billion euros (some 257 billion U.S. dollars) loan last week at an interest rate of 4.96 percent. The ECB also pumped 50 billion dollars back into interbank money markets on Tuesday.
The ECB has been fighting against the current financial crisis by injecting cash into the market to avoid adjusting key interest rate, which was at 4.25 percent, a seven-year high, to control inflation. Since last week, the financial crisis was worsened in Europe and the world around, and banks need more money to maintain their daily operations and avoid bankruptcy.
On Sunday, the German government said it will provide guarantee for all private banks to fight the current financial crisis in a bid to boost public confidence. On Monday, the government reached an agreement with other banks and insurers of the country to provide a 50-billion-euro (67.6 billion U.S. dollar) rescue package for Hypo Real Estate Holding AG to avoid bankruptcy.
Fed to Purchase U.S. Commercial Paper to Ease Crunch
The Federal Reserve will create a special fund to purchase U.S. commercial paper after the credit crunch threatened to cut off a key source of funding for corporations.
The Treasury will make a deposit with the Fed's New York district bank to help set up the special purpose vehicle. The central bank will also lend to the program at policy makers' target rate for overnight loans between banks. The Fed Board invoked emergency powers to set up the unit, the central bank said in a statement released in Washington.
Today's action follows a slide in the commercial-paper market to a three-year low of $1.6 trillion last week as investors fled even companies with few links to the subprime mortgage crisis. Companies from newspaper firm Gannett Co. to electricity producer Southern Co. have been forced to tap credit lines or forego raising debt because of the market's disruption.
The Fed didn't say how much commercial paper, which hundreds of companies use to finance payrolls and meet other cash needs, it plans to purchase. Stocks climbed and Treasuries sank after the Fed's announcement. Futures on the Standard & Poor's 500 Stock Index gained 1.9 percent to 1,073.60 at 9:15 a.m. in New York. Yields on benchmark 10-year notes climbed to 3.55 percent from 3.45 percent late yesterday.
Today's announcement came hours before Fed Chairman Ben S. Bernanke speaks on the economic outlook at 1:15 p.m. in Washington. He and Treasury Secretary Henry Paulson held discussions yesterday as stock markets slid and money market rates climbed as the crisis deepened. The Fed's new unit will buy three-month dollar-denominated commercial paper at a spread over the three-month overnight- indexed swap rate, which is a measure of traders' expectations for the Fed's benchmark rate.
Commercial paper purchased by the vehicle must be rated at least A1/P1/F1, the Fed said. Issuers will pay the unit an upfront fee based on the commercial paper initially sold to the vehicle. The vehicle will cease buying commercial paper on April 30, 2009, unless the Board of Governors agrees to extend it. The Fed yesterday said it will double its cash auctions to banks to as much as $900 billion, and telegraphed today's announcement by saying it was looking for other ways to alleviate liquidity strains.
Euro, Dollar Gain on Fed Move
The euro gained against the dollar and the dollar gained against the yen early Tuesday morning after the Federal Reserve announced a new funding facility to purchase commercial paper from eligible issuers.
The Commercial Paper Funding Facility comes in response to considerable strains in recent weeks as money-market mutual funds and other investors, often facing liquidity pressures, have become increasingly reluctant to purchase commercial paper, especially at longer-dated maturities, the Fed said in a press release. The facility will complement the Fed's existing credit facilities to help provide liquidity to term funding markets and serve as a backstop to U.S. issuers of commercial paper.
The Fed said the Treasury Department believes that the facility is necessary to prevent substantial disruptions to the financial markets and the economy and will make a special deposit at the Federal Reserve Bank of New York in support of the facility. "A lot of companies that are rated AAA and AA were having some issues. Now, there's a backstop, and that's encouraging riskier positions," said Dustin Reid, a foreign exchange strategist at ABN Amro in Chicago.
The dollar and yen have been benefiting for the last several weeks on the liquidation of yen and dollar-funded investments in higher-yielding, riskier currencies due to the uncertainty in financial markets and expectations for a global recession. Tuesday morning in New York, the euro was at $1.3671 from $1.3507 late Monday. The dollar was at 102.59 yen from 101.61 yen, according to EBS. The euro was at 140.31 yen from 137.39 yen. The U.K. pound was at $1.7561 from $1.7467, and the dollar was at 1.1388 Swiss francs from 1.1469 francs.
These levels follow the euro's decline a day earlier to a 14-month low of $1.3444 and a three-year low of 135.05 yen. The dollar also fell to a six-month low of 100.22 yen. The yen staged a fast advance against its major rivals Monday, and the dollar climbed against the euro and emerging market currencies, when the Dow Jones Industrial Average declined under the 10,000 level.
"The issue here is one of institutions struggling to access dollar funding in the overnight uncollateralized market and instead attempting to raise dollar funding through the FX swap or FX cross currency basis swap market," said Chris Turner, head of foreign exchange strategy research at ING Wholesale Banking in London.
The Fed's plan Tuesday morning is helping to heal the conditions hindering companies from accessing funding. Markets were also encouraged overnight by a surprisingly large rate cut by the Reserve Bank of Australia, which reignited hopes, yet to be fulfilled, for coordinated global measures of easing interest rates. The RBA unexpectedly cut rates by 100 basis points to 6.0%, compared with expectations for a 50-basis-point reduction. However, Chris Turner of ING noted that the RBA is "one of the most pro-active central banks."
Goldman Sachs analyst Francesco Garzarelli wrote in a research note that rate cuts are now in the offing by the Fed, Bank of Japan, European Central Bank and Bank of England by year-end. No major data are scheduled for release Tuesday in New York. However, the Federal Reserve Chairman Ben Bernanke will speak on the economic outlook Tuesday afternoon. Minneapolis Federal Reserve Bank President Gary Stern also speaks Tuesday, on the repercussions from the financial shock. The minutes from the last Fed meeting also will be published.
Elsewhere, emerging market currencies remain under pressure. The unwinding of bets in these markets is in large part what has fueled the dollar's surge. In one example, the South Korean won sank to its lowest close in more than six years overnight.
Meanwhile, Iceland's Prime Minister said Tuesday his country has been talking to Russia about a currency loan, and said Russia has "taken a friendly position on this."
Iceland's central bank issued a statement Tuesday that the exchange rate of the krona has depreciated sharply in recent weeks and is now lower than is compatible with a balanced economy. Iceland's central bank will peg its currency to a basket of currencies, which will then give a euro-Icelandic krona exchange rate of 131, someone familiar with the situation told Dow Jones Newswires. Euro/krona exchange rates have been quoted in recent days at around 200, according to unofficial accounts from currency traders, as official trading in the currency has all but broken down with Iceland fighting for financial survival.
Fed Sets Floor Below Rate Target, Engineering 'Stealth' Cut
The Federal Reserve may have trimmed borrowing costs yesterday without actually saying so. The central bank used power granted under last week's financial-rescue legislation to effectively set a floor under its main interest rate that's lower than the 2 percent target set by policy makers last month.
The Fed may now pay interest on bank reserves while it floods financial markets with liquidity, pushing down the overnight lending rate by about 0.75 percentage point to 1.25 percent. "Absolutely, it's a stealth easing," said John Ryding, founder and chief economist of RDQ Economics LLC in New York and a former Fed researcher.
The announcement, and a Fed decision to double the auction of cash to banks to as much as $900 billion, failed to avert a 3.9 percent decline yesterday in the Standard & Poor's 500 Index. The index has tumbled 28 percent this year even as the central bank has expanded credit more than at any time in seven decades, including a 3.25 percentage-point cut in the main rate during the past 13 months.
"The problem is it's an easing that's trying to offset a massive tightening in the market. Net-net, are we easier in policy? In some sense the answer is no," Ryding said. By paying interest on reserves, the Fed can pump more cash into the financial system without worrying the overnight lending rate will drop to zero at the end of each day as banks withdraw excess reserves. The move doesn't preclude a further reduction in the target rate by the Federal Open Market Committee.
The 0.75-point spread, announced yesterday, was the biggest surprise in the Fed's moves to implement its authority under the financial-rescue legislation, economists said. The Fed set the new rate Oct. 3, the same day the House approved the bill and President George W. Bush signed it into law.
The FOMC, composed of the Washington-based governors and 12 Fed regional-bank presidents, meets about every six weeks to set a target for the overnight lending rate, which the New York Fed tries to achieve by buying and selling Treasury securities from bond dealers.
The Fed requires banks to keep a level of reserves at the central bank. On those funds, the Fed will pay a higher rate equal to the average target rate over a one or two-week period less 0.10 percentage point. For excess reserves, the rate is the lowest FOMC target over a period less 0.75 percentage point. The Fed said it would raise or lower the spread so the New York Fed trading desk can keep the federal funds rate near policy makers' target "based on experience and in response to evolving market conditions." The central bank didn't set a meeting schedule for discussing the reserve-interest rate.
The federal funds rate will probably trade below the FOMC's target as long as the Fed is channeling cash into the banking system, thereby prompting financial institutions to park their funds with the central bank each day. The rate may trade closer to the policy target when the credit crisis eases and the Fed begins to withdraw its emergency lending.
Still, a "soft federal funds rate does not provide a perfect substitute for a cut in the target," former Fed Governor Laurence Meyer and former Fed researcher Brian Sack, now with Macroeconomic Advisers LLC in Washington, said in a research note to clients.
The Fed said yesterday "the rate on excess balances should be set sufficiently low to provide an incentive for eligible institutions to trade funds in excess of required reserve balances and clearing balances in the federal funds market." The rate should also discourage banks from trading funds "far below" the federal funds rate. The interest payments begin Oct. 9.
A higher rate on payments may give banks too much of an incentive to keep funds at the central bank, said Peter Hooper, chief U.S. economist at Deutsche Bank Securities Inc. in New York and a former Fed official. "The whole objective here is to get banks to start lending again, and the more you pay them to hold on to their reserves, the less likely they'll be willing to lend."
Even if the funds rate trades below the 2 percent target, it doesn't mean the FOMC is deploying a new policy tool by paying interest on reserves, said Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York. "I doubt the FOMC will want to give up their Fed funds rate target as the key indicator of monetary policy."
Russia and Brazil crumble as commodity prices crash
The entire complex of commodities and emerging market stocks, bonds, and currencies is now in free-fall as the economic crisis spreads like brushfire, threatening to draw every corner of the globe into the vortex of recession.
Oil, grains, and industrial metals all crumbled as the week began despite the passage of the Paulson bail-out plan in Washington and dramatic moves by European governments to shore up their banking systems, compounding the steepest commodity crash in over half a century. The big exception yesterday was gold, which surged $34 to $864 an ounce on safe-haven buying as the markets came face to face with the unsettling reality that the euro is no healthier than the dollar, and perhaps sicker.
The euro’s dramatic slide over the past two weeks has for the first time exposed the instability of the twin-pillar system holding up global finance. Hans Redeker, currency chief at BNP Paribas, said investors fear that no one is in charge of Europe’s monetary union. “Who is Mr Europe? What is his telephone number? There is no such thing. We have a cancer eating at the system because even healthy companies cannot roll over their debts, yet the politicians still don’t understand the risk,” he said.
The sudden shift in commodity sentiment has led to a massive withdrawal of funds from frontier markets, triggering stock market routs across Latin America, Asia, and Eastern Europe. The MSCI index of emerging markets fell 11pc yesterday in its worst day ever. Russia suspended trading after Moscow’s Micex index crashed 19pc in its biggest one-day drop since the 1998 default. The state-controlled VTB bank fell 25pc.
“Traders are just sitting there staring at the screens and going, 'Wow’,” said Ron Smith, a strategist at Alfa Bank. Brazil shut the Sao Paulo exchange after the Bovespa index crashed 15pc in panic trading, led by flight from the resource giants Vale and Petroleo Brasileiro. Mexico’s Bolsa was off 7pc; India’s Sensex was off 6pc.
The Goldman Sachs Commodity Index has tumbled a third since May. Chartists say it is now perched precariously on its seven-year line, threatening to challenge the “supercycle” thesis that became so fashionable at the top of the bubble. “The boom was fuelled by massive speculation,” said Charles Dumas, chief strategist at Lombard Street Research.
“Commodity derivatives in the spring had a face of $10 trillion, so it doesn’t take many bulls to sell and send prices crashing. Remember all those clever bankers saying this was the new investment medium, 'uncorrelated’ with either assets? Well, it’s correlated now – downwards,” he said.
The Australian dollar, the beacon of commodity sentiment, went into near-meltdown yesterday, dropping 9.7pc against the yen in the largest one-day drop on record as Japanese investors dumped their Uridashi bonds and scrambled to close bets on high-yield economies – known as the carry trade. Brent crude oil fell to $85 a barrel, down over 40pc since the July spike. It is a casualty of the synchronised recession engulfing the entire G7 bloc of leading powers.
Japan and the eurozone are already contracting: the Anglo-Saxon economies are close behind. The new twist is an abrupt downturn in China, until now the dominant force in the oil and metals boom. Albert Edwards, global strategist at Société Generale, said China depends on exports to US and Europe for its lifeblood, and could face banking problems of its own.
“I think China is going into recession as well. This is going to catch investors off-guard.”
Stephen Jen, currency chief at Morgan Stanley, said the “glowing reputation” enjoyed by emerging markets during the global boom was a deception caused by the easy-money largesse of the credit bubble. Strip that away, and the picture looks very different. “They are very vulnerable to a U-turn in capital flows,” he said.
The oil slide has reached the point where it is setting off a powerful chain reaction through the nexus of global markets. It may soon be unprofitable to divert much of the US crop harvest to biofuels, so futures contracts are rapidly scaling back assumptions. Corn fell 6.4pc yesterday, while soya beans were off 5.4pc.
There are fears that Russia could slip into a downward spiral if oil drops to $50 a barrel, which is now the lower end of Merrill Lynch’s forecast. Moscow has become addicted to the oil bonanza, ratcheting up spending so quickly that it may now need prices to stay above $90 to fund spending plans. Veteran analysts say they have seen this movie before.
Europe Fails to Find Coordinated Response to Financial Crisis
European finance ministers failed to agree on steps to shore up the banking system hours after their countries' leaders pledged to do whatever was needed to restore confidence. There appeared to be little support for suggestions from France and Italy that Europe create a U.S.-style bank rescue fund at yesterday's monthly meeting of euro-area finance ministers in Luxembourg.
Italian Prime Minister Silvio Berlusconi and French Finance Minister Christine Lagarde both have suggested a plan modeled after the $700 billion U.S. fund approved by Congress last week. The ministers in Luxembourg failed to reach consensus on anything beyond a reiteration of a promise by heads of state to protect bank deposits.
"We all agreed that we want to do all we can to avoid financial institutions of systemic importance failing," Luxembourg Finance Minister Jean-Claude Juncker said after the meeting. "We reinforced arrangements concerning deposit protection."
Officials in countries across Europe, mostly acting unilaterally, are rushing to rescue banks on the brink of collapse as the global credit squeeze bears down on the continent. Europe's Dow Jones Stoxx 600 Index had its steepest decline in two decades yesterday and the euro fell below $1.35 against the dollar for the first time in more than a year. "One country's solution is another country's problem," Swedish Finance Minister Anders Borg told reporters in Luxembourg today. "We need to push for common solution" on deposits.
"As far as I can tell, everyone's going their own way," said Peter Dixon, an economist at Commerzbank AG in London. "They can give blanket guarantees. They're almost meaningless, because depositors weren't going to lose money anyway. But it does take some of the heat out of the system." Before yesterday's meeting, European Union leaders pledged to protect depositors from losing their savings to bolster confidence as share prices tumbled.
EU countries "will take whatever measures are necessary to maintain the stability of the financial system," the 27 EU member countries said in a joint statement that was released by Berlusconi's office. "We will continue to take the necessary measures to protect the system so that individual depositors in our countries' banks do not suffer any loss of money." That statement followed earlier pledges by German Chancellor Angela Merkel and French President Nicolas Sarkozy to guarantee savings accounts.
Increasing deposit guarantees to up to 100,000 euros is "an issue under examination," Irish Finance Minister Brian Lenihan told reporters in Luxembourg today. "To restore confidence amongst depositors is very important. An increase in guarantees is only one element in the solution."
Berlusconi two days ago said Italy would propose that EU governments contribute 3 percent of gross domestic product to a bailout fund to guarantee deposits at European banks. He said that other leaders were warming up to the idea. Italy didn't present the proposal at yesterday's meeting. France's Lagarde floated a similar proposal last week, telling the German newspaper Handelsblatt that a "rescue package" was needed to help "smaller" European states "threatened with a banking failure."
Germany shot down that idea, and Henri Guaino, a special adviser to Sarkozy, later distanced the president from Lagarde's proposal, saying in a telephone interview that "France has neither studied nor proposed a plan of that type." Differences between Germany and France were apparent again yesterday.
"Coordination between all of us is very important," said Lagarde said at yesterday's Luxembourg meeting. In Berlin, Merkel stressed that "each member country must tackle its own problems and we can't risk creating new dangers to the banking system." The finance ministers yesterday achieved little beyond what the leaders of Europe's four biggest economies did this past weekend.
At that summit, Germany, the U.K., France and Italy also failed to agree on a unified response, pledging instead to work together to limit the economic fallout, ease accounting rules and seek tougher financial regulations. "We have discussed recapitalization, liquidity, also minimum deposits," Luxembourg Economy Minister Jeannot Krecke said in an interview with Bloomberg Television. "We have some kind of agreement on the deposits."
Even that agreement was undermined by discord over a plan by Ireland to protect not only deposits in six local banks but also loans they have taken. The German government criticized the Irish measure as distorting the European market, with Deputy Finance Minister Joerg Asmussen calling it "a rescue umbrella that discriminates in the internal market."
The European Central Bank said the Irish government should have "properly" informed the EU before announcing the bank- guarantee plan. And EU Competition Commissioner Neelie Kroes asked Ireland to expand the measure to include non-Irish banks to comply with EU rules that prohibit discriminating in favor of domestic institutions. "We've seen negative consequences if a country goes off on its own with unilateral action," EU Commissioner for Economic and Monetary Affairs Joaquin Almunia said in Luxembourg. "We need a clear, coordinated, European approach."
The debate followed rescues of major European institutions in recent days. Amsterdam- and Brussels-based Fortis, Dexia SA, which is based in Brussels and Paris, and Hypo Real Estate Holding AG of Germany required lifelines to avoid collapse.
Europe's Dow Jones Stoxx 600 Index sank 7.6 percent yesterday, the steepest drop since October 1987.
Europe's plunge helped erase about $2.5 trillion from global equities as investors disregarded the U.S. Treasury plan to revive credit markets with a $700 billion bank bailout. European stocks rebounded today as a bigger-than-expected interest-rate cut in Australia spurred speculation central banks around the world will reduce borrowing costs to cushion their economies from the credit freeze.
Iceland suspends bank stocks as krona plunges
Iceland suspended trading in its main banks and guaranteed savers' deposits yesterday after the country's currency went into freefall and the Government was faced with the prospect of financial and economic meltdown.
The suspension of share dealing in banks and other financial firms by the Financial Supervision Authority just before the local stock exchange opened was designed to stop panic trading. The regulator said fears about the banks' security had reached the stage where prices would not be set norm-ally. The decision was also made to ensure equal treatment of invest-ors because "the issuers cannot ensure confidentiality of price-sensitive information which has not been made public".
The Icelandic Government became the latest to guarantee all bank deposits in a bid to reassure local savers.
The krona, which had already lost a fifth of its value against the euro, plunged a further 23 per cent yesterday to a record low of 230, after steep declines last week. The currency's woes put further pressure on Iceland's banks and the country's 320,000 people by increasing the cost of their foreign debts.
Iceland's biggest bank, Kaupthing, said at the weekend that it was financially sound but investors were panicked after Glitnir, its smaller rival, was rescued last week despite repeated government assertions that the financial sector was in good health.
After the Government spent €600m bailing out Glitnir, fears about the rest of the country's banks has hit confidence in Iceland's once-booming economy. Iceland's banks have expanded internationally and piled on loans in recent years, resulting in the assets of the biggest three lenders totalling about 14 trillion krona, or nine times the country's economy.
Iceland's banks are now looking to sell overseas assets and bring the money back into the country to reduce pressure on the currency and ease local credit conditions. Landsbanki, the island's second-biggest bank, has already agreed to sell off some businesses, including its UK-based brokerage business.
Kaupthing bought the UK bank and wealth manager Singer & Friedlander in 2005 and is a lender to Baugur, the investment company whose UK retail holdings include Hamleys, and the entrepreneur Robert Tchenguiz. The Government is also calling on pension funds to repatriate overseas funds. Another bailout would be hard for the Government to finance because the central bank's foreign reserves stood at 308bn krona in August.
Marathon talks at the weekend failed to produce a hoped-for financial stability plan. The increasingly divided Government's banking minister, Brogvin Sigurdsson, said the plan was "well under way". The cost of insuring against debt default by the three biggest banks rose to records in credit default markets (CDS) last week, making the lenders the least-trusted issuers of bank debt in Europe.
Markets have also shunned the country's sovereign debt, with CDS prices hitting a record last week after a series of downgrades by rating agencies. Iceland's woes are the most extreme example of the further financial stress facing European financial systems. Yesterday, BNP Paribas completed the virtual dismantling of Fortis, the Benelux financial services group.
The French bank paid €14.5bn to take over Fortis's Belgian and Luxembourg banking operations and Belgian insurance arm in a deal brokered by Belgium's Government. The move followed the Dutch Government's shock nationalisation of Fortis's Netherlands business on Friday. Shares in Italy's UniCredit were suspended repeatedly yesterday as its shares fell sharply after a U-turn move to raise €6.6bn from investors.
Iceland's dreams go up in smoke
What a difference a year makes. Only last November, Iceland's status as one of the most successful economies in the West was underlined when it was judged the best place to live in the world.
Iceland had ousted Norway from the head of the UN's league table of 177 countries that compared per-capita income, education, health care and life expectancy – which, at 80.55 years for males, was third highest in the world. This was only one in a string of glowing assessments of a country (population 313,000) which had pulled off a modern-day economic miracle. No wonder they are also said to be the happiest people on the planet.
The inhabitants of this newly discovered Utopia, with its much-admired free health and education systems, bought the most books, owned most mobile telephones per head, and included the highest proportion of working women in the world. Iceland had also presided over the fastest expansion of a banking system anywhere in the world. Little did anyone know that the expansion once so admired would go on to saddle the country with liabilities in excess of $100 billion – liabilities that now dwarf its gross domestic product of $14 billion.
Iceland overreached itself in spectacular fashion, and the party is coming to a messy end. Yesterday, trading in the shares of six major financial institutions was suspended as the government sought to avert meltdown. Sigurdur Einarsson, Chairman, Kaupthing Bank, warned against people being too alarmist.
"Over the years we have built a strong and well-diversified bank. We have some of the strongest capital ratios in the European bank sector. We've got good asset quality and a highly diversified loan portfolio. Kaupthing has and continues to manage its business prudently and, with our strong fundamentals, we are naturally concerned when we hear malicious rumours and sensationalism about Kaupthing being reflected irresponsibly. We ask people to look at the facts, not rumour and inuendo."
Meanwhile, Icelandic interest rates have been catapulted to 15.5 per cent, peaks not seen in Britain since Black Wednesday, in an attempt to rein in inflation. The krona's freefall on the international currency markets is surpassed only by the catastrophic failure of Zimbabwean currency. One of the country's three banks, Glitnir, has been nationalised; another wants money from its customers. Foreign currency is running out as international banks refuse pleas to lend money.
No longer smiling, office workers hurry home wondering out loud if they will have jobs to go to by the end of the week. Car showrooms are deserted. Estate agents are closing early. There are few takers for the thousands of unsold houses on their books. An unexpected cold spell is keeping many people inside their homes, another reason why the shops, many of which have discount sales, are quiet.
The speed with which Iceland rose and then fell to earth has bewildered not just the islanders but also Geir Haarde, the Prime Minister who has spent the past four days locked away with his advisers in Reykjavik. He emerged on Monday to announce new powers for the country's financial regulator: "We were faced with the real possibility that the national economy would be sucked into the global banking swell and end in national bankruptcy. The legislation is necessary to avoid that fate."
The dramatic change in Iceland, from the poor relation of Europe to one of its wealthiest and apparently most successful, and now back again, dates from the mid-1990s with the privatisation of the banks and the founding of the country's Stock Exchange. The free market reforms unleashed a new generation of thrusting, young businessmen, many of whom picked up their banking trade in the United States.
They were determined that their country would no longer have to rely on fishing for its principal source of wealth; they loathed the international perception of Iceland as a parochial nation of farmers and fishermen who could not hold their own on the world business stage. They had learnt at school all about the last Cod War with Britain, in 1976, when Iceland unilaterally extended its territorial waters, desperate to increase the financial yield from its trawler fleet. So, in keeping with the traditions of their Viking ancestors, the new army of corporate raiders went overseas to seek their fortune.
Kaupthing, one of the three banks at centre of the debt crisis, is not even in the top 100 of the world's biggest banks. But its influence on the British economy is out of all proportion to its 124th ranking. In five years it has underwritten more than £3 billion in debt to help finance British deals.
This is why the bankruptcy is not only adding to the turmoil on London Stock Exchange – which at one point yesterday lost eight per cent of its value – but also sending ripples through the British High Street. Baugur, the Icelandic investment house, has amassed large stakes in retailers including Hamleys, House of Fraser, Oasis, Debenhams and Iceland the frozen food store. Question marks hang over their future.
Kaupthing lent the money to Baugur to finance its investment in Arcadia back in 2001, which it then sold on to the British billionaire Philip Green. It also snapped up the UK merchant bank Singer & Friedlander for £547 million in 2005 – a company which has helped bankroll some of Britain's best known entrepreneurs, such as Gordon Ramsay. It also advised the sportswear tycoon Mike Ashley on his troubled £134 million purchase of Newcastle United football club. Kaupthing was also a big investor in the London property market, which has become another millstone round the bank's neck.
The Icelandic bankers were able to raise billions for their expansion from the booming new Stock Market in Reykjavik and because of Iceland's extraordinary well-funded pension system. For decades one of the poorest countries in Europe, Iceland could finally celebrate as the average family's wealth grew by 45 per cent in five years. GDP accelerated at between four to six per cent a year and the wealth was invested in property that, in turn, fuelled an unsustainable boom in house prices. In the good times, credit companies sprang up offering 100 per cent loans, many in foreign currency such as Japanese yen or Swiss francs. But with the krona in freefall, some loans have doubled in size and thousands are defaulting.
Some did counsel caution. In 2004, Bjorn Gudmundsson, an economist with Landsbanki, said: "We think the economy will cool rapidly in 2007. Much of the investment in infrastructure will come to an end then." But the dealmakers thought the good times would last for ever. In the same year that Gudmundsson sounded his warning, Icelandic investors spent £895 million on shares in British companies alone.
It was almost inevitable that when the international credit crisis unleashed the worst financial tsunami the world had seen since 1929, there was little that Iceland, which disbanded its armed forces 700 years ago, could do to repel the shock waves. Iceland has guaranteed all its savers deposits, but could not extend this guarantee to the hundreds of thousands of British savers who have invested money in their internet savings banks.
The mood of crisis was heightened further when the Government suspended all public service broadcasting, a measure usually reserved for volcano warnings. The chairman of the opposition left-green party, Steingrimur Sigfusson, has called for a coalition government to lead Iceland through its financial emergency. The trade unions, meanwhile, are pressing for Iceland to begin talks about becoming part of the European Union, which the government has been reluctant to join for years. The pension funds have now also agreed to help the Government by selling assets.
It took a while, though, for the penny to drop. As recently as this spring, when questions were being asked about the economy, the country was in denial. Dagur Eggertsson, a former mayor of Reykjavik, said: "Someone called it 'bumblebee economics' because it is hard to figure out how it flies, but it does, and very nicely, too." The bumblebee, though, like the billionaires who thought they could buy up the British high street, is no longer flying high.
Analysts see more credit pain for Bank of America
Wall Street analysts were quick to scale back their earnings expectations for Bank of America Corp. after it pre-announced third-quarter results, saying the company will face more credit woes as the economy continues to weaken.
Bank of America after Monday's closing bell reported its quarterly net income fell 68% from the year-ago period, a bigger-than-expected drop. The nation's largest bank also halved its dividend and announced plans to raise at least $10 billion to shore up its balance sheet. Bank of America shares were off more than 9% in early trade Tuesday.
Wall Street analysts think Bank of America's credit-write downs and dilutive capital raises are far from over with so many dark clouds on the economic horizon. "Management was fairly pessimistic on the call about the outlook for consumer credit, guiding to elevated loss rates and provision levels well into 2009," wrote Keefe Bruyette & Woods analysts Jefferson Harralson and Brady Gailey in a research note Tuesday.
"It appears that Bank of America moved up its release date in order to beat Wells Fargo or Citigroup to the marketplace and possibly to raise the capital before the short-sale rules are lifted," KBW said. Wells Fargo and Citigroup are locked in a battle to buy Wachovia Corp. The Securities and Exchange Commission's short-selling ban will expire just before midnight on Wednesday.
The KBW analysts, who recently downgraded Bank of America shares to underperform from market perform, said their chief concerns surround the company's home equity, credit card and home builder portfolios. They also cut their 2008 and 2009 profit estimates for Bank of America. Likewise, Robert W. Baird and Co. analysts trimmed their profit forecasts for the company for the next two years.
"While we like the Bank of America franchise and longer-term earnings power, we believe it is premature to get long the stock at current prices, although we find the risk/reward to be attractive in a pullback," they wrote in a client report. Meanwhile, Mike Mayo at Deutsche Bank maintained a hold rating on the stock, citing the after-hours decline Monday evening. Although Bank of America is showing "more realism" with its plans to raise capital and slash the dividend payout by 50%, it "suffers as the largest U.S. consumer bank at a time of greater consumer weakness." Mayo lowered his 2009 profit estimate.
With pressured banks raising so much capital to cover expected losses, Oppenheimer & Co. analyst Meredith Whitney said a "sooner is better" mentality will prevail and "distinguish survivors and the more challenged among banks." Bank of America is digesting its massive acquisitions of mortgage lender Countrywide Financial and Wall Street giant Merrill Lynch. Meanwhile, the bank continues to build up its reserves for loan losses.
"With a deeper recession seeming more probable by the day, we believe Bank of America is far from finished with these charges," said Morningstar Inc. analyst Jaime Peters. "Although we are not pleased that the company is seeking this dilutive capital, keeping customer confidence is the most important goal for Bank of America, and a large capital cushion should help with that goal," Peters said. "Nervous customers seeking a safe bank helped increase deposits at Bank of America by $21 billion during the quarter -- the only truly positive development we saw at the company."
Excluding Countrywide, Bank of America said core deposits during the third quarter rose 4%, driven in part by "flight to safety." Regulators seizing control of Washington Mutual last quarter in the biggest banking failure ever was a grim reminder of the spreading credit crunch.
Stocks fell sharply on Monday, with the Dow Jones Industrial Average down as much as 800 points before recovering late in the session, as investors feared the worsening financial crisis could tip the global economy into recession. Bank of America earlier this week said it reached a settlement requiring it to modify $8.4 billion in mortgage loans by Countrywide to let nearly 400,000 troubled borrowers stay in their homes.
Russia to Lend Banks $36 Billion to Ease Credit
Russia's government pledged more cash for banks in a new bid to kick-start corporate lending during the country's biggest financial test since the 1998 default.
Russian President Dmitry Medvedev said today that the country's biggest banks should get 950 billion rubles ($36 billion) of loans for five years to help unfreeze credit markets. State-run OAO Sberbank and VTB Group should get 500 billion rubles and 200 billion rubles, respectively, Medvedev said at a meeting with senior finance officials in the Kremlin.
"To prevent events connected with insufficient stability of certain banks, we are taking extra serious measures," Finance Minister Alexei Kudrin told reporters after the meeting. "This greatly improves the state of the banking system for any other operations, supporting the real sector and lending by banks to each other."
Russia has pledged to make about $190 billion available to banks and companies with loans, cash auctions and tax cuts in an effort to maintain a decade-long economic boom. "Panic and capitulation" by investors around the world contributed to yesterday's record 19 percent decline in Russia's two main stock indexes, Renaissance Capital research chief Roland Nash said.
"The previous measures aimed to stabilize the situation with liquidity," said Stanislav Ponomarenko, head of financial markets research at ING Bank NV in Moscow. The "money perhaps wasn't distributed to all who needed it. The new measures aim to improve the situation in the medium term, support economic growth."
The Finance Ministry pledged $44 billion for OAO Sberbank, VTB Group and OAO Gazprombank on Sept. 17 on the understanding that the funds would be used to end a seizure on money markets. The global credit crunch may shave 1 percentage point off Russian growth next year, meaning the economy may expand as little as 5.7 percent, the Finance Ministry estimated.
The government will ask lawmakers for permission to use money from the $562.8 billion of gold and foreign currency reserves, which include Russia's oil funds, to pay for the loans announced today, Kudrin said. The loans "will allow banks' capital to be improved," he said.
The government is seeking to get 450 billion rubles of 950 billion rubles from one of its two sovereign oil funds to channel to VTB, Russian Agricultural Bank and other lenders. The central bank will use its "own resources" to loan 500 billion rubles to Sberbank, according to Kudrin. The government has yet to decide which of the funds to tap, Kudrin said.
He also said that more than 100 banks will get access to unsecured loans from the central bank by mid-November. The size of the loan a bank can receive would depend on the size of that bank's capital, according to Kudrin. "We expect the market to stabilize. Today, stock prices don't reflect the real value of our assets," Kudrin said. "I think we're probably coming to a point where everyone will be buying shares, taking into account that the market will, of course, grow."
Bank of Japan to manage policy independently
The head of Japan's central bank said Tuesday that while global financial turmoil is intensifying, each country should manage monetary policy independently, damping speculation of coordinated rate cuts by major economies.
Despite heightened anxiety about the financial meltdown spreading from Wall Street to Europe and beyond, Bank of Japan Gov. Masaaki Shirakawa offered a muted sense of urgency about its potential impact on Japan. "It is not desirable to undertake policy coordination that would involve measures inappropriate for each country's economic and price situation," Shirakawa said.
The comments threw cold water on expectations that financial officials from the Group of Seven countries may propose a coordinated, emergency policy move during their meeting later this week. Earlier in the day, the central bank left its key interest rate unchanged at 0.5 percent for the 20th straight month, citing a "sluggish" economy along with high inflation rates.
The BOJ said in its statement that the economy will likely remain lethargic "for the time being as a slowdown in overseas economies becomes more evident." However, it maintained its long-held stance that the world's second-largest economy would eventually return to a "moderate growth path."
The decision followed news from Sydney that Australia's central bank cut its official interest rate by a bigger-than-expected 1 percentage point to 6 percent, a move that lifted Australian stocks and some other regional markets on hopes that other central banks would follow suit.
Shirakawa's comments disappointed market observers, who had expected a more proactive stance in light of recent bank failures overseas and plunging equity markets, said Hitomi Kimura, a fixed income strategist at JP Morgan Securities in Tokyo. Instead, what they got was more of the same.
"People were hoping that the BOJ would show more understanding in what has been going on in the markets, that (the central bank) is on alert to be ready to take action," she said. Japan's benchmark stock index dropped to the lowest in almost five years on Tuesday as selling spread across the board. The Nikkei 225 lost 3.0 percent to close at 10,155.90 -- its lowest finish since December 2003. Shirakawa blamed the recent weakness in Japanese stocks on overall global declines.
"We will be monitoring stock price movements, as well as their impact on the economy and financial markets," he said. Merrill Lynch economists Takuji Okubo and Masayuki Kichikawa doubt that the Bank of Japan will lower its main interest rate -- already so low -- anytime soon. Earlier Tuesday the Bank of Japan injected another 1 trillion yen ($9.9 billion) into the money market in its 15th straight day of emergency operations to foster smoother lending among banks.
The Bank of Japan's quarterly "tankan" survey released last week revealed a troubling snapshot of the world's second-largest economy: waning corporate sentiment, lower profit forecasts and a pullback in capital spending. Major Japan manufacturers were the gloomiest in five years, and with demand slumping overseas they were bracing for more turbulence in the months ahead.
The North Atlantic banking system is insolvent
It’s reasonable to assume that the banking system in the North Atlantic region is insolvent and would be bankrupt but for the reality of recent government bailouts and the expectation of future government bailouts. Certainly, for the system as a whole, the marked-to-market value of its assets is way below that of its liabilities. I strongly suspect that even the hold-to-maturity value of its assets is well below that of its liabilities.
Although the system as a whole is broke, there are no doubt individual banks that are solvent. We may not, however be certain as to which banks are solvent and which banks are not. I also take it is given that it is desirable - essential even - to preserve the core of the banking system and to keep it operating without interruption, because it fulfills an essential role in the intermediation of funds between financial surplus units and financial deficit units - a role for which no substitute can be found or created in the short and medium term.
The bulk of the banking system therefore needs to be bailed out. In practice this means that most of the large banks need to be bailed out in the first instance. Consolidation through mergers, acquisitions or liquidations will mostly have to wait until order has been restored in the global financial markets.
The main remaining question then becomes who will pay for the bail out, the tax payers or the existing creditors of the banks (including the shareholders and other providers of equity). I have a strong preference for putting much of the cost of a bailout on the existing creditors. This is in part for reasons of equity and fairness: the existing creditors made bad investments/loans; they ought to pay for their failures.
They earned a risk premium while the going was good. They ought to eat the risk when it materialises. It is also for incentive reasons. Future lending to banks and future purchases of bank obligations will be undertaken with a better appreciation of the credit risk involved. Another massive over-expansion of the banking sector will be less likely.
Conventional insolvency procedures are of course one mechanism for ensuring that the creditors pay. Typically, the shareholders get wiped out and the debt gets restructured. Conventional bankruptcy as applied to banks is, however, too disruptive of essential intermediation and portfolio management. So we need a special resolution procedure (SRR), which creates a condition called regulatory insolvency, which allows the financial structure of banks to be modified radically in little or no time and at little if any transaction cost.
Regulatory insolvency can be invoked by the bank regulator or some other duly constituted body, before the conditions for normal balance sheet insolvency (liabilities in excess of assets) or liquidity insolvency (inability to meet ones financial obligations) apply. When regulatory insolvency is invoked, an Administrator takes over the running of the bank. This Administrator has full powers to manage the assets, liabilities and employees of the bank. The ordinary shareholders lose their voting power and indeed any governance rights.
Their other ownership and income rights can be diluted or extinguished. The claims of the other unsecured creditors can be subjected to a charge (or haircut) or be extinguished completely. The management and board can be sacked without golden parachutes. The assets and/or the remaining liabilities of the bank can be sold or transferred to other parties, or the bank can be managed by the Administrator as a going concern until further notice.
The Conservator appointed for Fannie and Freddie is an example of such an Administrator. The FDIC appoints such Administrators for federally insured deposit-taking banks in the US. There was no SRR for investment banks in the US, nor was there or is there one in the UK for any banks. This is about to change for the UK. In the US the issue has become moot with the disappearance of the independent investment bank.
In the case of deposit-taking banks, one class of creditors - individual depositors and holders of saving accounts - has been declared a sacred cow by most governments, partly to avoid the systemic externalities of bank runs, partly because individual monitoring of bank creditworthiness by holders of small bank accounts may be inefficient, but mainly for political reasons. I will take this government guarantee of individual deposit and saving accounts as a binding constraint. That leaves the other creditors, secured and unsecured.
I propose that the special resolution regime for banks about to be considered by the UK Parliament be designed in such a way that it achieves any desired increase in the capital ratios of a bank entering the SRR (or any desired reduction in the leverage ratio) to the maximum possible exent through a mandatory debt-to-equity conversion. Unsecured creditors would be first in line for a haircut (in reverse order of seniority).
Secured creditors would retain their claim to the collateral securing their loan or bond, but would share with the unsecured creditors the haircut in their claim on the bank. New capital should only injected by the government if there either is not enough debt in the balance sheet or if the balance sheet of the bank is considered too small. While it is conventional for existing equity holders to be wiped out before debt is converted into equity, I don’t consider this essential. Dilution may provide adequate punishment and incentives for future equity investment decisions.
It may be the case that, when the authorities reflect on the lessons of the crisis, they may decide that some or all banking activities should be provided through state-owned banks and that some or all existing banks ought to be nationalised (have majority state ownership). It would not be right, from an efficiency or an equity perspective, if such nationalisations were to cause the orginal shareholders and creditors to get a better deal than they would have had without government assistance.
The dilution or extinguishing of the existing shareholder stakes and the haircut on the existing creditors (and/or the mandatory debt-to-equity conversion) should therefore take place before new public sector capital goes in. I hope that the new UK special resolution regime will put the tax payer before the existing shareholders and the existing creditors of the banks. The worst of all possible worlds would be the Irish (and now also Danish) approach where all creditors of the banks are guaranteed by the government (for a fee that undoubtedly will not cover the government’s opportunity cost) and the tax payer is left without any upside.
Can GM and Ford Scrape By?
Just three months ago, General Motors Chairman and CEO Rick Wagoner said he was moving to secure $15 billion in cash through asset sales, borrowing, and cost cuts that would see the company through to 2009 even in the worst of times.
Barely three months later, with its stock trading at a 54-year low, GM is looking for more ways to save cash. The grim market conditions that underpinned its liquidity plan weren't downbeat enough, it turns out. Several sources inside the company say GM is looking at product delays to save cash, hoping the company can weather the weak economy and liquidity crisis and make it through to 2010.
All but essential programs are at least getting a review, the sources said. Even the next-generation Chevrolet Malibu could be on the table. GM wants each of its cars to get a makeover every 5.5 years, but it may have to stretch that to 7.5 years for some models to stay in the black. A GM spokesman says the company is delaying some product programs but that nothing major has been held up yet.
The war gaming around cash savings shows just how tough times have become for Detroit's Big Three. On Monday, Oct. 6, GM's shares fell 52¢, or nearly 6%, to 8.48, its lowest price since 1954, according to Bloomberg Financial Markets. Ford Motor stock fell 36¢, or 9%, to 3.69, its lowest since 1984. GM, Ford, and Chrysler have had their credit ratings downgraded as they burn cash and sales plummet. Last month, every major automaker—except GM, which had a big slug of sales to rental fleets and a fire sale—saw sales drop at least 20% (BusinessWeek.com, 10/1/08). Some dropped 30%. With revenue sinking fast, Detroit's carmakers are trying to save every penny.
GM executives and product planners say nothing is final and that they could reinstate some plans if the market turns around. But the company is still taking a hard look at what can be delayed as the company's shortfall in sales and revenue burns cash.
Sources inside the company say that all new products planned for 2009 and 2010 (BusinessWeek.com, 6/3/08) are intact, because most of the development money has been spent. But there could be a lull in new-vehicle launches in 2011 and 2012 if GM has to delay more plans. That means GM would have some stale products just as the market is expected to turn around. But as a survival plan, it could work.
GM would conserve cash now to make it through the recession and credit crunch. Around 2011 and 2012, when wage cuts and a big health-care deal with the auto workers union are expected to save GM several billion dollars a year, the company would have more money to market its cars while getting the product plan back on track, says James Hall, principal of 2953 Analytics, a Detroit consulting firm. "By 2011, the union deal starts to pay off and hopefully, the market gets better," Hall says. "GM has cars people want to buy."
It's cold comfort, but GM isn't alone when it comes to swinging the ax. Last week, Chrysler cut 250 white-collar workers. Ford also has laid off salaried staff and shelved new models, including a rear-wheel-drive sedan for Lincoln. In addition, the company has delayed a redesign of its hulking Lincoln Navigator and Ford Expedition SUVs. But those plans to slash costs and raise money haven't increased confidence among equity investors or lenders that the carmakers will be able to ride out the storm.
While investors were selling off auto stocks, Fitch on Oct. 6 downgraded Ford's credit rating to deep-junk territory, CCC, where GM and Chrysler issues are already languishing. Fitch analyst Mark Oline says that the credit crisis, combined with an already tough economy, will keep car sales in the doldrums through 2009. Oline says Ford had $26.6 billion in cash at the end of the second quarter. At its cash-burn rate, the company can stay flush for 18 months. Then it would hit its minimum of $10 billion to $12 billion needed to run the business. Ford could also tap some of the federal government's recently approved $25 billion credit line.
Things are a bit trickier for GM. The company has tapped most of its credit lines. Its international operations were generating cash, but overseas economies are slipping now, too, says Oline. That means the company will almost certainly have to find a way to raise more money. GM had $21 billion in cash at the end of June. The company has a further $5 billion in available credit and cash and plans to save $10 billion from cost cuts.
Assuming GM can also tap $5 billion to $7 billion in federal loans that the federal government has approved, GM has up to $21 billion in excess liquidity on top of the $14 billion it needs to run the company, says Gimme Credit analyst Shelly Lombard. Given GM's cash-burn rate of more than $3 billion a quarter, the company has five to seven quarters before it gets down below the bare minimum it needs to buy parts and keep factories humming, Lombard says. GM's best bet is to tap the government's loan program and hope the market turns up.
How China could wreck the US economy
The recent bailout package being approved in the US Congress needs to be viewed in the context of the spurt in the accumulation of forex reserves of China by about $500 billion in the last six months to about $2 trillion in aggregate.
This gargantuan build-up of forex reserves by China has strangely received very little attention of economists, policy analysts, currency traders and, of course, geo-strategists around the world. Why is China engaged in this exercise? What could be its implications on the on going global financial crisis? Could China trip the bailout package announced by the US last week? Crucially what are the implications for the existing global order?
What is intriguing in the Chinese forex reserve build-up is that both trade surplus and foreign direct investment account only for a part of this gargantuan pile. After adjusting for all known sources of reserve accretion, experts conclude that approximately an excess of $200 billion could have flown into China as 'hot money' -- read inexplicable flow of funds -- in this period.
The Economist -- in one of its issue in recent months -- quotes Michael Pettis, an economist working in China, who explains how and why hot money flows into China. According to Pettis, hot money comes into China when companies overstate FDI and over-invoice exports. But where is such money getting parked in China? The Chinese stock market, like many of its counter parts across the globe, continues to plunge. Hence, it may not be an attractive destination for hot money.
Some experts suggest that it could have gone into property while the predominant view is that it could simply be the Chinese banks that offer interest rates in excess of 4 per cent on yuan deposits compared with a lower rate on dollars. How a 2 per cent interest rate differential results in such cross-border flow of capital requires some explanation.
What makes the dollar-yuan exchange rates central to any discussion on global finance is the fact that trade between the United States and China has burgeoned in the past decade or so. But this is not a two-way trade as would be commonly believed. Most of this is unilateral -- i.e. exports from China to the US. In fact, this is the fundamental reason for the burgeoning current account surplus that in turn translates into China's forex reserves.
In the process, over the years, the US has become extremely dependent on China not only for supplying cheap goods but also for the Chinese to fund such imports by parking their forex surplus within the US. This twin-dependency on the Chinese for goods and money to finance its deficits has always engaged the attention of the US policy framers who till recently were not at all comfortable with this arrangement. And now added to this is the latest aggressive build-up of forex reserves by China surely has the Americans in a bind.
Economists in the US till recently believed that a weak yuan implicitly subsidises the Chinese exports leading to such huge trade imbalances between the two countries. Consequently, they have been pointing out to the imperative need for a substantial appreciation of the yuan by a minimum of 20-25 per cent vis-a-vis the US dollar to remedy the situation. In the alternative they have suggested a countervailing duty of a similar scale on imports from China.
Further, economists are of the opinion that by constant intervention in the forex market not only does the Chinese Central Bank ensure a weak yuan it also causes competitive devaluation of various currencies in Asia. The net consequence is a domino effect with the result that the US dollar is artificially valued at higher-level vis-a-vis most Asian currencies. Experts believe that a significant yuan revaluation will ensure a more realistic exchange rate mechanism in Asia as it could force other countries to follow suit.
It is in this connection that C Fred Bergsten of the Peterson Institute, in a testimony before the hearing on the Treasury Department's Report to Congress on International Economic and Exchange Rate Policy in early 2007, states: "By keeping its own currency undervalued, China has also deterred a number of other Asian countries from letting their currencies rise very much against the for fear of losing competitive position against China."
Naturally, in anticipation of a significant revaluation of the yuan, most experts believe given the uncertainty associated with the global financial markets that hot money is flowing to a relatively safe destination. After all, China not only offers higher return but also is virtually insured against any downward movement against the US dollar.
In effect, is this hot money flowing into China in anticipation of this revaluation of the yuan? Or is it a simple case of China maintaining trade competitiveness through a weak yuan? Or is there something more to it than meets the eye? Are the Chinese acquiring the dollars with some sinister motive? In effect, has the Chinese strategy of a weak currency over the years the un-stated policy of dynamiting the American economy?
What is worrying the Americans is that China accounts for about one-fourth of the global forex surpluses and are the counterparts of the US current account deficit. Put simply, while China accumulates forex reserves, the US accumulates a corresponding debt. And the Americans are aware that it is the Chinese are the biggest accumulators of the US treasury bonds.
What is indeed intriguing is that a country -- the US -- that prides on being 'independent' of other countries, especially in security affairs, is now caught in a quagmire as it has to be constantly in the good books of the Chinese government if it wants to avoid a sudden shock.
Countries that hold large US dollar denominated forex reserves have a powerful tool in their arsenal -- they could wreck American financial markets at a mere click of a mouse by selling their dollar holdings. Imagine China with a holding nearly $2 trillion worth of treasury bonds seceding to sell the same overnight.
And that could instantaneously dynamite the global financial system as it could suck out liquidity and cause interest rates to shoot through the roof. Remember, the $700 billion package announced last week by the US is precisely aimed at addressing the liquidity crunch within the US.
China, of course, might have no sinister intent, as this would be at a huge cost. But the Chinese know that no country can ever become a global superpower without a cost. As and when the Chinese decide to take a hit on their dollar holdings, global finance could indeed take a roller coaster ride. Obviously, the Americans' borrowing from China and the Chinese supply of money to the US is indeed an intriguing geo-political game. Surely, this cannot be simple economics by any stretch of imagination.
Given this paradigm, till date experts opine that both are locked in a tight bear hug. According to Lawrence Summers, 'It is a new form of mutually assured destruction that has quietly emerged over the last few years. This implies that China needs the US (for its exports and to park its forex reserves) as much as the US needs China (for imports and borrowings).
So have the Americans played into the hands of Chinese? Recent events in the US have turned this 'MAD paradigm' upside down. It is in this context that the recent bailout package needs to be viewed, which seeks to increase liquidity over a period of time by the US government taking over sub-prime assets from financial institutions. That, according to the American thinking, is expected to provide liquidity to the US economy.
But it is all these happenings within the US that makes this accumulation of forex reserves by China extremely interesting. It may be noted that the Chinese, unlike the others, have always questioned the global order with the US at the helm of affairs. And the Chinese accumulation of forex reserves is surely a strategy that perhaps has an ominous side to it.
All this is not pure economics as it is made out to be. Rather, it was and remains a well-planned economic, political and military strategy of the Chinese. And in a way it is the mirror image of the Star Wars programme that the then US President Reagan unleashed on the erstwhile USSR in the early eighties that eventually bankrupted the later within a few years as it engaged in competitive arms build-up with the former.
Statecraft is all about engaging other countries at one's own terms, pace, time and cost. This is what the US did to the USSR in the eighties and succeeded in dynamiting that country. And that is what China could do to a vulnerable US in the coming months. Crucially, if it doesn't, from the Chinese perspective it might well rue this moment forever.
The US to date was depending on the Chinese for imports and to finance them as well for such imports. Now they will have to be considerably dependent on the Chinese to protect their currency as well as to ensure liquidity in their money markets. And that completely alters the existing global order.
One in Four Mammals at Risk of Extinction
One in four of the world's 5,487 known mammal species face extinction, according to a new conservation "report card" unveiled today. Marine mammals face even steeper odds, with one in three species at risk of disappearing, according to the study.
The assessment, done as part of the International Union for Conservation of Nature's (IUCN's) Red List of Threatened Species, took more than 1,700 experts from 130 countries five years to complete. The report's findings were released today in conjunction with this week's IUCN meeting in Barcelona, Spain, and will appear later this week in the journal Science. "Our results paint a bleak picture of the global status of mammals worldwide," the study authors wrote.
Humans are mostly to blame, as habitat loss, pollution, and hunting continue to squeeze at-risk species. The new report updates the last IUCN survey conducted in 1996 and adds 700 species not previously assessed. "Perversely, the species that humans show greatest affinity toward—the largest mammals such as primates, big cats, and whales—are significantly more likely to be threatened with extinction," Barney Long, a biologist at the World Wildlife Fund in Washington, D.C., said in an email.
Some of the most threatened species are found in Asia, a region undergoing rapid human population and economic growth. "This is leading to habitat loss due to agricultural expansion; development of infrastructure such as roads, which fragment critical landscapes; and increasing areas for industrial crops such as oil palm and pulp for paper," said Long, who helped create the new assessment.
Currently, 79 percent of Asia's primate species face extinction. Worldwide, habitat loss affects roughly 40 percent of threatened mammal species, while human hunting affects 17 percent, Long said. Seventy-eight percent of marine mammals are threatened by accidental deaths, such as becoming bycatch in fishing nets intended for other species.
Marine mammals are "threatened purely because humankind does not care enough to mitigate deaths that do not even benefit our species," Long said. "All these threats represent human-driven activities that, if not controlled, will soon lead to a dramatic increase in the 76 species of mammal that are known to have gone extinct since 1500," Long said.
Timothy Ragen is executive director of the U.S. government's Marine Mammal Commission in Bethesda, Maryland.
"We are causing a period of excessive decline or loss in the diversity of nonhuman life over time," he said, adding that the problem will only get worse as human populations grow. "If we expect to be good stewards, we will have to reexamine our relationship with other forms of life and be willing to make the changes needed to conserve our natural world," Ragen said.
The IUCN Red List is apolitical in scope, but political will is required to reverse species' downward spirals, added lead study author Jan Schipper, director of global mammal assessments for IUCN and the nonprofit Conservation International based in Arlington, Virginia. "The species that are recovering are the ones we're focusing restoration and recovery efforts on," he said. According to the report, 5 percent of threatened species have seen rebounds due to conservation efforts.