Teenage girls working in Bibb Mill No. 1. Macon, Georgia.
Ilargi: The reason the Fed and Treasury refuse to reveal details about the assets they bought, and are still buying, is not, as they claim, that it is sensitive information, or that it could negatively affect valuations of participating banks, insurers and lenders. We know this because the true reason is revealed in the new and not-improved deal the US government reached last night with AIG.
If it would be revealed what is going on behind the doors of the Washington and New York casino bathrooms, a lot of people would get very angry. The AIG accord spells out what will be paid, with taxpayers’ funds, for hundreds of billions of toxic securities and derivatives that are worth zero, close to zero or less than zero (yes, that is possible).
The bail-out plan will pay 50 cents on the dollar for paper that has no value. Perhaps paying 5 cents on the dollar would have been deemed acceptable and defensible (albeit under protest), but paying 10 times or more the realistic remaining value, and using taxpayer money to do it, is simply fraudulous. Keeping AIG alive was already an incomprehensible decision from a long term point of view. Stuffing the carcass with US taxpayer dollars, in order to support the other walking dead, is perverted necrophilia. And I don't think having intercourse with corpses is all that popular among Americans.
Bloomberg's court case, which seeks to force Paulson and Bernanke to reveal the assets, the sellers and the valuations, may seem to be valid under the Freedom of Information Act, but don't forget that one of the stipulations in the original Paulson plan is that Hank the Panky can't be sued for anything he decides under the plan. The case is perhaps a good test to see how much democracy is left in the US, but one that is by no means certain to lead to a favorable outcome. Don't forget, the Treasury snuck in a tax change that favors, to the tune of $140 billion, the same parties that profit from the AIG asset valuation outrage. Paulson feels pretty invincible these days. And so do his friends.
As GM looks set to get funding, at least from the Obama team, it's getting harder to see what that money would be good for, or even used for. Deutsche bank issued a report today that says General Motors is worth zero. Nothing. Zilch. Another candidate for the morgue. A corporation with stock that has no value at all, is gone, deceased, pining for the daisies and pushing up the fjords. Any additional US government funding is useless, a waste, bad business, if not downright criminal.
Already it is clear that even if Washington is conceited enough to provide the funds Detroit clamors for, between 2 to 2.5 million jobs will disappear anyway. There is no way more than half of the production capacity can or will be saved. GM was in deep trouble even during the recent economic boom. It has been managed into the ground over the past two decades, and keeping it afloat purely for political propaganda issues is a tactic that will backfire with a vengeance.
Better be aware and wary of that, Barack. If Washington continues to be seen throwing money before the Wall Street and Detroit swine, instead of trying to revive its economy, Treasuries and other bonds will be flattened by steamrolling international markets, and outside financing for US debt will be as stone cold dead as its corporations are. Any money doled out should go to companies that have a fighting chance, not to the present bunch of zombies.
Fannie Mae today reports another record loss of $29 billion. Remember, this is an entity which the US government has ordered to buy the majority of $40 billion in additional mortgages, every single month. Fannie and Freddie are the only entities standing between on the one hand what is left of the US housing market, and on the other its total collapse. With losses like that, how much longer do you think they can prop up real estate prices? Are there still people who think I'm nuts for predicting an 80% or larger drop in prices?
Talking about disappearing jobs, several media report that Deutsche Post will soon fire 33.000 Americans. Circuit City files for bankruptcy, and thousands more jobs go poof. It's not the first time I say this: a huge humber of jobs will vanish before Christmas, at least hundreds of thousands. Pink slips will be all the rage this shopping season.
Deutsche Bank: GM Is Worth Nothing
Deutsche Bank said publicly today what many detractors of General Motors Inc. have been thinking for some time — the company is worthless. In a note, Rod Lache of Deutsche reduced his rating on the shares to sell (helpful) and put a price target of $0 on the automaker, saying the company has few options at this point beyond “external government intervention.”
They believe the company does not have the cash to fund its operations past December, though Mr. Lache believes the government will be “compelled to participate” in some kind of loan package for the company, for without it, “it would precipitate systemic risk that would be difficult to overcome for automakers, suppliers, retailers and sectors of the U.S. economy.” They cite a Center for Automotive Research study that projects about 2.5 million in lost jobs and a $125 billion decline in U.S. personal income, which would reduce GDP by a full percentage point. Still, even with a loan, the company is on a tightrope due to its efficiency in burning through cash.
With shares of GM at $3.26 (down 25% Monday), there are few analysts out there making bold predictions for a strong rally. Deutsche is the first analyst to put a $0 price target on the company, and the average of nine targets is $4.56 a share, according to Thomson Reuters. Soleil-Ward Transportation is the most optimistic, with an $8 price target on the shares.
For GM, Deutsche does not see many options. One would be a series of low-cost loans, but Mr. Lache says GM is not in a position to argue that it is near a turnaround, and that dampens lawmakers’ interest in providing loans. The second scenario would be a Chrysler-bailout situation, “akin to an out of court bankruptcy restructuring,” but he adds that “given the limited time that GM has at this point, we have doubts that such a structure could be put into effect in time.” Lastly, there’s the disaster scenario — a federal bankruptcy.
Fed Defies Transparency Aim in Refusal to Disclose
The Federal Reserve is refusing to identify the recipients of almost $2 trillion of emergency loans from American taxpayers or the troubled assets the central bank is accepting as collateral. Fed Chairman Ben S. Bernanke and Treasury Secretary Henry Paulson said in September they would comply with congressional demands for transparency in a $700 billion bailout of the banking system. Two months later, as the Fed lends far more than that in separate rescue programs that didn't require approval by Congress, Americans have no idea where their money is going or what securities the banks are pledging in return.
"The collateral is not being adequately disclosed, and that's a big problem," said Dan Fuss, vice chairman of Boston- based Loomis Sayles & Co., where he co-manages $17 billion in bonds. "In a liquid market, this wouldn't matter, but we're not. The market is very nervous and very thin." Bloomberg News has requested details of the Fed lending under the U.S. Freedom of Information Act and filed a federal lawsuit Nov. 7 seeking to force disclosure. The Fed made the loans under terms of 11 programs, eight of them created in the past 15 months, in the midst of the biggest financial crisis since the Great Depression.
"It's your money; it's not the Fed's money," said billionaire Ted Forstmann, senior partner of Forstmann Little & Co. in New York. "Of course there should be transparency." The Fed's lending is significant because the central bank has stepped into a rescue role that was also the purpose of the $700 billion Troubled Asset Relief Program, or TARP, bailout plan -- without safeguards put into the TARP legislation by Congress. Total Fed lending topped $2 trillion for the first time last week and has risen by 140 percent, or $1.172 trillion, in the seven weeks since Fed governors relaxed the collateral standards on Sept. 14. The difference includes a $788 billion increase in loans to banks through the Fed and $474 billion in other lending, mostly through the central bank's purchase of Fannie Mae and Freddie Mac bonds.
Before Sept. 14, the Fed accepted mostly top-rated government and asset-backed securities as collateral. After that date, the central bank widened standards to accept other kinds of securities, some with lower ratings. The Fed collects interest on all its loans. The plan to purchase distressed securities through TARP called for buying at the "lowest price that the secretary (of the Treasury) determines to be consistent with the purposes of this Act," according to the Emergency Economic Stabilization Act of 2008, the law that covers TARP. The legislation didn't require any specific method for the purchases beyond saying mechanisms such as auctions or reverse auctions should be used "when appropriate." In a reverse auction, bidders offer to sell securities at successively lower prices, helping to ensure that the Fed would pay less. The measure also included a five-member oversight board that includes
At a Sept. 23 Senate Banking Committee hearing in Washington, Paulson called for transparency in the purchase of distressed assets under the TARP program. "We need oversight," Paulson told lawmakers. "We need protection. We need transparency. I want it. We all want it." At a joint House-Senate hearing the next day, Bernanke also stressed the importance of openness in the program. "Transparency is a big issue," he said. The Fed lent cash and government bonds to banks, which gave the Fed collateral in the form of equities and debt, including subprime and structured securities such as collateralized debt obligations, according to the Fed Web site. The borrowers have included the now-bankrupt Lehman Brothers Holdings Inc., Citigroup Inc. and JPMorgan Chase & Co.
Banks oppose any release of information because it might signal weakness and spur short-selling or a run by depositors, said Scott Talbott, senior vice president of government affairs for the Financial Services Roundtable, a Washington trade group. "You have to balance the need for transparency with protecting the public interest," Talbott said. "Taxpayers have a right to know where their tax dollars are going, but one piece of information standing alone could undermine public confidence in the system." The nation's biggest banks, Citigroup, Bank of America Corp., JPMorgan Chase, Wells Fargo & Co., Goldman Sachs Group Inc. and Morgan Stanley, declined to comment on whether they have borrowed money from the Fed. They received $120 billion in capital from the TARP, which was signed into law Oct. 3.
In an interview Nov. 6, House Financial Services Committee Chairman Barney Frank said the Fed's disclosure is sufficient and that the risk the central bank is taking on is appropriate in the current economic climate. Frank said he has discussed the program with Timothy F. Geithner, president and chief executive officer of the Federal Reserve Bank of New York and a possible candidate to succeed Paulson as Treasury secretary. "I talk to Geithner and he was pretty sure that they're OK," said Frank, a Massachusetts Democrat. "If the risk is that the Fed takes a little bit of a haircut, well that's regrettable." Such losses would be acceptable, he said, if the program helps revive the economy.
Frank said the Fed shouldn't reveal the assets it holds or how it values them because of "delicacy with respect to pricing." He said such disclosure would "give people clues to what your pricing is and what they might be able to sell us and what your estimates are." He wouldn't say why he thought that information would be problematic. Revealing how the Fed values collateral could help thaw frozen credit markets, said Ron D'Vari, chief executive officer of NewOak Capital LLC in New York and the former head of structured finance at BlackRock Inc. "I'd love to hear the methodology, how the Fed priced the assets," D'Vari said. "That would unclog the market very quickly." TARP's $700 billion so far is being used to buy preferred shares in banks to shore up their capital. The program was originally intended to hold banks' troubled assets while markets were frozen.
The Bloomberg lawsuit argues that the collateral lists "are central to understanding and assessing the government's response to the most cataclysmic financial crisis in America since the Great Depression." The Fed has lent at least $81 billion to American International Group Inc., the world's largest insurer, so that it can pay obligations to banks. AIG today said it received an expanded government rescue package valued at more than $150 billion. The central bank is also responsible for losses on a $26.8 billion portfolio guaranteed after Bear Stearns Cos. was bought by JPMorgan. "As a taxpayer, it is absolutely important that we know how they're lending money and who they're lending it to," said Lucy Dalglish, executive director of the Arlington, Virginia- based Reporters Committee for Freedom of the Press.
Ultimately, the Fed will have to remove some securities held as collateral from some programs because the central bank's rules call for instruments rated below investment grade to be taken back by the borrower and marked down in value. Losses on those assets could then be written off, partly through the capital recently injected into those banks by the Treasury. Moody's Investors Service alone has cut its ratings on 926 mortgage-backed securities worth $42 billion to junk from investment grade since Sept. 14, making them ineligible for collateral on some Fed loans. The Fed's collateral "absolutely should be made public," said Mark Cuban, an activist investor, the owner of the Dallas Mavericks professional basketball team and the creator of the Web site BailoutSleuth.com, which focuses on the secrecy shrouding the Fed's moves.
Deutsche Post to Cut 33,000 Jobs in US
Germany's Deutsche Post is planning to cut 33,000 jobs -- mostly positions in its US express delivery service, according to press reports. Layoffs might also come in the company's German units. German logistics giant Deutsche Post is expected to announce plans to cut thousands of jobs in the United States on Monday in the wake of heavy losses. The Bonn-based firm is set to axe up to 33,000 posts in its embattled American express delivery business, the Munich-based Süddeutsche Zeitung is reporting. The Wall Street Journal and the Frankfurter Allgemeine Zeitung also carried reports about the cuts, which mark a major setback for the firm's ambitious expansion plans abroad.
Deutsche Post has not commented on the reports, but an announcement is expected later Monday in the company's third-quarter earnings report. Up to 13,000 people directly employed by Deutsche Post will be affected -- many at American subsidiary DHL, which has sustained billions in losses since its purchase of Airborne Inc. in 2003 -- and around 20,000 employees at subcontracting companies -- the Süddeutsche reported, citing sources close to the company. Thousands of administrative positions in other countries, including Germany, are also reportedly in danger.
Deutsche Post will give up almost the whole of its loss-making domestic express delivery service within the US, where it was failing to crack the market in the face of stiff competition from better-established competitors like FedEx and United Parcel Service. Though it will wind down much of its domestic operations, DHL is expected to continue its international deliveries in America. Several weeks ago, Deutsche Post disclosed DHL was on track to make a loss of up to €1.3 billion ($1.7 billion) this year.
U.S. Throws New Lifeline to AIG, Scrapping Original Rescue Deal
The U.S. government reached a deal Sunday night to scrap its original $123 billion bailout of American International Group Inc. and replace it with a new $150 billion package, according to people familiar with the matter. While the arrangement stands to considerably ease terms on the faltering insurer, it gives the government an unprecedented role as an actor in financial markets. It could also spark a political backlash, especially from congressional Democrats, because the Treasury, while adding to its AIG obligations, has thus far refused to extend a hand to the struggling Big Three auto makers.
Details of the revised deal could be announced as soon as Monday -- when the company is expected to report third-quarter earnings. Under the terms ironed out late Sunday, the government would give AIG more money, including $40 billion from the U.S. Treasury's $700 billion Troubled Asset Relief Program. It would also receive less interest than on the bulk of the original loan, while freeing AIG from exposure to some of the risky financial instruments that nearly caused it to file for bankruptcy protection. The $150 billion in government aid consists of a $60 billion loan, a $40 billion preferred-stock investment and $50 billion in capital largely to purchase distressed assets which are to be placed into two separate financing entities.
The new package is a tacit acknowledgment that the original $85 billion rescue in September, combined with an additional $37.8 billion made available to the company last month, together haven't come close to stabilizing AIG. The giant insurer employs more than 100,000 people world-wide and touches business and finance at innumerable points throughout the global economy. Treasury is currently considering whether to expand the $700 billion rescue program to apply to a range of financial institutions that provide financing to the broad economy. The department is expected to focus more heavily on injecting equity into companies, placing on the back burner its original plan to buy up troubled assets, such as bad loans and mortgage-backed securities.
The changes at AIG follow widespread criticism from some large shareholders of the original rescue plan, which would have required AIG to quickly sell assets in a declining market while also paying steep interest rates on its loans from the government. That plan also failed to adequately address the main challenge facing the insurer -- how it was hemorrhaging billions on credit default swaps and other financial instruments -- as it posted collateral to nervous trading partners. AIG Chief Executive Edward Liddy, appointed in mid-September with the support of the government, has scrambled to resolve the insurer's problems under the original bailout framework.
AIG laid out a far-reaching plan in early October for selling off assets to pay back the first loan the government extended, which was for up to $85 billion. But the turmoil in the markets has made it difficult for potential buyers to secure funding. The revised structure is designed to improve both AIG's ability to sell assets for a decent price and the taxpayer's ability to recoup the money that has been pumped into the insurer. It also transfers to the government many of the risks once absorbed by AIG, potentially exposing the government to billions of dollars in future losses. Under the new agreement, the government will replace its original $85 billion, two-year loan with a $60 billion loan due in five years. Interest on the loan is set to drop from 8.5% plus three-month Libor interest-rate benchmark to 3% plus Libor.
In addition, the government would tap the $700 billion Troubled Asset Relief Program to inject $40 billion into AIG in return for preferred shares. Those shares would carry 10% annual interest payments. The government's equity interest in AIG would remain at 79.9% following the changes. The government's initial intervention was driven by concern that AIG's failure to meet it obligations in the credit default swap market would create a global financial meltdown. (A credit default swap, or CDS, is essentially an insurance policy on a bond acquired by investors to guard against default. AIG wrote tens of billions of dollars worth of these contracts.) Under the revised deal, AIG is expected to transfer the troubled holdings into two separate entities.
The first such vehicle is to be capitalized with $30 billion from the government and $5 billion from AIG. That money will be used to acquire the underlying securities with a face value of $70 billion that AIG agreed to insure with the credit default swaps. These securities, known as collateralized debt obligations, are thinly traded investments that include pools of loans. The vehicle will seek to acquire the securities from their trading partners on the CDS contracts for about 50 cents on the dollar. The securities in question don't account for all of AIG's credit default swap exposure but are connected to the most troubled assets. The government may be betting that its involvement will encourage AIG's trading partners to sell the securities tied to the CDS contracts to the new entity.
Once it holds the securities, AIG could cancel the credit default swaps and take possession of the collateral it had posted to back the contracts. The total collateral at stake is about $30 billion. It may also have some unintended consequences across the markets. For the plan to work, AIG's trading partners -- the banks and financial institutions that are on the other side of its credit-default-swap contracts -- may have to agree to any changes in the terms of their agreements with AIG. The agreements may be difficult to work out. Some financial institutions that face AIG in credit-default swaps don't actually hold the physical securities on which they purchased protection.
A second vehicle would be set up to solve the liquidity problems in AIG's securities-lending business. The business involves lending out securities to short sellers or others and investing the collateral for gains. AIG has labored to unload illiquid assets in order to give back the collateral it accepted. AIG's exposure to the securities-lending market forced it to seek a $37.8 billion loan from the government to cover its commitments. Under the new plan, the government is expected to inject about $20 billion into the securities lending vehicle, with AIG providing an additional $1 billion. The entity would then buy the illiquid securities the AIG unit holds, known as residential mortgage-backed securities, for about 50 cents on the dollar. AIG would use the proceeds to shut down the $37.8 billion lending facility which it has not yet fully tapped.
Over time, two scenarios could emerge. The assets held by the two vehicles might recover in value, allowing the government to eventually make money on the investment. Conversely, the assets -- many of which are tied to the housing market -- could continue to decline in value, hitting taxpayers with big losses. The challenges facing AIG remain enormous. With so much uncertainty about its future, it is battling to retain some key business customers as well as valuable employees in its operating units.
Ilargi: Yves Smith at NakedCapitalism provides an excellent review of the conspicuous new AIG deal.
AIG: The Looting Continues (Banana Republic Watch)
Let us review the basics:
1. AIG came desperate to the US government for a rescue, and a whopper at that. The Federal government has no oversight responsibility for AIG, which oh by the way, just happens to have very large overseas operations (in other words, one could take the position that AIG's problems, for a whole host of reasons, are really not the Federal government's problem). However, having seen the disruption that the collapse of Lehman caused, and knowing that AIG was a substantial and unhedged writer of credit default swaps, the powers that be were worried that a bankruptcy could be cataclysmic.
2. The initial deal was punitive by design. Some key elements of the Fed's loan:
– An $85 billion, two year facility with interest at Libor + 850 basis points (and note the 850 basis point was the commitment fee, payable on the whole amount; the Libor addition kicked on on funds drawn down)
– The loan was secured by all of AIG's assets and those of its primary non-regulated subsidiaries
– The government received 79.9% of AIG and had a veto right on payment of common and preferred stock.
– The loan was to be repaid by asset sales
Now this could and should have been treated as a nationalization in all but name. The very top management was replaced (and realistically, only limited housecleaning would be possible given the specialized nature of many of their businesses). The only reason the government did not take 100% of the equity was for the same reason they only took 79.9% of Freddie and Fannie in their conservatorship: going above that level would force the Federal government to consolidate their balance sheets. But instead, stunningly, the accounting fiction, that AIG is an independent operation with rights, as opposed to a ward of the state, is not only being dignified, it is being acted upon.
Look at the list of terms above. The government has the right to seize absolutely everything of value AIG has until it pays off the loans, hold virtually all of the equity, and can veto many key actions (the senior position with respect to the assets gives it more rights than those listed above). Think of AIG as a felon: until it pays its debts to society, it has virtually no rights. Well, that was the theory, but now the deal has been retraded twice. The first time was done with as little notice as possible, but the dispersal of another $37.8 billion was rather hard to hide. Per the Fed's press release:Under this program, the New York Fed will borrow up to $37.8 billion in investment-grade, fixed-income securities from AIG in return for cash collateral. These securities were previously lent by AIG’s insurance company subsidiaries to third parties. As expected, drawdowns to date under the existing $85 billion New York Fed loan facility have been used, in part, to settle transactions with counterparties returning these third-party securities to AIG.
Now this may sound all well and good, but recall the original deal. The loan was ALREADY collaterallized by ALL the assets. So despite the form of the transaction, the Fed is simply lending more money against the same pool of collateral.
Now given AIG's liquidity needs, and the object of this exercise (not to have AIG go under) the second loan was presumably necessary, but the efforts to dress it up as as a loan against collateral is an amusing fiction (all this second loan does is degrade the collateral against the original loan. There are no free lunches here, except, of course, for AIG). Again, if we go back to the felon metaphor, the state had budgeted X for his care, but it turns out he has a really nasty disease that really has to be treated or it will infect the entire prison population and the guards too, so the cost of his incarceration has gone from X to X + Y.
But now we get to the heinous part. AIG should have no rights at this point. Zero. Zip. Nada. The government already on the hook for an open-ended liability. Yet the Fed is treating AIG as a party that has rights and is negotiating with them, as opposed to dictating terms. This is staggering.
Let us parse the Wall Street Journal story:The U.S. government was near a deal Sunday night to scrap its original $123 billion bailout of American International Group Inc. and replace it with a new $150 billion package, according to people familiar with the matter.
While the proposed arrangement would considerably ease terms on the faltering insurer, it would give the government an unprecedented role as an actor in financial markets. It could also spark a political backlash, especially from congressional Democrats, because the Treasury, while adding to its AIG obligations, has thus far refused to extend a hand to the struggling Big Three auto makers.
Before we get to the particulars, read the overview. AIG is getting yet more money, now close to double the initial commitment, and the terms are being made more favorable. And not by a little. Note the Journal, hardly a critic of Big Business, used the term "considerably".
There is only one legitimate reason for modifying the terms of AIG's loans: that the cash outflow for the interest might be so high that it is worsening the liquidity pressures on AIG. Fine, Keep the interest payments the same, but allow a significant portion (50%? 65%?) to be deferred and added to principal. A second issue mentioned in today's Wall Street Journal was that AIG is now concerned that they might not be able to repay the loan in two years. Fine. Extend the term another year. Those are the ONLY changes warranted.
Remember, AIG does NOT has any God-given right to existence. If every significant operation AIG has must be sold to repay the taxpayer, and AIG ceases to exist, that would be a perfectly fine outcome. A systemic collapse would have been avoided, taxpayers would have gotten as much as possible out of a bad situation, and AIG would be liquidated in an orderly fashion. What is wrong with that picture?
Instead, AIG is being coddled for no reason whatsoever. Back to the Journal:Details of the revised deal could be announced as soon as Monday -- when the company is expected to report third-quarter earnings -- but remained in flux. Under the terms being discussed late Sunday, the government would give AIG more money, including $40 billion from the U.S. Treasury's $700 billion Troubled Asset Relief Program. It would also demand less interest than on the bulk of the original loan, while freeing AIG from exposure to some of the risky financial instruments that nearly caused it to file for bankruptcy protection.
The $150 billion in government aid consists of a $60 billion loan, a $40 billion preferred stock investment and $50 billion in capital largely to buy and backstop distressed assets in two special financing vehicles.
Well, actually there is a reason, and it stinks to high heaven. Remember the original consternation about the TARP, when it was thought to be a vehicle for buying bad assets from banks. The only way that arrangement made sense was if the Treasury paid inflated prices, which served two purposes. First, it was a back door mechanism for recapitalizing banks. Second, the inflated prices could be used by banks holding similar assets for valuation purposes. When banks are reluctant to lend to each other because they are worried about the solvency risk of their counterparties, that means they already distrust their published financials. But the Treasury department thinks that making their statements even more dubious by letting them uses phony valuations is a solution.
And lo and behold, the Treasury is going to buy crap assets at amazing prices:Under the terms being finalized on Sunday night, the government would replace its original $85 billion loan with a two-year duration with a $60 billion loan with a five-year duration. Interest on the loan would drop from 8.5% plus three-month Libor interest-rate benchmark to 3% plus Libor. (Libor, the London interbank offered rate, is a common short-term benchmark.)
We aren't to the dud asset part yet, but behold the nonsense. AIG gets a 5 year term, up from two, and a massive gift in the form of a 5% reduction in its rate of interest. A complete gimmie. Every mortgage borrower in America whose bank has gotten any money from the TARP should write their Congressman asking to know why they aren't getting a their interest rate reduced by nearly half. Ah, but I forget. Your bankruptcy, sadly, does not pose a threat to the financial system.
Back to the Journal:In addition, the government would tap the $700 billion Troubled Asset Relief Program to inject $40 billion into AIG in return for preferred shares. Those shares would carry 10% annual interest payments. The government's equity interest in AIG would remain at 79.9% following the changes.
Um, shares do not carry interest payments. They can have dividends paid at a fixed rate. The terminology here is highly misleading and gives the impression that the preferred dividends have the same standing as interest payments, when they are subordinate.
Back to the article:The government's initial intervention was driven by concern that AIG's failure to meet it obligations in the credit default swap market would create a global financial meltdown. (A credit default swap, or CDS, is essentially an insurance policy on a bond acquired by investors to guard against default. AIG wrote tens of billions of dollars worth of these contracts.) Under the revised deal, AIG would transfer the troubled holdings into two separate entities that would be capitalized by the government.
The first such vehicle would be capitalized with $30 billion from the government and $5 billion from AIG. That money would be used to acquire the underlying securities with a face value of $70 billion that AIG agreed to insure with the credit default swaps. These securities, known as collateralized debt obligations, are thinly traded investments that include pools of loans. The vehicle would seek to acquire the securities from their trading partners on the CDS contracts for about 50 cents on the dollar.
The securities in question don't account for all of AIG's credit default swap exposure but are connected to the most troubled assets. Most of the trading partners AIG would seek to acquire the assets from are other financial institutions. The government may be betting that federal involvement will encourage the trading partners to sell the assets to the AIG vehicle. A price of 50 cents on the dollar for CDOs across all tranches, particularly when the objective is to buy the dreckiest dreck (the ones where AIG's losses on its CDS guarantees would be greatest) is simply breathtaking. It's a wet dream for anyone who owns them.
Remember, this would be the price across ALL tranches. Recall that in Merrill's not-all-that-long-ago sale of its super-senior CDOs (the very best tranches) it got a nominal price of 22 cents on the dollar, but that did not accurately represent the economics of the transaction. The hedge fund Lone Star paid only 25% of that amount (or 5.5 cents) in cash, the rest was contingent on performance. So Merrill might have sold the CDOs for as little as 5.5%.
Ah, I bet Lone Star is now scrambling to see if it won the lottery. If its Merrill CDOs happened to be guaranteed by AIG (and Sunday's story by Gretchen Morgenson said they were until AIG got leery of its exposures) then Merrill (and BofA) have just gotten wildly lucky. BofA will get the maximum it was entitled to, and Lone Star, having paid only 5.5% of face in case, will get to recoup 50% less the 16.5% contingent payment it will have to make to BofA. So it will get over six times the amount it put as risk in less than a year.
Back to the Journal:Once it holds the securities, AIG could cancel the credit default swaps and take possession of the collateral it had posted back the contracts. The total collateral at stake is about $30 billion. It may also have some unintended consequences across the markets. For the plan to work, AIG's trading partners -- the banks and financial institutions that are on the other side of its credit-default-swap contracts -- may have to agree to any changes in the terms of their agreements with AIG.
Such changes could cause those partners, which have pried billions of dollars worth of collateral from AIG over the past year, to return some or much of the collateral. That could be a costly exercise for some financial institutions, because the cash they received from AIG has in recent months been a cheap source of funding for many banks.
The agreements may be difficult to work out. Some financial institutions that face AIG in credit-default swaps don't actually hold the physical securities on which they purchased protection. Merrill Lynch & Co., for example, previously sold many mortgage CDOs it underwrote to European banks. Through a complex set of transactions, Merrill took back the credit risk of some of those assets and hedged that risk by buying credit-default swaps from AIG. When the securities fell in value, the European banks demanded collateral from Merrill which in turn demanded collateral from AIG.
Frankly, I regard this section as noise. The real objective is to overpay for the CDOs and provide a huge subsidy to the current holders, who are presumed to be banks (a lot of the really crappy late vintage CDOs were sold in Europe) but per the Lone Star example, some of the fortunate beneficiaries may turn out to be hedge funds. If AIG can unwind any of these CDOs, good luck. My understanding is that this has only been done in cases of payment failure. If the CDO is substantially held (meaning each of the tranches as well as the whole) by an entity friendly to AIG, then the game changes, but given the cost of unwinding a CDO, query whether that would be the best route to go.
This statement (from the middle of the story) sums up the sheer dishonesty of the entire exercise:The revised structure is designed to improve both AIG's ability to sell assets for a decent price and the taxpayer's ability to recoup the money that has been pumped into the insurer. It also transfers to the government many of the risks once absorbed by AIG, potentially exposing the government to billions of dollars in future losses.
The phrase "designed to improve....the taxpayer's ability to recoup the money that has been pumped into the insurer" is a complete and utter lie. The authors (Matthew Karnitsching, Liam Pleven and Serena Ng) and whoever edited the piece should be ashamed of printing such a blatant falsehood. The changes in terms, in every respect, make the deal worse for the taxpayer. But for the Journal to perpetuate such pro-business rubbish is par for the course.
We said in our title that the AIG case constitutes looting. We refer to notion as set forth by Nobel prize winner George Akerlof and Paul Romer in their 1994 paper, "Looting: The Economic Underworld of Bankruptcy for Profit."Our theoretical analysis shows that an economic underground can come to life if firms have an incentive to go broke for profit at society's expense (to loot) instead of to go for broke (to gamble on success). Bankruptcy for profit will occur if poor accounting, lax regulation, or low penalties for abuse give owners an incentive to pay themselves more than their firms are worth and then default on their debt obligations.
This is precisely what happened at AIG. Executives there are handsomely paid, yet senior management cast a blind eye as one unit earned outsized profits while taking risks that would have driven AIG into bankruptcy were it not for the Fed's rescue. Before you say, "Well, it was just a few bad apples," the biggest single job of senior management in a financial institution ought to be to assure the health and survival of the entity, which means risk management and control is top of the list (it was at Goldman when it was a private firm). Anytime a unit starts reporting very large profits, managers should be all over it like a cheap suit to make sure the earnings are not the product of massive risktaking. It only takes one aggressive trader plus inattentive management to bring down an entire firm, as Nick Leeson demonstrated with Barings.
But the worst is that not only was the initial AIG de facto bankruptcy a case of looting, the government has now decided to aid and abet AIG management in further looting. What pro-taxpayer purpose is there in the improvement of terms above? None. As we pointed out, there were only a couple of reasons for easing up on AIG, and they could have been provided for with minor changes that would not leave the taxpayer materially worse off. Instead, major concessions have been made to AIG, all to the detriment of the taxpayer. AIG management now has job security for five years (and AIG top brass is very well paid) and better odds of salvaging something for themselves when the five years are up thanks to the government giving them an unwarranted subsidy.
When the TARP was announced, we called it "Mussolini-Style Corporatism in Action." Sadly, it looks as if events are panning out as foretold.
A Quiet Windfall For U.S. Banks
The financial world was fixated on Capitol Hill as Congress battled over the Bush administration's request for a $700 billion bailout of the banking industry. In the midst of this late-September drama, the Treasury Department issued a five-sentence notice that attracted almost no public attention. But corporate tax lawyers quickly realized the enormous implications of the document: Administration officials had just given American banks a windfall of as much as $140 billion.
The sweeping change to two decades of tax policy escaped the notice of lawmakers for several days, as they remained consumed with the controversial bailout bill. When they found out, some legislators were furious. Some congressional staff members have privately concluded that the notice was illegal. But they have worried that saying so publicly could unravel several recent bank mergers made possible by the change and send the economy into an even deeper tailspin. "Did the Treasury Department have the authority to do this? I think almost every tax expert would agree that the answer is no," said George K. Yin, the former chief of staff of the Joint Committee on Taxation, the nonpartisan congressional authority on taxes. "They basically repealed a 22-year-old law that Congress passed as a backdoor way of providing aid to banks."
The story of the obscure provision underscores what critics in Congress, academia and the legal profession warn are the dangers of the broad authority being exercised by Treasury Secretary Henry M. Paulson Jr. in addressing the financial crisis. Lawmakers are now looking at whether the new notice was introduced to benefit specific banks, as well as whether it inappropriately accelerated bank takeovers. The change to Section 382 of the tax code -- a provision that limited a kind of tax shelter arising in corporate mergers -- came after a two-decade effort by conservative economists and Republican administration officials to eliminate or overhaul the law, which is so little-known that even influential tax experts sometimes draw a blank at its mention. Until the financial meltdown, its opponents thought it would be nearly impossible to revamp the section because this would look like a corporate giveaway, according to lobbyists.
Andrew C. DeSouza, a Treasury spokesman, said the administration had the legal authority to issue the notice as part of its power to interpret the tax code and provide legal guidance to companies. He described the Sept. 30 notice, which allows some banks to keep more money by lowering their taxes, as a way to help financial institutions during a time of economic crisis. "This is part of our overall effort to provide relief," he said. The Treasury itself did not estimate how much the tax change would cost, DeSouza said.
The guidance issued from the IRS caught even some of the closest followers of tax law off guard because it seemed to come out of the blue when Treasury's work seemed focused almost exclusively on the bailout. "It was a shock to most of the tax law community. It was one of those things where it pops up on your screen and your jaw drops," said Candace A. Ridgway, a partner at Jones Day, a law firm that represents banks that could benefit from the notice. "I've been in tax law for 20 years, and I've never seen anything like this." More than a dozen tax lawyers interviewed for this story -- including several representing banks that stand to reap billions from the change -- said the Treasury had no authority to issue the notice.
Several other tax lawyers, all of whom represent banks, said the change was legal. Like DeSouza, they said the legal authority came from Section 382 itself, which says the secretary can write regulations to "carry out the purposes of this section." Section 382 of the tax code was created by Congress in 1986 to end what it considered an abuse of the tax system: companies sheltering their profits from taxation by acquiring shell companies whose only real value was the losses on their books. The firms would then use the acquired company's losses to offset their gains and avoid paying taxes. Lawmakers decried the tax shelters as a scam and created a formula to strictly limit the use of those purchased losses for tax purposes. But from the beginning, some conservative economists and Republican administration officials criticized the new law as unwieldy and unnecessary meddling by the government in the business world.
"This has never been a good economic policy," said Kenneth W. Gideon, an assistant Treasury secretary for tax policy under President George H.W. Bush and now a partner at Skadden, Arps, Slate, Meagher & Flom, a law firm that represents banks. The opposition to Section 382 is part of a broader ideological battle over how the tax code deals with a company's losses. Some conservative economists argue that not only should a firm be able to use losses to offset gains, but that in a year when a company only loses money, it should be entitled to a cash refund from the government. During the current Bush administration, senior officials considered ways to implement some version of the policy.
A Treasury paper in December 2007 -- issued under the names of Eric Solomon, the top tax policy official in the department, and his deputy, Robert Carroll -- criticized limits on the use of losses and suggested that they be relaxed. A logical extension of that argument would be an overhaul of 382, according to Carroll, who left his position as deputy assistant secretary in the Treasury's office of tax policy earlier this year.Yet lobbyists trying to modify the obscure section found that they could get no traction in Congress or with the Treasury. "It's really been the third rail of tax policy to touch 382," said Kevin A. Hassett, director of economic policy studies at the American Enterprise Institute.
As turmoil swept financial markets, banking officials stepped up their efforts to change the law. Senior executives from the banking industry told top Treasury officials at the beginning of the year that Section 382 was bad for businesses because it was preventing mergers, according to Scott E. Talbott, senior vice president for the Financial Services Roundtable, which lobbies for some of the country's largest financial institutions. He declined to identify the executives and said the discussions were not a concerted lobbying effort. Lobbyists for the biotechnology industry also raised concerns about the provision at an April meeting with Solomon, the assistant secretary for tax policy, according to talking points prepared for the session.
DeSouza, the Treasury spokesman, said department officials in August began internal discussions about the tax change. "We received absolutely no requests from any bank or financial institution to do this," he said. Although the department's action was prompted by spreading troubles in the financial markets, Carroll said, it was consistent with what the Treasury had deemed in the December report to be good tax policy. The notice was released on a momentous day in the banking industry. It not only came 24 hours after the House of Representatives initially defeated the bailout bill, but also one day after Wachovia agreed to be acquired by Citigroup in a government-brokered deal. The Treasury notice suddenly made it much more attractive to acquire distressed banks, and Wells Fargo, which had been an earlier suitor for Wachovia, made a new and ultimately successful play to take it over.
The Jones Day law firm said the tax change, which some analysts soon dubbed "the Wells Fargo Ruling," could be worth about $25 billion for Wells Fargo. Wells Fargo declined to comment for this article. The tax world, meanwhile, was rushing to figure out the full impact of the notice and who was responsible for the change. Jones Day released a widely circulated commentary that concluded that the change could cost taxpayers about $140 billion. Robert L. Willens, a prominent corporate tax expert in New York City, said the price is more likely to be $105 billion to $110 billion. Over the next month, two more bank mergers took place with the benefit of the new tax guidance. PNC, which took over National City, saved about $5.1 billion from the modification, about the total amount that it spent to acquire the bank, Willens said. Banco Santander, which took over Sovereign Bancorp, netted an extra $2 billion because of the change, he said.
Attorneys representing banks celebrated the notice. The week after it was issued, former Treasury officials now in private practice met with Solomon, the department's top tax policy official. They asked him to relax the limitations on banks even further, so that foreign banks could benefit from the tax break, too. No one in the Treasury informed the tax-writing committees of Congress about this move, which could reduce revenue by tens of billions of dollars. Legislators learned about the notice only days later. DeSouza, the Treasury spokesman, said Congress is not normally consulted about administrative guidance. Sen. Charles E. Grassley (R-Iowa), ranking member on the Finance Committee, was particularly outraged and had his staff push for an explanation from the Bush administration, according to congressional aides.
In an off-the-record conference call on Oct. 7, nearly a dozen Capitol Hill staffers demanded answers from Solomon for about an hour. Several of the participants left the call even more convinced that the administration had overstepped its authority, according to people familiar with the conversation. But lawmakers worried about discussing their concerns publicly. The staff of Sen. Max Baucus (D-Mont.), chairman of the Finance Committee, had asked that the entire conference call be kept secret, according to a person with knowledge of the call. "We're all nervous about saying that this was illegal because of our fears about the marketplace," said one congressional aide, who like others spoke on condition of anonymity because of the sensitivity of the matter. "To the extent we want to try to publicly stop this, we're going to be gumming up some important deals."
Grassley and Sen. Charles E. Schumer (D-N.Y.) have publicly expressed concerns about the notice but have so far avoided saying that it is illegal. "Congress wants to help," Grassley said. "We also have a responsibility to make sure power isn't abused and that the sensibilities of Main Street aren't left in the dust as Treasury works to inject remedies into the financial system." Carol Guthrie, spokeswoman for the Democrats on the Finance Committee, said it is in frequent contact with the Treasury about the financial rescue efforts, including how it exercises authority over tax policy. Lawmakers are considering legislation to undo the change. According to tax attorneys, no one would have legal standing to file a lawsuit challenging the Treasury notice, so only Congress or Treasury could reverse it. Such action could undo the notice going forward or make it clear that it was never legal, a move that experts say would be unlikely.
But several aides said they were still torn between their belief that the change is illegal and fear of further destabilizing the economy. "None of us wants to be blamed for ruining these mergers and creating a new Great Depression," one said. Some legal experts said these under-the-radar objections mirror the objections to the congressional resolution authorizing the war in Iraq. "It's just like after September 11. Back then no one wanted to be seen as not patriotic, and now no one wants to be seen as not doing all they can to save the financial system," said Lee A. Sheppard, a tax attorney who is a contributing editor at the trade publication Tax Analysts. "We're left now with congressional Democrats that have spines like overcooked spaghetti. So who is going to stop the Treasury secretary from doing whatever he wants?
Fannie Mae Reports Record $29 Billion Loss After Asset Writedowns
Fannie Mae posted a record quarterly loss as new Chief Executive Officer Herbert Allison slashed the value of the mortgage-finance provider's assets by at least $21.4 billion and said it may need to tap federal funds next year. In its first report since being seized by the U.S. government in September, Washington-based Fannie Mae said its third-quarter net loss was $29 billion, or $13 a share, the largest for any company in the Standard & Poor's 500 this year.
Allison, installed when the government took over Fannie and smaller rival Freddie Mac, reduced most of Fannie's deferred tax credits, increased default estimates and said credit losses will increase. The decisions cut the company's net worth by 79 percent and shows the new management is taking a dimmer view of Fannie's financial future than the team under former CEO Daniel Mudd. "The earnings were gruesome," said Howard Shapiro, an analyst at Fox-Pitt Kelton Inc. in New York. "They're trying to clean house." Fannie's new management increased reserves for future credit losses from $3.7 billion last quarter and took a higher- than-expected charge against its $5.2 billion in "temporary" losses. The company's net loss in the same period last year was $1.4 billion, or $1.56 a share.
Fannie, which traded at almost $50 a share a year ago, rose 4 cents to 78 cents at 9:31 a.m. in New York Stock Exchange composite trading. Fannie's stock market value slumped from $39 billion at the beginning of the year to about $4 billion as of Nov. 7, including the government's 79 percent stake. Fannie slashed its net worth, or the difference between assets and liabilities, to $9.4 billion on Sept. 30 from $44.1 billion at Dec. 31. The company said today it may fall to negative net worth by the end of next quarter, requiring it to seek government funding. Fannie said today that it hadn't tapped any federal aid through Nov. 7. The Federal Housing Finance Agency placed Fannie and Freddie under its control Sept. 6 and forced out management after examiners found their capital to be too low and of poor quality. Treasury Secretary Henry Paulson pledged to invest as much as $100 billion in each company as needed to keep their net worth positive.
The companies will need that money "sooner rather than later," according to Paul Miller, an analyst at Friedman, Billings, Ramsey in Arlington, Virginia. Miller predicted Allison, 65, would write down higher-than-expected credit costs, Miller said. Fannie and Freddie, which own or guarantee about 40 percent of the U.S. mortgage market, stumbled just as the government started leaning on them to revive the housing market. Fannie was created in the 1930s under Franklin D. Roosevelt's "New Deal" plan to revive the U.S. economy. Freddie was started in 1970. The companies were designed to expand homeownership and provide market stability. They make money by financing mortgage-asset purchases with low-cost debt and on guarantees of home-loan securities they create out of loans from lenders.
Fannie's tax credit, which totaled $20.6 billion as of June 30, had built up as losses deepened. Companies take the credits with the intent of using them to reduce tax bills when they become profitable again. The credits need to be written down if a company doesn't see profits in the near future. The use of deferred-tax assets and other accounting methods by Fannie and Freddie to inflate their capital reserves was cited by regulators as one of the reasons why the government took control of the firms. In the statement today, Fannie said it had $4.6 billion of tax credits remaining.
Fannie set aside $6.7 billion to cover delinquencies as home prices drop, up from $3.7 billion last quarter. The company also charged off $1.8 billion in securities losses it had previously categorized as temporary because executives had anticipated the assets would recover. Credit-related expenses rose 74 percent to $9.2 billion from $5.3 billion last quarter, including the provisions for future losses. "The new management team has no incentive to sugarcoat their earnings," Miller said.
Auto Makers Force Bailout Issue
The auto-industry crisis is forcing a broader debate over how far the government should go to prop up ailing industries, as the Bush administration resists Democrats' request to use part of the $700 billion financial-rescue fund to aid Detroit's three struggling car makers. House Speaker Nancy Pelosi of California and Senate Majority Leader Harry Reid of Nevada, in a letter Saturday, formally requested that Treasury Secretary Henry Paulson consider giving "temporary assistance to the auto industry" using money originally appropriated to shore up the banking system.
The Democratic lawmakers said federal aid should come with "strong conditions," such as requirements that car makers build more fuel-efficient vehicles, and equity stakes for the government so taxpayers could profit if the companies recover. Senior economic advisers to President-elect Barack Obama said he broadly backs the appeal by Mrs. Pelosi and Mr. Reid on behalf of the auto industry. Mr. Obama, who on Friday called the industry "the backbone of American manufacturing," is scheduled to meet President George W. Bush at the White House Monday. Rahm Emanuel, chief of staff for Mr. Obama, said Sunday on ABC's "This Week" that Mr. Obama wants the government to move faster to release $25 billion of low-cost federal loans already approved for the auto industry. He said the Bush administration has other authorities it should "use at this immediate time," but didn't specifically call on it to tap financial-rescue funds to help Detroit.
So far, the administration has balked at pleas from auto makers and their allies on Capitol Hill to use money from the Treasury's Troubled Assets Relief Program, or TARP, to help companies outside the financial sector. "It was not set up for anything else," said Bush spokesman Tony Fratto. He said the only assistance authorized by Congress for the auto industry is a $25 billion loan package meant to help the industry retool to meet higher fuel-economy standards. Auto-industry officials and allies are concerned that the rules governing the retooling loans are too strict, requiring that companies accepting the money meet standards of "viability" -- which might exclude money-losing General Motors Corp., Ford Motor Co. and Chrysler LLC. GM warned Friday that it might not have enough cash to operate its business by the middle of 2009. Tapping into the $700 billion would be the fastest way to inject government cash into the sector, since doing so wouldn't require action by Congress.
Aides said Mr. Obama's economic-transition team is looking into a more flexible definition of "viability" for the $25 billion program. The push by the Detroit Three for more federal money underscores a bigger problem that will confront the Obama administration and Congress: After riding to Wall Street's rescue, the government could find it hard to refuse other industries seen as teetering on collapse. Detroit auto executives told top lawmakers last week that the collapse of one or more of their companies would have economywide consequences, putting as many as three million jobs at risk.
Democratic leaders want to convene a lame-duck session of Congress in two weeks to begin dealing with the nation's economic challenges. Mrs. Pelosi has suggested a short-term stimulus package of as much as $100 billion, including spending for road and bridge projects, extended jobless benefits, funds to help states cover Medicaid costs and food assistance for low-income families. An auto-industry bailout could be added to the stimulus package, or moved separately. But the Democratic leadership is waiting for a signal from the White House that Mr. Bush would sign a new stimulus bill.
Aside from questions about the wisdom of government intervention or putting taxpayer money at risk, bailing out Detroit could put Washington in the position of subsidizing job losses. The car makers have at least 10 assembly plants more than they need to meet demand, according to Oliver Wyman Consulting. That translates to roughly 30,000 factory jobs plus significant numbers of engineers and other salaried personnel. GM estimates it needs to slash its salaried-employee costs in North America by 30%. Car makers would likely use federal money to subsidize these job cuts, buying out older workers to make room for new, lower paid replacements.
United Auto Workers President Ron Gettelfinger has said more union concessions are out of the question, union lobbyist Alan Reuther said in an interview with Dow Jones Newswires on Friday. "We feel we've already stepped up" by giving ground last year on future workers' pay and benefits and retiree health care, Mr. Reuther said. The UAW wants assurances a bailout would help secure its members' retirement and health-care benefits.
"Certainly we're speaking to the UAW," a senior Obama aide said Sunday.
Detroit Auto Makers Need More Than a Bailout
As President-elect Barack Obama prepares to enter the White House, he must ponder what to do about the world's trouble spots: Iran, Iraq, North Korea, the Caucasus. And, oh yes, Detroit. On Friday, General Motors and Ford announced more multibillion-dollar losses in the third quarter; closely held Chrysler doesn't publicly report results. When GM, which seems in the worst shape, was 45 minutes late releasing its results, rumors spread that a bankruptcy filing was imminent. It wasn't, but the company says it could run out of cash in the first half of next year. Make that the first quarter if the current cash bleed continues. GM is lobbying furiously for emergency federal assistance, with Ford and Chrysler close behind.
Let's assume that the powers in Washington -- the Bush team now, the Obama team soon -- deem GM too big to let fail. If so, it's also too big to be entrusted to the same people who have led it to its current, perilous state, and who are too tied to the past to create a different future. In return for any direct government aid, the board and the management should go. Shareholders should lose their paltry remaining equity. And a government-appointed receiver -- someone hard-nosed and nonpolitical -- should have broad power to revamp GM with a viable business plan and return it to a private operation as soon as possible.
That will mean tearing up existing contracts with unions, dealers and suppliers, closing some operations and selling others, and downsizing the company. After all that, the company can float new shares, with taxpayers getting some of the benefits. The same basic rules should apply to Ford and Chrysler. These are radical steps, and they wouldn't avoid significant job losses. But there isn't much alternative besides simply letting GM collapse, which isn't politically viable. At least a government-appointed receiver would help assure car buyers that GM will be around, in some form, to honor warranties on its vehicles. It would help minimize losses to the government's Pension Benefit Guaranty Corp.
But giving GM a blank check -- which the company and the United Auto Workers union badly want, and which Washington will be tempted to grant -- would be an enormous mistake. The company would just burn through the money and come back for more. Even more jobs would be wiped out in the end. The current economic crisis didn't cause the meltdown in Detroit. The car companies started losing billions of dollars several years ago when the economy was healthy and car sales stood at near-record levels. They complained that they were unfairly stuck with enormous "legacy costs," but those didn't just happen. For decades, the United Auto Workers union stoutly defended gold-plated medical benefits that virtually no one else had. UAW workers and retirees had no deductibles, copays or other facts of life in these United States.
A few years ago the UAW even waged a spirited fight to protect the "right" of workers to smoke on the assembly line, something that simply isn't allowed at, say, Honda's U.S. factories. Aside from the obvious health risk, what about cigarette ashes falling onto those fine leather seats being bolted into the cars? Why was this even an issue? When GM's bond ratings plunged into junk territory a couple years ago the auto maker sold 51% of its financing arm, GMAC, to Cerberus, a private-equity powerhouse. Then last summer Cerberus bought 80% of Chrysler from Daimler for just 25% of what the German company paid for the company a decade earlier. It looked like a great deal at the time, like buying a "fixer upper" house at a steep discount. Until, that is, you have to shell out big bucks to shore up the foundation, repair the leaky roof, etc.
Cerberus tried hard in recent weeks to sell Chrysler to GM, with government financial assistance. Controlling GMAC's lending to GM dealers and customers gave Cerberus enormous leverage at the negotiating table. Cerberus squeezed hard, say industry analysts and insiders, but the GM board balked. Last Friday the companies said the talks were off -- "for the moment," as the company's chief operating officer put it. For the moment? How about, like, forever? Buying Chrysler would just give GM an excuse to delay the fundamental task of putting its house in order. Management would turn its energy to producing pretty PowerPoint slides with all the requisite buzzwords: synergies, transformation, downsizing, rightsizing and exercising. What's needed, instead, is exorcising.
A thorough housecleaning at GM is the only way to give the company a fresh start. GM is structured for its glory days of the 1960s, when it had half the U.S. car market -- not for the first decade of this century, when it has just over 20% of the market. General Motors simply cannot support eight domestic brands (Cadillac, Buick, Pontiac, Chevrolet, GMC, Saturn, Saab and Hummer) with adequate product-development and marketing dollars. Even the good vehicles the company develops (for example, the Cadillac CTS and Chevy Malibu) get lost in the wash. Nevertheless, the current board of directors and management have stuck stubbornly to this structure. The lone exception was a dissident director, Jerome B. York, who resigned a couple years ago. He warned that without fundamental changes the "unthinkable" might happen to GM. Well, here we are.
Which brings us back to what the government should do. If public dollars are the only way to keep General Motors afloat, as the company contends, a complete restructuring under a government overseer or oversight board has to be the price. That is essentially the role played by the federal Air Transportation Stabilization Board in doling out taxpayer dollars to the airlines in the wake of 9/11. The board consisted of senior government officials with a staff recruited largely from the private sector. It was no figurehead. When one airline brought in a lengthy, convoluted restructuring plan, a board official ordered it to come back with something simpler and sustainable. The Stabilization Board did its job -- selling government-guaranteed airline loans and warrants to private investors, monitoring airline bankruptcies to protect the interests of taxpayers -- and even returned money to the government.
As for Ford and Chrysler, if they want similar public assistance they should pay the same price. Wiping out existing shareholders would end the Ford family's control of Ford Motor. But keeping the family in the driver's seat wouldn't be an appropriate use of tax dollars. Nor is bailing out the principals of Cerberus, who include CEO Stephen Feinberg, Chairman John Snow, the former Treasury secretary, and global investing chief Dan Quayle, former vice president. Government loan guarantees, with stringent strings attached and new management at the helm, helped save Chrysler in 1980. But it's now 2008, 35 years since the first oil shock put Japanese cars on the map in America. "Since the mid-Seventies," one Detroit manager recently told me, "I have sat through umpteen meetings describing how we had to beat the Japanese to survive. Thirty-five years later we are still trying to figure it out." Which is why pouring taxpayer billions into the same old dysfunctional morass isn't the answer.
Circuit City Files for Bankruptcy
Circuit City Stores Inc. filed for bankruptcy amid rising competition from Best Buy Co., Wal-Mart Stores Inc. and online electronics retailers. The petition for Chapter 11 protection in U.S. Bankruptcy Court in Richmond, Virginia, listed $3.4 billion in assets and $2.32 billion in liabilities. The company said it is entering court protection owing Hewlett-Packard Co. $119 million and Samsung Electronics Co. $116 million.
The Richmond-based company, founded in 1949 when Samuel Wurtzel opened the city's first retail television store, has lost more than $5 billion in stock-market value in two years. Circuit City plans to stay in business while it comes up with a plan to restructure. "It's very incongruent for retailers to file bankruptcy before Christmas," Burt Flickinger, managing director of consultant Strategic Resource Group in New York, said in a Bloomberg Television interview. "You're gong to see a record number of retailer bankruptcies and closings." Concerns among vendors that Circuit City wouldn't be able to pay for the merchandise it sells "escalated considerably" in the past week, the company said in the filing.
The chain, with 721 stores in the U.S. and 770 in Canada, has said competition hurt sales, especially at older locations in lower-income neighborhoods. Amazon.com Inc. and other Web-based retailers of computers, televisions and music also have lured customers away. On Nov. 3, the company said it would close a fifth of its U.S. stores and renegotiate leases on some locations to conserve cash. The closings will leave it with about 566 U.S. stores and trim about 20 percent of the 43,000-strong workforce. Circuit City also said today it cut 700 jobs in its regional and district store support department.
Circuit City said it owes about $650 million to suppliers, with electronics manufacturers Sony Corp., Zenith Corp., Toshiba Corp., Garmin Ltd. and Nikon Inc. among the creditors. Circuit City tried to sell itself in May after Blockbuster Inc. made a preliminary offer that was later withdrawn. The retailer fired higher-paid workers and opened smaller stores to cut costs. Until the shift, the company's strategy had been to sell in locations as large as 44,000 square feet (4,090 square meters), which it calls "superstores."
Circuit City said it obtained $1.1 billion in bankruptcy financing, which replaces a $1.3 billion line of credit. The second-biggest U.S. electronics retailer hired FTI Consulting Inc. for restructuring advice and replaced its chief executive officer Philip Schoonover in September with Director James Marcum, who led two other retailers through bankruptcies. Marcum, an associate of activist investor Mark Wattles, was named interim CEO. On Sept. 29, Circuit City reported a loss of $239.2 million that was more than triple from a year earlier after sales fell for the sixth straight quarter.
Circuit City's rivals gained market share by offering Apple Inc. and Dell Inc. computers. Larger Best Buy and discount retailer Wal-Mart lowered prices on flat-panel televisions to lure U.S. customers, who are limiting spending because of higher food costs, further job losses and declining home values. The global financial crisis is making it harder for the chain to stock its shelves and for consumers to finance purchases. The company took on more debt this year, increasing a $500 million revolving credit agreement to $1.3 billion in January, according to its most recent quarterly filing with the U.S. Securities and Exchange Commission. As of May 31, Circuit City said it still had $963 million available to borrow.
Citigroup in Talks to Buy a Bank
Less than a month after walking away from Wachovia Corp., Citigroup Inc. is in discussions to acquire another U.S. bank, according to people familiar with the situation. The target's name couldn't be determined, but it is a regional bank that overlaps geographically with Citigroup's retail-banking unit, which has its highest concentration of branches in the Northeast, California and Texas. A deal could be reached later this month, the people said.
With Wachovia racing to complete its purchase by Wells Fargo & Co., any acquisition by Citigroup could feel like a consolation prize, because none of the remaining sellers among U.S. banks comes close to Wachovia in size. The fallout from that deal has added to tensions between Citigroup executives and directors, according to people familiar with the matter. Some board members have felt they weren't sufficiently kept in the loop, while some executives groused that directors are trying to wield too much clout, people familiar with the matter say. Some insiders say an acquisition would pump up morale at Citigroup and ease the embarrassment of the Wachovia mess.
Beyond that, the renewed takeover efforts show that Citigroup Chief Executive Vikram Pandit is determined to secure a deeper base of deposits tied to the world's largest economy. Such deposits are relatively cheap and a reliable funding source that makes them even more attractive as turmoil continues to swirl through the capital markets. After Citigroup's U.S. deposit levels declined slightly in the third quarter, the company has been trying to lure new accounts by offering unusually high interest rates on certificates of deposit. Another reason why Mr. Pandit wants Citigroup to bulk up in the U.S.: As the financial crisis ricochets around the world, Citigroup's vast global network is becoming yet another source of pain for a company that has piled up net losses of $20.25 billion in the past four quarters.
Last month, Citigroup reported a surprising leap in third-quarter losses on loans in Brazil, India and Mexico, while warning that deteriorating conditions in Colombia, Greece, Italy, Japan, Spain and elsewhere were possible harbingers of rising consumer defaults. The New York company's sizable operations in economies that have been relatively unscathed by the financial crisis, such as Argentina and Turkey, also could be vulnerable. "It's going to get a lot worse everywhere," says David Trone, an analyst at Fox-Pitt Kelton. Citigroup is the U.S. bank most heavily exposed to havoc in emerging markets, he adds.
Executives at Citigroup say any losses outside the U.S. will be manageable. They say the bank is in much better shape than it would have been had it plowed deeper into U.S. real-estate loans. "I'd take the emerging-markets position any day of the week," Gary Crittenden, Citigroup's chief financial officer, said in an interview. Citigroup does business in 106 countries on six continents. Its closest rival, HSBC Holdings PLC, operates in 85 countries. U.S.-based J.P. Morgan Chase & Co., Bank of America Corp. and Wells Fargo exceed Citigroup in stock-market value but have little or no international retail presence. Overall, Citigroup gets about half its revenue from outside the U.S. Around the world, Citigroup offers retail banking, credit cards and wealth-management services to consumers, while providing corporate clients with investment banking, cash management and transaction processing.
Since taking over last December, Mr. Pandit has been eager to push even deeper into emerging markets. To overcome the lack of credit bureaus and other infrastructure that banks rely on in the U.S. and Western Europe to guide lending decisions, Citigroup uses a credit-scoring system that it built. As the rest of the world is afflicted by economic woes, Citigroup's method will be tested. "You're underwriting more on judgment than on facts and science," says Mr. Trone of Fox-Pitt Kelton. Citigroup responds that its credit models have been honed for decades and are among the most sophisticated in the world. Still, rising defaults on international consumer loans are inevitable, the bank acknowledges. In the third quarter, Citigroup suffered losses on 4.5% of its international consumer loans, compared with a 3.9% rate in the U.S.
"There will be increasing credit costs across the globe," Mr. Crittenden says. "But the magnitude hopefully will be muted by the fact that our customer base is upscale." Citigroup says it has socked away enough reserves to absorb 10 months of non-U.S. loan defaults. Still, William Rhodes, a senior vice chairman at Citigroup, has said that a bailout of emerging economies by the International Monetary Fund is needed to avoid a "firestorm." Since losing out on Wachovia and taking a hard look at Washington Mutual Inc. before the Seattle company's failed banking operations were sold to J.P. Morgan in September, Citigroup has been fortified with $25 billion in taxpayer-funded capital from the Treasury Department. That makes it easier for Citigroup to pursue another U.S. bank, though some lawmakers have complained that federal infusions should be funneled into loans, not acquisitions.
Treasury's Paulson warned WaMu CEO to sell before it failed
Two months before Washington Mutual failed, Treasury Secretary Henry Paulson warned then-CEO Kerry Killinger that he ought to sell the Seattle-based thrift before it deteriorated further. "Paulson said, 'You should have sold to JPMorgan Chase in the spring, and you should do so now. Things could get a lot more difficult for you,' " said one of several current and former high-ranking WaMu executives familiar with details of the call.
Paulson's July comment, which has not been previously reported, caught Killinger and his top brass off-guard, executives said. Bank officials had recently raised $7.2 billion in capital from investors led by private-equity fund TPG, and they thought that was enough money to weather the worsening mortgage crisis. Killinger declined to comment for this article, and WaMu executives close to him spoke only on condition of anonymity. A Treasury spokeswoman said it does not comment on Paulson's private conversations.
Last spring, JPMorgan offered up to $8 a share for WaMu, with the final price depending on how its loans performed. Instead, WaMu sold a partial stake to TPG. When WaMu was seized by federal regulators Sept. 25, most of its banking operations were sold to JPMorgan for $1.9 billion — and the company's stock was rendered worthless. Killinger called Paulson in July to ask that the Treasury secretary use his influence with the Securities and Exchange Commission to add WaMu to a list of 19 financial institutions that were temporarily protected from a form of trading called "naked short selling" that can drive share prices artificially low. Paulson refused to help Killinger get WaMu on the list.
WaMu did get on a subsequent list: In mid-September, panic in the stock market prompted the SEC to ban all short selling on 799 financial-institution stocks. That ban came too late for the Seattle thrift, which failed the next week after a run on the bank that was precipitated by credit-rating agencies reducing WaMu's debt to junk-bond status. Its declining ratings were due partly to its falling stock price, which had been harmed by short selling.
The WaMu executives did not accuse Paulson of pushing WaMu to fail. Although the thrift's primary regulator, the Office of Thrift Supervision is a bureau of the Treasury, the head of the OTS reports to the president rather than to Paulson.
Banco Santander to Boost Capital With Rights Issue
Banco Santander SA said Monday it plans to raise €7.19 billion ($9.18 billion) through a rights issue, becoming the first Spanish bank to boost capital as a result of the financial turmoil. Spain's largest bank by assets said it will issue 1.6 billion new shares at €4.50 each, a 46% discount to Friday's closing price of €8.34. The move represents a reversal for Santander. As late as Oct. 29, when it announced third-quarter results, the bank had said it wouldn't need to raise capital.
However, a wave of capital raising among European and U.S. peers has put pressure on Santander and, to a lesser extent, its rival Banco Bilbao Vizcaya Argentaria SA to strengthen their balance sheets. BBVA on Monday insisted it had no need to raise new capital. Santander's shares fell on the news, weighing on other Spanish banks. Santander lost 3.8% to €8.02 in midday trading, while BBVA was down 1.4% at €9.45. Smaller Spanish banks were also underperforming the broader market. On a conference call, Santander's Chief Financial Officer Jose Antonio Alvarez said difficult market conditions had made the bank postpone a series of planned asset sales that would have served to boost capital. He said Monday's move wasn't related to any plans to make more acquisitions or to any hidden losses.
The bank said it expected core Tier-1 capital to rise to 7% in the medium term as a result of the capital infusion. Santander's core capital as of Sept. 30 was 6.31%, although it was expected to drop in coming months as the bank digests recent buys. In a show of strength during the financial crisis, Santander has acquired British lenders Alliance & Leicester and Bradford & Bingley, strengthening its position in the U.K. market. It also bought the 75% of U.S. bank Sovereign Bancorp that it didn't already own. The rights issue, which is fully underwritten, represents almost 14% of Santander's €53.3 billion market value at the close of trade Friday. Santander currently has 6.4 billion shares outstanding.
Mr. Alvarez said the bank had weighed the possibility of cutting its dividend payment instead of the rights issue, but decided that retail investors would prefer to continue to receive dividends. Santander added that the preferential subscription rights can be exercised during a 15-day period which is expected to start on Nov. 13 and end Nov. 27. The bank said members of Banco Santander's board of directors intend to subscribe to the capital increase.
Merrill Lynch structured the transaction.
Does a bigger boom imply a bigger bust?
For the US housing sector – and the financial firms that financed the boom – a bigger boom meant a bigger bust. Home prices rose higher than before — and now are falling fast. Shipping too. The Baltic dry index rose high on the back of Chinese demand. And recently it has fallen even faster than it rose. The Baltic index tracks the cost of shipping bulk goods. But it is indicative of the broad contraction in global trade that is almost certainly now underway.
No wonder that China is now pondering the risk that its export boom could turn into an export bust. Its export boom was comparable in scale to the United States housing boom. Perhaps bigger – as it also drew on demand fueled by Europe’s housing boom (and, until recently, the RMB’s large depreciation v the euro) as well as US demand. Whatever the cause, China’s exports have grown steadily larger over the past few years. Indeed, as the following chart shows, it is almost impossible for words to do justice to the scale of China’s export boom.
Yes, the pace of nominal export growth has slowed recently. But that is largely the result of a bigger base – not any major slowdown. Real export growth has slowed more than nominal exports. But real export growth – despite the loud complaints of the textile sector – has remained positive so far this year. The basic story of this decade – at least until now — is of an enormous boom. There isn’t even much volatility. Particularly relative to say the 1990s. Back then the pace of growth was generally slower and – as importantly — periods of rapid export growth were followed by periods of no growth. This shows up clearly in a chart that looks at the 12m change in exports (exports in the most recent 12ms – exports in the preceding 12ms).
In the 1990s, Chinese export growth looked rather cyclical. In this decade though exports basically just kept growing and growing. That though is almost certainly changing. My measure of export growth picks up long-term trends, but not short-term changes. If CLSA’s purchasing managers’ survey is right, there is no little doubt that China’s manufacturing sector is heading toward a recession. Real export growth almost certainly will slow sharply in the fourth quarter. And — as many have noted — there is a significant risk that domestic investment may slow along with exports. Some investment was directed at building up the export sector; even more likely went into China’s domestic property market. The scale of any slump in investment really matters. China’s investment boom was a bigger source of China’s growth this decade than China’s export boom.
China’s policy response is directionally right. A large domestically oriented stimulus is exactly what is needed. $585 billion is over 10% of China’s GDP – so it is large. At least it if it is really new money. Unfortunately, as the FT’s Geoff Dyer notes, that isn’t clear yet. If the stimulus is mostly just funds that China would have spent in any case, its actual impact will be modest. But if it is real new money, it could be large enough to make a difference.
The big question though is whether it can be put into effect quickly enough to offset the likely downturn.
It isn’t totally inconceivable that the y/y increase in China’s exports could go from over $250 billion to something close to zero … China’s financial sector doesn’t rely on financing from the international banking system. That leaves it in a better position than other emerging economies. On the other hand, China has relied more than most on external demand to support its growth – which is a problem in a global context when external demand is disappearing. Let’s hope China can reorient its economy quickly …
Gordon Brown hints at tax cuts
Prime Minister Gordon Brown has promised families to help them through the economic slump as he gave his clearest indication yet that he is preparing to deliver billions of pounds in tax cuts within the next two weeks. The measures are expected to be worth several hundred pounds to every family and will include an increase in tax credits and more help with fuel bills for the elderly. Mr Brown said: "What I am determined to do is to get all countries around the world trying to get their economies moving again and one way you can do that is by putting more money into the economy by tax cuts or by public spending rises. That's something that we've got to look at in the next few weeks,"
The Prime Minister also promised he would "look at everything" when it came to making tax cuts. There is mounting speculation that Chancellor Alistair Darling will use his autumn mini-Budget, due in the coming weeks, to unveil a package of tax cuts worth up to £15 billion and aimed at cutting household bills for families. Mr Brown spoke about cuts as he met a young family who were selected by GMTV to question him at Downing Street. He told young parents Chris and Sarah Charlton, from York, that food and fuel prices, mortgage repayments and gas and electricity bills should start decreasing in the next few months. He said: "We're here to help families during this difficult time. I'm determined we do the best by British families and make sure we show people we're doing everything we can to help them."
Mr Brown has made clear he does not want to cut public spending so any tax cuts are likely to have to be funded from borrowing.
The Conservatives have attacked that approach, warning it risks pushing up interest rates and requiring tax rises once the economy recovered. Conservative leader David Cameron said. "He's talking about borrowing even more. And what does that mean? The risk of higher interest rates and mortgage bills and higher taxes to pay off the debt tomorrow." The Conservatives are expected to announce plans for tax cuts funded from savings in government spending. They are thought to involve scrapping National Insurance payments for new workers to make it easier for employers to take staff on.
Liberal Democrat leader Nick Clegg, whose party promises tax cuts for most people paid for by extra levies on high earners and higher green taxes, said the Government would be "playing smoke and mirrors with the British electorate" if it promised tax cuts paid for by borrowing. He said: "You are in effect saying we will give you tax cuts today which you have to pay for tomorrow. That is wrong. You need permanent, big tax cuts." The answer was to close "multi-billion pound tax loopholes" exploited by the super-rich, he said.
Britain's city centres left reeling by house price crash
The 1.5 percentage point cut in interest rates by the Bank of England last week came just hours after the latest house price index by the Halifax showed values had fallen by a record 15pc in the last twelve months. Confidence and credit have deserted the housing market. The Monetary Policy Committee will be hoping that the lowest borrowing rates for 53 years will help residential property prices to recover from one of their steepest challenges since the Second World War. However, according to estate agents and consultants out in the field across the UK, the depths of the slump in parts of the market is worse than the research from the various lenders and property websites suggests.
At an auction organised by Allsop last Monday, a flat in an upmarket area of Leeds that was bought for £400,000 in July 2007 sold for just £159,000. A reduction of 60pc. At the same auction a flat in the city centre of nearby Wakefield, bought for £189,000 on October 31 2007, sold for just £69,000. They were not the only bargains on offer. The auction was originally planned to run for two days but was extended to four because of the number of repossessions. "Unfortunately these were someones' dreams and they have been repossessed," said Andrew Wells, a partner at Allsop in Leeds, said. "It has become someone's deal now. You could argue that this is a forced sale or a fire sale, but its been on the market with an estate agent and no-one has bought it. A property is only worth what someone will pay."
The city centre and urban flats market has taken a pummelling, he added. A recent survey by property website Mouseprice said city centre prices had fallen by up to 17pc but he called this "absolute nonsense". "I don't know how they did their data," he explained. "City centre flats haven't fallen 17pc – it's much worse than that." In late September, Alastair Stewart, an analyst at Dresdner Kleinwort, returned from a tour of city centres in the Midlands and the North of England to proclaim that, especially among new-build apartments, the housing market was seeing "carnage beyond even our most bearish expectations" with a massive over-supply of apartments, developers selling at virtually any price to shift stock and almost all forthcoming new developments "mothballed". He also found Barratt Homes were offering 43pc off on bulk deals of five-or-more flats in East Yorkshire.
Over a month on, and following the Government's dramatic bail-out of the banking sector, the cities of Leeds, Sheffield and Birmingham have more troubled tales about the apartment market. "We've just got a situation at the moment where nobody is buying. You could talk to agents in this street where they have probably sold one dwelling per month each," Mr Wells said. "Any developer will listen to any agent who goes to them with a buyer who wants more than one unit. You can negotiate a very good discount." Agents in Leeds reported falls in prices of new-build apartments of 30-40pc, pushed down by discounted bulk buys, with similar declines and low levels of transactions in Sheffield.
"We are only putting properties on the market with people who will be flexible with their asking price," said John Francis of Crapper & Haigh. "We are being a bit more choosy – we don't want to waste a seller's time or our money." In England's second city - Birmingham – agents report discounts of 25pc-30pc off bulk purchases with up to 40pc off on purchase of ten or more apartments. Additionally, there have been barely any new starts of apartment blocks in the last two years and, like Sheffield and Leeds, some existing projects have simply ground to a halt. Amid the declining market, developers are being forced to offer a range of innovative and attractive incentives to potential buyers including 75:25 shared equity schemes and rent-to-buy – where the occupier, who is unable to acquire a mortgage or is concerned that the value of the property may fall, rents the property for up to three years before buying at a pre-agreed in price.
Agents also say Birmingham is seeing so-called 'chain-breaker deals' where the developer will give funds, up to £10,000 in some cases, to a buyer who is threatening to break the buyer-seller chain so that they can complete their purchase and allow all the sales higher up the chain to go through. However, despite the fall in prices, owner-occupier purchases remain "negligible", according to Savills director Simon Horan. Research from Savills suggests that, prior to the interest rate cut on Thursday, only five lenders were offering mortgages on new-build properties and they have a maximum loan-to-value ratio of 65pc. The only acquisitions of apartments have come from so-called "vulture funds", who are able to drive hard bargains because of the lack of interest in the market.
Urban apartments have been at the forefront of the sharp decline in the property market because their boom over the last ten years was founded on the growth of buy-to-let investors, who became one of the first casualties of the credit crisis. Many of the flats were bought off-plan as investors anticipated a rise in value as the property was built and were thus caught out by the dramatic falls in prices. However, perhaps the most significant factor is that urban apartment blocks have none of the defensive qualities that detached family homes have – it is the one part of the housing market that is over-supplied after years of urban regeneration projects and councils identifying them as the easiest way to meet Government housing targets.
"The city centre flats are just a nightmare," says Mr Francis in Sheffield. "There are far too many of them and I don't know how people are going to sell them. Ten years ago we had no city centre living in Sheffield but it's gone absolutely crazy – they are on every street corner. From nothing we have gone to thousands and there is only a certain type of buyer who wants to live in the city centres. You are not going to get families." The future for the city centre apartments now appears mixed, with the Northern cities reporting that the respective land values of the sites have fallen by up to 50pc. David Fenton, a residential development partner at Knight Frank in Birmingham, said land was now finding its "realistic value" with developers realising that trying to squeeze the maximum amount of units from a piece of land was not the most economical approach.
"Will we see flats again? Maybe," he said. "Probably in smaller numbers such as 30 or 40 units rather than 300." Agents insist that there does remain some demand for city centre accommodation because of continuing rise in rental values. In Manchester rents are increasing to such an extent that some landlords are insisting on six month contracts – rather than a year – because they know they can increase the price after that period. Alistair Humphrey, whose Eadon Lockwood & Riddle estate agency in Sheffield has been one of many forced to downsize and lay off staff, said: "The last downturn we had was in the early 1990s and the difference then was that we saw it coming. "It took about three years overall – a year to slowdown, a year on the bottom and a year to pull out again – but there weren't any cliffs like there has been with this worldwide banking debacle that we are living with at the moment. It is going to take a long time for confidence to come back."
Fitch cuts Romania to junk, warns on South Korea, Mexico, Russia and South Africa
Fitch Ratings cut Romania's credit to "junk" status in one of four emerging market downgrades on Monday and said the global crisis had put those of South Korea, South Africa, Russia and Mexico at risk. The ratings agency's move comes nearly two weeks after a Standard & Poor's downgrade turned the east European country into the only European Union member state with a non-investment grade credit rating and is the latest sign that the global financial crisis is still spreading across emerging markets.
Ratings agency views on the value of debt taken by developing economies are one key to ensuring investor demand for the bonds they issue in their own or hard currencies. Investors, once bullish on eastern Europe's prospects for growth and deeper integration into the EU, have dumped assets on concerns that states in the Balkans or Baltics could follow Hungary into crisis as they struggle with large debt burdens. Fitch also cut its ratings on Kazakhstan and EU member Bulgaria by one notch to BBB-, the lowest investment-grade level, and lowered Hungary to BBB from BBB-plus. The agency cut Romania by two notches to BB-plus from BBB and lowered its outlook on South Korea, Mexico, Russia and South Africa to negative from stable, while those for Chile and Malaysia were cut to stable from positive.
The actions are part of a review of 17 big investment-grade emerging markets, which resulted in four downgrades and seven outlook revisions, it said on Monday. Emerging markets with current account deficits and those reliant on short-term external funding have been among the worst hit by the crisis that has already led the International Monetary Fund to provide loans to Hungary and Ukraine. The widespread risk aversion has led foreign investors to flee markets such as South Korea in droves, aggravating the impact of the liquidity crunch. In emerging Europe, the downgrades dragged down local currencies, with the leu briefly shedding 1 percent against the euro .
Fitch said the world's largest economies were facing a recession that could be as severe as those of the early 1980s and 1990s, casting doubt over how less developed economies can adjust, even if some have more robust balance sheets and liquidity positions than in previous times of turmoil. "The profound shift in the global economic and financial outlook poses significant real economy and policy challenges for emerging markets," David Riley, head of Fitch's global sovereign ratings group, said in the statement. "Policymakers in emerging economies have even less scope for policy errors than their counterparts in so-called 'advanced' countries, but they are better placed to navigate these challenges than ever before."
Some emerging European countries are the most vulnerable to a financial crisis, Fitch said, given their large current account deficits and their reliance on short-term borrowing. Romania is likely to require external financial support to prevent "a sovereign credit crisis", Fitch said, as it deals with a current account deficit that is expected to exceed 14 percent of gross domestic product this year. But Romanian policy makers remained defiant, after slamming S&P criticism as unfair, saying that Fitch did not take into account fast economic growth this year, low external debt levels and robust hard currency reserves. Finance Minister Varujan Vosganian warned opposition groups have not "taken responsibility" for public policy.
The ruling Liberal Party is trailing two other groups in opinion polls ahead of a parliamentary election on Nov. 30. Infighting ahead of the vote is seen as a key obstacle to any coordinated response to economic risks stemming from global woes. Last month, Romania said it did not need IMF help, while the Washington-based institution denied reports that it was talking about a rescue package with one of the EU poorest member states. Fitch's echo those made by S&P last month, which warned of mounting risks to Romania's economy due to rising private sector debt and its dependency on increasingly uncertain foreign markets.
Latvia mulling IMF loan as crisis sweeps Nordic region
Latvia has been forced to bail out its second largest bank over the weekend and may soon need a rescue by the International Monetary Fund as the financial crisis engulfs the Baltic region, and much of Scandinanvia. Premier Ivars Godmanis stunned the country by announcing that Parex banka had been half-nationalised in an attempt to head off a serious crisis in the face of escalating capital flight from the country. "We have to do everything to avoid trouble, not only for specific banks, but for the banking system as a whole," he said.
Mr Godmanis said Latvia was examining a raft of measures to rescue the economy, including possible aid from the IMF and European Union. Iceland, Hungary, and Ukraine have already obtained loans for the IMF. Latvia is facing a brutal recession after years of torrid credit growth and one of the most extreme property bubbles in Eastern Europe. The economy contracted by 4.2pc in the third quarter. House prices have fallen 21pc over the last year, according to Global Property Guide. The swing from boom to bust has been made worse by heavy use of mortgages in euros, Swiss francs, and yen.
The rating agencies have rushed through a spate of downgrades in recent days for the Baltic trio of Latvia, Estonia, and Lithuania, warning that heavily reliance on short-term foreign funding has left them dangerously exposed to the global squeeze. "If the situation were to worsen, Latvia could be forced to seek balance-of-payments support from the EU or the International Monetary Fund," said Kenneth Orchard, senior analyst at Moody's. "The global liquidity crisis will probably cause a shock to the Latvian banking system, which will reverberate throughout the rest of the economy. Unless there are major improvements in the European syndicated loan market by early 2009, the government will be forced to take remedial action."
Oskars Firmanus, head of the Latvian consultancy Paus Konsults, said the Parex rescue had badly shaken depositors in Riga. "It has come as a big surprise. The bank has been very secretive and did not tell anybody there was a problem. People have been lining on the streets over the weekends trying to get their money out of ATM machines," he said. Swedish banks have large exposure to the Baltic market, adding to their woes as the industrial downturn hits Scandinavia.
The IMF warned in a recent report that the Baltic operations of Stockholm's banks "could cause a credit crunch in Sweden itself" if the closure of the wholesale capital markets continues for much longer. Total lending to Eastern Europe by Swedish banks is equal to 25pc of the country's GDP. Swedbank dominates lending in Latvia and Estonia, while SEB is the biggest lender to Lithuania. The share price of the two banks have fallen by 70pc from their peak.
Shipowners cut losses by scrapping orders
Shipowners are forfeiting tens of millions of dollars to cancel contracts to buy vessels rendered uneconomic by one of the industry’s sharpest downturns. Last week, New York-listed Genco Shipping announced it was forfeiting $53m in deposits it had placed to buy six new vessels due to cost a total $530m.Hellenic Carriers, listed on London’s junior Aim market, said it was forfeiting a $6.97m deposit and making a further $1m payment to abandon a $69.7m contract sealed in July to buy a dry-bulk carrier.
At the same time, Oslo-listed Golden Ocean told Lloyd’s List, the shipping daily, it was reviewing its ship orders, although none had yet been cancelled.
The cancellations follow a collapse in the short-term, spot market rates for dry-bulk ships carrying iron ore, coal, bauxite, wheat and other commodities. The fall – of 71.9 per cent in October alone – has sent ship values tumbling. Consequently, it is often more worthwhile for shipowners to forfeit their deposits and pay compensation than to go through with deals on which they would never earn a reasonable return.
Quentin Soanes, managing director of Braemar Seascope, a London shipbroker, said that, for the worst-hit sizes of dry-bulk carriers, 40-50 per cent of existing orders could be cancelled. Braemar’s current estimate of the world order book of dry bulk ships stands at 3,920 vessels. He said: “It’s going to be very, very messy, I think,”.
By cancelling orders, the shipowners rfelease badly needed cash they would otherwise have to put towards future payments on ship purchases.
Fotini Karamanlis, chief executive of Hellenic Carriers, said her company was acting prudently: “We chose not to take the risk of acquiring a ship that would be operating at a loss from day one.” John Wobensmith, Genco Shipping’s chief financial officer, said: “The company’s liquidity has been strengthened during a difficult market environment and our ability to act opportunistically has been enhanced.”
Shipyards, meanwhile, are struggling to secure the guarantees that will refund shipowners if they fail to complete their orders. Without such guarantees, orders become void. Stamatis Molaris, chief executive of Excel Maritime Carriers, told investors he no longer expected to receive four large dry-bulk carriers ordered for $311m from Korea Shipyard in Mokpo, South Korea. The recently established yard has so far provided no guarantees. “Those four new buildings will not deliver,” he said.