Three-horse team fire truck pulling water tower. Washington, D.C.
Ilargi: The problem with all plans to backstop mortgages is the same and eternal one that should have kept the government out of mortgages in the first place: it drives up prices. I know that in the US, the practice goes all the way back to the 1930's, and it may well have been well-intentioned, but it came with its own seed of failure built in from the start.
Today’s price levels are so high that any and all backstops are even far more perverted than they were 70 years ago, but the principle remains. The solution is not, and never can be, to allow or even seduce prospective buyers, through loans or giveaways or any other means, to purchase highly overvalued properties.
You see, that is good for the banks who write the mortgages; they receive far more in mortgage payments and interest. It is not good for the buyers, who get much deeper into debt than they would have if the government would stay away. You could have a system in housing that involves the government, but then you would have to throw banks out of that system altogether. If both are involved, homeowners automatically end up paying more.
I would be hugely in favor of kicking the banks out: they add nothing, they just take away. Now that Fannie and Freddie are back in government hands, and they buy 95% of all mortgages, the only role banks play is in pocketing fees, without any kind of responsibility. And that is of course never good. In my view, all basic human needs should be taken out of the marketplace, or at least food, water and shelter. I don’t mind leaving clothes in there, as long as you make sure everyone has enough.
But when it comes to food and water being bought and sold by large anonymous investors, there must inevitably come a time when a profit can be made through people's misery. Every community needs to have ownership of its basic needs. For housing, you could revert to George Bailey, but looking at the way the banking industry has grown into a gang of blood-thirsty sharks, I don't see the original savings and loan model as viable, not until the last guy to leave Wall Street turns off the lights.
Of course, there is the discrepancy between buyers on the one hand and owners that want to sell on the other. While buyers benefit from lower prices, owners obviously do not. Still, you don't have to choose sides to resolve this Gordian knot. All you really need to do is to know the cost of building a house, and to place a maximum profit margin on top of that. That is no different from what you must do to keep food affordable, or from the way water prices are still set in large parts of the world. If we allow our basic needs to be turned into investment and profit-making opportunities, we allow ourselves to be treated as such as well.
If there is more money to be made in selling sending our food and our water to other communities than our own, we will be either poorer, hungry, thirsty, or all of the above. Equally, if we allow people outside our communities to buy, sell, lend out and manipulate our homes for profit, we will end up either poorer or without shelter, and again most likely both.
It is not realistic to think that these principles will be adopted tomorrow morning. But in the meantime, plans like the one that Sheila Bair announced this morning, which facilitate the continuation of a system with highly overvalued real estate, can only fail, and will do so at the cost of the very people they claim to help. And once again, the only parties that benefit are the major banks and lenders. The losses reported this week by Fannie Mae and Freddie Mac, which are really just the tip of the iceberg, will all come back to haunt the same homebuyers (well, their grandchildren) who were supposed to be helped under Roosevelt’s New Deal, which gave birth to Fannie Mae.
These are unintended consequences that will cost US taxpayers trillions of dollars. Fannie and Freddie’s combined losses, just in the 3rd quarter, are $54 billion. At its 2005-06 peak, the total value of US residential real estate was estimated at some $23 trillion. According to Case/Shiller, it has since lost at least 22%, or $5 trillion. A large part of that loss sits in Fannie and Freddie’s portfolio’s, and the government is aggressively pushing them to buy more loans, close to $500 billion per year. The official line is that this will benefit the potential buyer and the consumer, customer, taxpayer, citizen. The reality is that such enormous mounds of losses are dumped on the heads of Americans, you won't be able to dig them out and find them back.
These consequences may never have been foreseen by Roosevelt and his people, though that is by no means sure. In the years since, however, both banks and governments have come to understand very well how much money can be made by pushing up real estate prices. All they had to do was promote the myth of the American dream of homeownership.
And that is perhaps the most amazing trick as well as the biggest crime: making people believe that something works to their advantage, while in reality it drives them into debt-riddled poverty. People have this remarkable talent to fool themselves, to see only what they wish to see, and it can be a gift from heaven. But that's not always a given.
At times it helps to look beyond your dreams. There are entire industries out there who use that talent of yours to see only what you wish, in order to sell you detergent, cars, houses, politicians and a whole lot of other things that you'd be better off without. Your dreams have a way of betraying you when you use them to escape. It's high time, and High Noon. Ask yourself why you dream what you dream.
Iceland's Lesson for the G20
As a test case for an internationally coordinated financial rescue, efforts to drum up emergency aid for Iceland are distinctly dispiriting ahead of this weekend's G20 summit. Getting help to Iceland is urgent. International trading of the kronur is essentially frozen. The import-dependent island economy is on the cusp of a slump and faces rampant near-term inflation. There have been reports of possible mass emigration.
Iceland and the International Monetary Fund did agree on a $2 billion loan back on Oct. 24 to help restore the tiny island economy's stability after its banking sector collapsed. But the IMF has set an important condition. Iceland has to secure twice that amount from other sources before the IMF hands over any money. That's a pretty tall order for a borrower already teetering on the brink. So it's little surprise that the rescue effort has hit a wall. Some other institutions that might lend to Iceland are waiting for the IMF money to come first.
Sweden's central bank, for one, will consider letting Iceland draw on a €500 million ($624.8 million) swap facility only after the IMF approves its part of the bailout. Further complicating the matter is a dispute between Iceland and the U.K. and the Netherlands over billions of pounds of deposits in an overseas unit of a failed Icelandic bank. No one talked about this as a potential deal breaker when a tentative IMF loan was announced three weeks ago. Now it seems the IMF has bowed to pressure from London and the Hague not to extend any credit until the two governments' disputes with Reykjavik are resolved. That may yet prove a protracted, legally complex process.
Iceland's leaders haven't covered themselves in glory with a number of U-turns. And rushing to borrow funds from Russia -- another deal that's still pending -- didn't endear the government to Western creditors. The result is that the rescue of a tiny island economy has become bogged down in multilateral wrangling. As the leaders of the world's biggest economies gather in Washington this weekend, the Icelandic experience should serve to temper expectations. Investors banking on a coherent international response to the much bigger issues facing the world's economy risk being disappointed.
Germany declares official recession
Germany has become the first of the G7 powers to declare an official recession. It will almost certainly be followed by France and Italy as growth collapses across the eurozone. The OECD club of rich states issued its own gloomy forecasts yesterday, warning that Euroland, the US and Japan, will all shrink next year – the first synchronized slump in the three areas since the first oil crisis of the mid-1970s. "This is certainly not a V-shaped recession," said Jorgen Elmeskov, the group's chief economist.
"In normal circumstances we'd say monetary policy is the instrument of choice, but these aren't normal times. The transmission of monetary policy may not work due to the credit crunch," he said. Germany's statistics office said output had fallen by 0.5pc in the third quarter, far worse than expected. It is the second quarter in a row of declining output. Bert Rurup, head of Germany's council of "Wisemen", said the crisis has turned vicious over the late summer. "The collapse of Lehman Brothers, which should absolutely have been prevented, brought the global financial system to the brink of collapse.
Governments have averted catastrophe by taking action, which should limit the sort of damage to the real economy that occurred in the Great Depression. But I can't exclude horror scenarios, however unlikely." Jacques Cailloux, Europe economist at RBS, said Germany is sliding into the deepest slump in half a century. "We expect the economy to contract by 1.2pc next year, the worst in the euro area," he said. Both RBS and Citigroup say the European Central Bank will have to follow the Bank of England with drastic rate cuts next month, perhaps with a three-quarter point rate reduction to 2.5pc.
Germany has been hit first – and hardest – because of its reliance on industrial exports. This is the flip-side of its achievement in becoming become the world's biggest exporter, with a current account surplus of 7pc of GDP. It is now "leveraged" to the downturn in China, the Gulf and Eastern Europe – the new locus of the financial crisis. Hungary, Ukraine, Serbia and Belarus are in the arms of the IMF. Russia is in chaos as oil prices crash. "Foreign orders have fallen by 18pc since November," said Mr Cailloux. "This is very bad for German manufacturing and we are afraid there is going to be a labour shock as they start to lay off people."
The engineering group Siemens is cutting 17,000 jobs. The German car industry – which accounts for 20pc of the nation's workforce – is going through an ordeal by fire. BMW has halted production at three plants, telling workers to stay home. The auto parts-maker Continental said it is laying off 5,000 contractors. The government has waived a new car tax for a year after new car sales fell by 8pc in October – they fell by 16pc across Europe over the same period – but the move is viewed as too little, too late.
While China is launching at $586bn (£396bn) fiscal blitz, and Japan is spending $275bn, Germany has so far stuck to its orthodox script – though it has a balanced budget, and ample scope for stimulus. Its pop-gun package of €12bn (£10bn) over two years is pocket change for Europe's biggest economy. "Germany is at a tipping point," said Giles Moec, from Bank of America. " It needs a fiscal plan of about 1pc of GDP right now, and this must be implemented immediately. But culturally Germans don't like big fiscal boosts."
The Left-Right coalition of Chancellor Angela Merkel – now looking very fractured – has been criticised for sleep-walking into this crisis. It dismissed warnings of recession as "preposterous" and denied that Germany was facing a credit crunch until the collapse of the mortgage lender Hypo Real in September, the trigger that forced Berlinto step in with a €500bn guarantee for deposits. Twelve banks and insurers have tapped the state rescue so far, including Commerzbank . German confidence in the financial system has since suffered a severe blow. A quarter of the country's property funds have had to freeze withdrawals, including those run by Morgan Stanley, Credit Suisse, AXA and Sweden's SEB, amounting to a total of €34bn.
These funds have been a conduit for investing Germany's abundant savings all over Europe and beyond. The crisis in the sector knocks away another prop for property prices in Britain, Spain, Ireland and Denmark. This has already hit the City of London, where Signa Deutschland has had to pull out of its £150m purchase of Milton Gate from UBS. Thomas Fricke, chief economic columnist at the FT Deutschland, said that ultimately it is the ECB that bears the most responsibility for this recession. "The bank's failure to cut rates after the summer of 2007 and the grotesque way it raised rates in July may prove to be one of the greatest monetary policy errors in history," he said.
Eurozone Officially in Recession
The economy of the euro zone slipped into recession for the first time during the third quarter, the European Union’s statistics agency confirmed Friday, as the financial crisis continued to depress manufacturing activity and consumer demand.
Gross domestic product declined 0.2 percent in the third quarter from the previous three months in both the euro zone, which comprises the 15 countries that use the euro as their currency, and the European Union as a whole, according to an initial estimate published by the agency Eurostat. The weakness in the third quarter was particularly marked in Germany and Italy, both of which have technically entered a recession with G.D.P. contractions of 0.5 percent from the previous quarter after a similar decline in the second period.
France managed to avoid a technical recession, defined as two consecutive quarters of negative growth, as its economy grew 0.1 percent. Spanish G.D.P. also fell, by 0.2 percent, posting the first quarterly decline since 1993. Dutch G.D.P. was flat, after also stagnating in the second quarter and British growth was down by 0.5 percent after a flat reading during the previous quarter. Compared with the same quarter a year earlier, G.D.P. grew 0.7 percent in the 15-member euro zone and 0.8 percent for the 27 countries of the European Union. Further details of the data were not provided in the estimate. But economists said a further contraction in euro zone G.D.P. in the current fourth quarter seems virtually assured and that the downturn was likely to endure well into next year.
“Historically, recessions preceded by episodes of banking-related financial stress have tended to be more profound and long-lasting,” said Martin van Vliet, an economist at the Dutch bank ING. “Consequently, it seems overwhelmingly likely that the current, credit-crisis induced downturn is going to be more painful than the previous one in 2001 to 2002, after the dotcom bubble burst.” Still, he said in a research note that he was hopeful that the aggressive and unconventional policy measures that have been taken by policy makers, including deep interest rate reductions and capital injections into banks, would help to “pave the way for a gradual recovery in the second half of next year.”
A separate statement on Friday showed that the economic malaise is touching automakers particularly hard. The Brussels-based European Automobile Manufacturers’ Association said European car sales plunged almost 15 percent in October, the sixth monthly decline. Registrations declined to 1.13 million vehicles last month from 1.33 million a year earlier, while sales for the first 10 months fell 5.4 percent to 12.8 million vehicles. The French carmaker Renault, meanwhile, confirmed Friday that it planned to further cut its output to reduce inventories of unsold cars by the end of the year to the same level as the end of last year. For October, its sales were down 14.1 percent from a year earlier.
In the United States, automakers, led by General Motors, are pleading for help from the government as their sales and share prices plummet. But the prospects of a government bailout for the Detroit carmakers dwindled Thursday as Democratic lawmakers conceded that they would face potentially insurmountable Republican opposition to such help during a lame-duck session next week. The European Union’s industry commissioner, Günter Verheugen, this week ruled out aid for European carmakers beyond existing help for research and development projects.
Analysts said the overall economic weakness in the euro zone was touching most sectors. “We suspect that weakness was broad based, with stagnation in consumption and outright contraction both in investment and exports,” Marco Valli, chief Italian economist at Unicredit Markets and Investment Banking in Milan, said in a research note. Looking ahead, he said, the overall picture looks discouraging, “as clearly suggested by plunging business surveys in October.” “Manufacturing activity is in a free fall due to an inventory overhang and plunging orders,” Mr. Valli said.
British pound sinks to record low against the euro
First property. Then shares. Now sterling is slumping. In July, £1 would still buy $2; lower than its recent record of $2.11 set last November, but healthy enough for shopping trips to New York to make sense. Yesterday, sterling was trading at about $1.48, a six-year low. Macy's and Sachs of Fifth Avenue may soon notice a sharp decline in the number of British accents at the tills. Our currency has also been bouncing along the bottom against the euro, which is now worth about 84p, its highest since the single currency was launched in 1999.
Suddenly the idea of parity – £1 = €1 – hoves into view. Broadly speaking, sterling has had a more violent battering in recent months than it endured after it famously fell out of the European Exchange Rate Mechanism on "Black Wednesday", 16 September 1992. The pound has fallen 25 per cent against the dollar and 15 per cent versus the euro this year. It has, you might say, had a bit of a pounding. The reasons for sterling's weakness are not difficult to see. To some extent, it is simply an adjustment to the way the pound has been overvalued for years: its fair value is about $1.50, according to the Organisation for Economic Co-operation and Development.
What's more, the UK is evidently headed for recession and the Bank of England is predicted to cut interest rates to historically low levels, maybe even below 1 per cent over the course of next year – the lowest level since the Bank was granted its charter in 1694. Such meagre prospective rewards for investors and the general belief that sterling assets have further to fall has prompted a sharp sell-off in the currency. Both the Governor of the Bank, Mervyn King, and the Chancellor of the Exchequer admitted on Wednesday that the country was facing a sharp, if short, recession. Few independent economists believe the UK will recover quite as quickly as the authorities forecast – or that this country is well placed to cope with the downturn.
The IMF says that the UK's will be the most marked contraction in output – down 1.3 per cent – among the major advanced economies. Unemployment stands at 1.8 million, and will almost certainly climb to two million by Christmas and three million by 2010. Yesterday, Europe's largest economy, Germany, the engine of the UK's largest market, the eurozone, confirmed it had entered its worst recession in 12 years or more. Investors are also becoming alarmed by the size of the British Government's budget deficit, predicted by the Chancellor to top £90m before long.
The prospect of a large quantity of UK government securities being issued to pay for the shortfall and various bank rescues has raised concerns about the way the economy is being run and longer term worries about inflation and growth. There is also a positive dollar story. One of the consequences of the recent financial turmoil was a flight to safety, with short-term (one week, say, or one month) US Treasury securities, the favoured haven of international capital, with the reassurance of the US government behind them; the Swiss franc was another notable beneficiary of this trend. Sterling has not enjoyed that same prestige. The Australian dollar has also languished unloved, a victim of the fall in commodity prices and the slowing Chinese economy.
Should the depreciation of sterling turn into a rout, we may even see the current policy of aggressive cuts in interest rates by the Bank of England suspended, if not reversed. For the moment, the Bank seems content to watch sterling fall. Although economic theory teaches that a weak pound could lead to inflation, the very poor state of the domestic demand limits the scope of manufacturers and others to pass on price increases in the shops. Nor has the pound declined by enough to transform our balance of trade. Export orders remain weak, despite the low level of sterling, because demand in Britain's main markets – the rest of Europe, North America, Japan and China – remains so feeble. It will, in other words, need an even more savage discounting of the dollar/euro/yen prices of Scotch whisky, Range Rovers and Richard Rogers' buildings to stimulate demand for them and generate more foreign exchange earnings.
However, the Bank of England has pledged to act if sterling's fall becomes uncontrollable. A pause in the Bank's policy of slashing interest rates would have a depressing impact on the wider economy – with house prices falling further, consumer confidence staying low and the credit crunch again restricting the supply of credit for businesses and consumers. Against a basket of currencies weighted according to the UK' s trade, sterling is down about 20 per cent on this time last year, a "pretty hefty" depreciation, in the words of the Bank of England's Deputy Governor for Monetary Policy, Charles Bean. It is one of the more severe of the many bouts of weakness the pound has suffered since the Second World War. It may be many years before a shopping trip to Manhattan or a Swiss skiing break seems quite the bargain it used to be.
US Retail Sales Decline Record 2.8% Amid Broad Weakness
U.S. retail sales took a record dive in October as consumers afraid for their jobs continued a retreat heading into the holiday shopping season and cut back spending on a wide variety of goods ranging from cars to furniture to electronics. Separately, U.S. import prices fell at a record pace last month, further evidence that falling oil prices and the slowing global economy are having a rapid damping effect on inflation.
Assuming that trend is confirmed by upcoming producer and consumer price reports, Federal Reserve policymakers should have added flexibility to address the credit crisis through liquidity programs and even more rate cuts without worrying about an inflationary outbreak. Retail sales tumbled 2.8% last month, the Commerce Department said Friday. It was the fourth drop in a row. Sales in September decreased 1.3%, revised down from an originally estimated 1.2% decline. Economists expected a 2.4% drop in sales during October, the first month of the fourth quarter. The 2.8% drop was the largest since records began in 1992. The previous record was a 2.65% decline in November 2001.
The retail sales report illustrates where Americans are spending their money -- or, in this case, cutting back. The credit crunch, shrinking asset prices, soft job market, and deteriorating economy are keeping people away from stores and forcing them to save money. The holiday shopping season isn't seen being as rewarding for retailers as in past years. Consumer spending is a big part of the economy. It makes up about 70% of gross domestic product, which is the scoreboard for the economy. GDP fell a seasonally adjusted 0.3% annual rate July through September, the Commerce Department said in its recent, first estimate of third-quarter GDP. Third-quarter consumer spending fell 3.1% -- the sharpest drop since 8.6% in second-quarter 1980.
Experts contend the drop in GDP opened what is a recession, although official word on a recession hasn't been given. The rule of thumb for a recession is two straight quarters of economic decline. It is the National Bureau of Economic Research, an academic group, that would officially determine whether the economy entered recession based on several economic indicators. The Commerce Department report Friday on retailing showed automobile and parts sales plunged by 5.5% in October. September sales decreased 4.8%.
Sales of all retailers except auto and parts dealers dropped in October by 2.2%. Economists expected a 1.6% decrease. Ex-auto sales in September had gone 0.5% lower, revised from a previously reported 0.6% decline. October gasoline station sales fell 12.7% last month, reflecting sinking gas prices. Gas sales fell 0.4% in September. Stripping away sales at gas stations, demand at all other retailers dropped 1.5% in October. Excluding auto sales and gas station sales, all other retailers saw sales fall 0.5% in October. That was a slight improvement over a 0.6% drop in September.
Sales last month fell 2.5% at furniture retailers; 0.4% at building material and garden supplies dealers; 1.4% at clothing stores; 2.3% at electronic stores; 1.6% at sporting goods, hobby and book stores; 0.4% at general merchandise stores; and 1.8% at mail order and Internet retailers. Sales rose 0.3% at eating and drinking places and 0.4% at health and personal care stores. Sales at food and beverage stores were flat. Import prices slid 4.7% on a monthly basis in October -- marking the largest one-month decline since the index was first published monthly in December 1988, the Labor Department said Friday. The record drop for October, which was greater than the 4.0% drop economists surveyed by Dow Jones Newswires had expected, follows a revised 3.3% drop in September that was larger than first estimated.
Still, reflecting sharp gains earlier in the year import prices were still up 6.7% from October 2007. Petroleum import prices fell 16.7% last month -- the biggest drop in more than five years -- but were nevertheless up 13.1% on the year. Prices have decreased 32.4% over the past quarter, representing the largest three-month drop since a quarterly decreae of 32.6% in February 1991, according to the Labor Department report. Excluding petroleum, import prices fell only 0.9% and were up 5.0% on the year. Friday's data were the first of what will likely be another very favorable series of inflation reports. The data should support market expectations for another Fed rate cut. Prices for non-petroleum industrial supplies and materials imports fell 3.2% last month, according to Friday's report.
Food prices, meanwhile, slid 1.6%, the largest decline since February 2006. Reflecting the broad-based nature of the decline last month, automobile import prices were up 0.1%. The prices of imported capital goods were down 0.2% and consumer products prices were up 0.1%. Prices of imported goods from the European Union fell 1.3% on a monthly basis. Prices of Canadian products, meanwhile, tumbled 4.4% compared to September. Prices of goods from China fell 0.3% -- the first monthly decline since January 2007. Prices from Japan, meanwhile, were up slightly at 0.5%. U.S. export prices fell 1.9% last month. The year-over-year rise was 4.2%. Prices of agricultural exports fell 8.7% on the month, while prices of non-agricultural exports fell 1.2%.
October US budget deficit hits record of $237.2 billion
The federal government began the new budget year with a record deficit of $237.2 billion, reflecting the billions of dollars the government has started to pay out to rescue the financial system. The Treasury Department said Thursday that the deficit for the first month in the new budget year was the highest monthly imbalance on record. It was far bigger than analysts expected, over four times larger than the October 2007 deficit of $56.8 billion, and more than half the total for all of last year.
The big surge reflected the government spending $115 billion to buy stock in the nation's largest banks. Those were the first payments made from the $700 billion government rescue program passed by Congress to deal with the most severe financial crisis to hit the country since the 1930s. The October deficit began a period in which economists are forecasting the red ink for the entire year could well hit $1 trillion, reflecting what many expect to be a severe recession, which will depress tax revenue, and the heavy costs of the financial system bailout.
President-elect Barack Obama has said that getting the economy back on track will be his top priority and has promised to work with Congress to pass a second stimulus program. The $237.2 billion deficit for October included total government spending of $402 billion, a record in terms of outlays. The spending figure included $115 billion paid to some of the country's largest banks to buy stock, the beginning of a program in which the government will spend $250 billion before the end of the year to take ownership shares in hundreds and potentially thousands of banks. The goal is to bolster banks' balance sheets so that they will resume more normal lending and keep the country from falling into a prolonged recession.
The deficit also was boosted by the government's move to purchase $21.5 billion in mortgage-backed securities, an effort the Bush administration announced when it took control of mortgage giants Fannie Mae and Freddie Mac in September because of rising losses in that market. Government receipts in October totaled $164.8 billion, down 7.5 percent from October 2007, reflecting the impact on revenues from the slumping economy.
For the 2008 budget year, which ended on Sept. 30, the deficit totaled a record $454.8 billion, reflecting the impact of the weak economy on revenues and a $168 billion stimulus program which sent stimulus payments to millions of Americans during the spring and early summer. The Bush administration in July estimated that the deficit for the current budget year could hit $482 billion, but that projection was made before the administration got Congress to pass a $700 billion rescue program on Oct. 3.
Former Goldman chairman sees slump worse than Great Depression
The economy faces a slump deeper than the Great Depression and a growing deficit threatens the credit of the United States itself, former Goldman Sachs chairman John Whitehead, said at the Reuters Global Finance Summit on Wednesday. Whitehead, 86, said the prospect of worsening consumer credit woes combined with an overtaxed federal government make him fear that the current slump is far from over.
"I think it would be worse than the depression," Whitehead said. "We're talking about reducing the credit of the United States of America, which is the backbone of the economic system." Whitehead encountered plenty of crises during his 38 years at the investment banking firm and was a young boy during the 1930s. Whitehead warned the country's financial strength is at risk due to the sweeping demand for tax relief and a long list of major government spending plans.
"I see nothing but large increases in the deficit, all of which are serving to decrease the credit standing of America," said Whitehead, who served as chairman of the Lower Manhattan Development Corp after the World Trade Center was destroyed during the September 11, 2001 attacks. Whitehead, who helped make Goldman a top-tier Wall Street firm and led its international expansion, left in 1984 to become a deputy secretary of state under Ronald Reagan.
He warned that the country's record deficit is poised to balloon as the public calls on government for more support. "Before I go to sleep at night, I wonder if tomorrow is the day Moody's and S&P will announce a downgrade of U.S. government bonds," he said. "Eventually U.S. government bonds would no longer be the triple-A credit that they've always been."
There are at least ten "trillion dollar problems," facing the United States, he said, including social security, expanding health insurance, rebuilding infrastructure and increased spending on green energy. At the same time, the public does not want to pay for it. "The public is not prepared to increase taxes. Both parties were for reducing taxes, reducing income to government, and both parties favored a number of new programs -- all very costly and all done by the government," he said.
Large deficits can weaken the country's credit and increase its borrowing costs, which already constitute a significant part of funding to cover expenses. Whitehead said it could take "several years" for the current problems to be resolved. Whitehead said he is speaking out on this topic because he is concerned no lawmakers are against these new spending programs and none will stand up and call for higher taxes. "I just want to get people thinking about this, and to realize this is a road to disaster," said Whitehead. "I've always been a positive person and optimistic, but I don't see a solution here."
Paulson says Congress should aid US automakers
U.S. Treasury Secretary Henry Paulson on Thursday encouraged Congress to come up with the funds to help ailing Detroit automakers, but stuck to his position that a $700 billion bailout fund is for financial institutions only.
In an interview with Bloomberg Television, Paulson said there were "other paths" to help automakers than the Treasury's Troubled Asset Relief Program, or TARP. "The intent of the TARP was to deal with financial institutions and major systemic issues," Paulson said.
"Congress, I believe, should address the question of the auto industry. I encourage Congress to come up with a pot, to get money to deal with this issue. And again, I don't think that bankruptcy (for U.S. automakers) is a good thing," he said.
Chances Are Slim for Stimulus, Auto Aid Till Obama Presidency
Congressional Democrats are scaling back plans for an economic-stimulus package as partisan deadlock clouds chances for passage of either that measure or a proposed bailout of Detroit's auto makers until the party's enlarged majority convenes in January. Democratic leaders want to move legislation that would give a jobs-producing jolt to the economy. They also support proposals to toss a $25 billion financial lifeline to Detroit. But it isn't clear either of those steps can pass before January, when President-elect Barack Obama and a new, more heavily Democratic Congress take office.
The biggest problem is in the Senate, where Democrats have only a 51-49 edge until year's end. The Bush administration is balking at the Democratic agenda, and Republicans in the House and Senate are growing more vocal about their concerns, especially concerning the auto package. "The financial situation facing the Big Three [auto makers] is not a national problem, but their problem," said Alabama Sen. Richard Shelby, the ranking Republican on the Senate Banking Committee. In the House, Minority Leader John Boehner, the Ohio Republican, assailed the proposed aid to Detroit as "neither fair to taxpayers nor sound fiscal policy."
Senate Banking Committee Chairman Christopher Dodd said Thursday that he knew of no Republicans who would support the $25 billion proposal by Democrats, and said he is disinclined to move a bill without bipartisan support. "I'd want to be careful about bringing up a proposition that might fail," given that a rescue plan would be more likely to pass under an Obama administration, the Connecticut Democrat told reporters on Capitol Hill. "There's some political considerations that need to be made over the next few days."
Senate Majority Leader Harry Reid of Nevada still plans to move forward next week. "Senator Reid still believes it is important to address this crisis plaguing our auto industry," said Reid spokesman Jim Manley, adding that bipartisan cooperation will be needed. "We cannot do it without the support of Senate Republicans, who I hope will join us to pass a bill that saves the jobs and protects the livelihoods of millions of hard-working Americans."
Mr. Dodd, meanwhile, wants to add foreclosure relief to an economic-stimulus package. He expressed frustration Thursday with efforts to help distressed homeowners by the private sector and the Bush administration, which was supposed to make foreclosure relief a top priority in the $700 billion rescue packaged enacted earlier this fall to stabilize financial markets.
"We want to see more progress," Mr. Dodd said, adding he is prepared to legislate -- "now, if possible" -- to address the problem. Democratic leaders are discussing action on a stimulus package that would be less ambitious than the $61 billion proposal that failed in the Senate earlier this fall. The new measure would extend jobless benefits, but propose more-modest investments than previously sought for things such as road and bridge construction, aid to states and food assistance for low-income families.
On the auto measure, House Financial Services Chairman Barney Frank is leading efforts to ready a consensus bill. In an interview, Mr. Frank said the legislation would extend $25 billion in aid, on top of $25 billion in taxpayer-backed loans already approved for the industry. Mr. Frank, a Massachusetts Democrat who was a key author of the financial-market rescue, said a top priority is providing "maximum protections for taxpayers."
A fresh sign of the auto industry's troubles came Thursday as Standard & Poor's Ratings Service lowered the credit ratings of two big auto suppliers, and put 13 others on watch for possible reductions, because of their ties to car makers. General Motors Corp., Ford Motor Co. and Chrysler LLC have argued that a collapse by any one of them could spark a chain reaction among parts suppliers and dealers that would hurt a wide swath of the U.S. economy. Even if the car companies get financial help, they are unlikely to avoid restructuring and downsizing, which would also affect suppliers.
Some Republicans, mostly from the industrial Midwest, have backed the auto industry's appeal for aid. Among them is Sen. George Voinovich of Ohio. "The senator believes helping the auto makers remain viable is truly putting Main Street over Wall Street," said a Voinovich spokesman. But for the most part, supporters of the industry have remained in the shadows on Capitol Hill.
Goldman Stops Rating GM, JPMorgan Downgrades Shares
Goldman Sachs Group Inc. dropped its coverage of General Motors Corp. shares, saying the largest U.S. automaker may need $22 billion of new capital and it's "highly uncertain" Congress will pass a bailout package this year.
"There is not currently a sufficient basis for determining an investment rating or price target for this company," Goldman analyst Patrick Archambault wrote in a research note today. "Given GM's large capital requirements, we believe a new government assistance program is most likely. The ability of Congress to pass such a measure this year is highly uncertain."
Separately, JPMorgan Chase & Co. analyst Himanshu Patel downgraded GM shares to "neutral" from "overweight" in a research note today, citing "the ambiguity of the government aid structure, and particularly its potential dilutive impact on equity." GM shares gained 14 cents, or 4.5 percent, to $3.22 in early New York trading at 6:21 a.m. today. The stock dropped 88 percent this year through yesterday.
GM Rescue Would Cause Massive Share Dilution - Goldman
Goldman Sachs suspended its rating on shares of General Motors Corp. (GM) Thursday, saying shareholders would face a massive dilution of their stakes under a government rescue plan. Goldman analyst Patrick Archambault told clients that GM needs a cash infusion of at least $22 billion in order regain a positive free cash flow. He estimates that as much $13.5 billion in new equity will have to be issued to the government in warrants, and to debt holders and the United Auto Workers in exchange for concessions.
The level of dilution Archambault expects is nearly eight times the current level of GM's current market capitalization of $1.7 billion. Archambault had a sell rating on the company's shares. GM shares declined 6.5% to $2.88 in recent trading. GM spokeswoman Renee Rashid-Merem said the company is involved in discussions with congressional leaders on different approaches to assistance, but that no decisions had been made. "At this point everything is speculative, so it's really not prudent for me to comment on what may or may not happen," she said.
Earlier Thursday, JPMorgan also cited dilution concerns as it abandoned the last remaining buy recommendation on GM shares by a major Wall Street research firm. JPMorgan analyst Himanshu Patel downgraded GM shares to neutral, citing the ambiguity around the structure of the government's rescue package, and the possibility of a dilutive hit to shareholders. General Motors' large third-quarter loss, disclosed Friday, and the faster- than-expected rate of its cash outflow moved the company to call for more government aid. The Big Three Detroit auto makers have already been promised $25 billion in low-cost loans from the U.S. Department of Energy in exchange for their pledge to increase fuel efficiency.
Goldman's Archambault said GM is likely to end this year with $12.5 billion in cash, within the $11 billion to $14 billion range it needs to continue its operations. He came to his estimate of $22 billion needed to rescue GM by estimating $20.7 billion in cash outflows through 2012 and $5.1 billion in debt repayments, offset by $3.8 billion in asset sales and interest savings from restructuring. About $4 billion of that cash will come from the Department of Energy loans, but the other $18 billion will have to come from the government or outside investors, he said.
GM's cash problems, stemming from the decline in its business in the economic downturn, are exacerbated by its enormous debt burden, which Archambault said must be addressed for GM to continue as a viable entity. If GM doesn't restructure its existing debt of $52.8 billion, which includes $8.4 billion in obligations to the UAW, its interest expense will accrue at an annual rate of $ 3.8 billion, he said. Archambault said solving both the debt and cash-flow problems requires significant concessions from both GM's union and its bondholders. He assumed bondholders would have to exchange their existing bonds for a combination of new bonds and equity at 35% par value.
GM's debt to the UAW could retain its par value but gain the option of a 100% conversion to equity, he said. A compelling case for a conversion of GM's UAW debt and the exchange of its bonds could be made to the union and bondholders "if this process is seen as an enabler of government support," Archambault said.
GM Bankruptcy Filing Would Be a 'Total Mess'
Investor Wilbur Ross, who made billions turning around distressed steel and textile companies, said a Chapter 11 filing by General Motors Corp. or another U.S. automaker wouldn't work and might devastate the economy. Going to court to reorganize would be "a very inhospitable environment for any of these guys," Ross, 70, said in an interview yesterday. "It would be a total mess."
His views run counter to those of investors such as hedge- fund manager William Ackman and executives including Jack Welch, the former chief executive officer of General Electric Co., who have said the automakers could solve some of their problems by restructuring in bankruptcy court. Others side with Ross. Ross, dubbed the "King of Bankruptcy" by Fortune magazine in 1998, said a restructuring bid by one of the three top U.S. automakers would topple its peers and drive weakened suppliers out of business because the credit crunch dried up financing.
"If we were in a different overall economic environment, one of them going down wouldn't necessarily kill" the industry, he said. A weakened economy and frozen debt markets make an automaker bankruptcy impossible, with a Chapter 11 filing for reorganization resulting in liquidation instead, Ross said. Failures by automakers and related businesses would lead to a drain on government spending for unemployment benefits, health care and pension recoveries, said Ross, whose WL Ross & Co. is based in New York. GM has said bankruptcy isn't an option. Ross's holdings include auto-parts maker International Automotive Components Group, which he assembled by buying assets from Lear Corp. and bankrupt Collins & Aikman Corp. He said he isn't advocating a U.S. industry bailout to aid his interests.
GM, Ford and Chrysler have asked for $25 billion in bridge loans to support their operations while they weather the worst automotive market in 17 years. Such legislation is being crafted by Democratic Senator Carl Levin and Representative Barney Frank, respectively of Michigan and Massachusetts. The Bush administration opposes tapping the $700 billion financial-rescue package for automakers. "It doesn't add up that they are letting GE and American Express to become banks to get aid, but they won't save the car industry," said Ross.
Ross created International Steel Group Inc. from the assets of LTV Corp., Bethlehem Steel Corp. and Weirton Steel Corp. at a time when the U.S. steel industry had gone through 35 bankruptcies in five years. After taking it public, in 2004 he agreed to sell the company to billionaire Lakshmi Mittal for $4.5 billion. Ross said the steel industry consolidation occurred when the economy was healthier and banks were willing to lend money. "It was a far different set of facts than we have now."
Freddie Mac asks Treasury for $13.8 billion after massive loss
Freddie Mac asked the Treasury for $13.8 billion after a record quarterly loss caused its net worth to fall below zero. The third-quarter net loss widened to $25.3 billion, or $19.44 a share, the McLean, Virginia-based Freddie said in a regulatory filing Friday. The losses forced Freddie to request government funds and the company said it expects to receive the money by Nov. 29.
The chief executive, David Moffett, named in September when the government seized control of Freddie and the larger Fannie Mae, increased writedowns for bad mortgages and securities and took a charge against most of Freddie's so-called deferred tax credits. The Fannie chief executive, Herbert Allison, took similar steps earlier this week and said the company may need government money at the end of the year.
"These companies don't really care what they report right now" that their shares are trading under $1, said Paul Miller, an analyst at Friedman, Billings, Ramsey Group Inc. in Arlington, Virginia. "You could very well get losses north of $100 billion on both of these companies." The Federal Housing Finance Agency took control of Freddie and Washington-based Fannie after examiners found their capital to be too low or of poor quality. Treasury Secretary Henry Paulson Jr. pledged to invest as much as $100 billion as needed in each company to maintain their positive net worth.
Paulson said at a news conference in Washington on Nov. 12 that the decision to seize control of Fannie and Freddie "proved all too necessary." "The GSEs were failing, and if they did fail, it would have materially exacerbated the recent market turmoil and more profoundly impacted household wealth, from family budgets, to home values, to savings for college and retirement," Paulson said.
Fannie said this week it may need more than the $100 billion in funding pledged by the Treasury to stay afloat. "This commitment may not be sufficient to keep us in solvent condition or from being placed into receivership," if there are further "substantial" losses or if the company is unable to sell unsecured debt, Fannie said in a Nov. 10 filing with the U.S. Securities and Exchange Commission.
Fannie's net worth, or the difference between assets and liabilities, tumbled to $9.4 billion as of Sept. 30 from $44.1 billion at Dec. 31. The Washington-based company said Nov. 10 that the number may be negative by the end of the year. Freddie's net worth stood at a negative $13.7 billion at the end of the quarter.
Fannie & Freddie: Science Projects Gone Wrong
Under the mountains of Switzerland lives one of the biggest science projects of all time. It’s a $15 billion dollar operation called the Large Hadron Collider. It is designed to figure out what the universe is made of by accelerating particles to a rate just under the speed of light, bouncing them against each other, and seeing what happens. Cool stuff.
Opponents of the project expressed fear that the effort could result in a disastrous unintended consequence: the creation of a black hole. A giant vacuum that starts eating matter until it has completely devoured the earth from the inside out. Those fears have been realized. We have not only created a black hole, but two. Not the world-eating monster doomsday theorists feared. These eat money, not matter. They are called Fannie Mae and Freddie Mac.
This morning Freddie said it posted a record third quarter loss of $25.4 billion dollars. That’s a per-share loss of $19.44. Not surprisingly, it needs more money. It’s asking the Treasury for another $13.8 billion dollars. This looks relatively modest compared to Fannie Mae’s quarterly loss of $29 billion bucks. The problem with these devourers of capital is that they are not normal companies. These are entities which possess a near explicit government guarantee on their assets. They operate under a federally-sponsored conservatorship and more money may be needed to keep them out of full fledged liquidation.
$55 billion dollars wiped out in just three months between the two. An endless buffett of taxpayer cooking. As the debate rages on in Washington about whether to help GM, Ford and Chrysler, Fannie and Freddie continue to wipe out capital at a record pace. But it also is getting more to eat every time it cleans the plate. It must be all about housing, because it’s surely not about jobs. Fannie Mae employs about 6,400 people. Freddie Mac just over 5,000 at last count.
Even as it works to get smaller, GM still has more than 200,000 workers. While scientists in Switzerland rush to smash particles together, American don’t have to venture under the Alps to see nearly the same thing. Fannie and Freddie are the ultimate collision of money and politics, and the black hole has been realized.
FDIC's Bair pushes aggressive mortgage plan
In a surprise move, FDIC Chairwoman Sheila Bair Friday unveiled details of her plan to have the government help delinquent homeowners. The proposal would have the government share up to 50% of the losses if the homeowner re-defaulted on the modified loan. The plan is expected to initially help 2.2 million borrowers get new loans; after some borrowers re-default, 1.5 million would ultimately keep their homes, the FDIC estimated.
It would also pay servicers $1,000 to adjust the loan so that monthly payments were as low as 31% of a borrower's income. The plan would cost an estimated $24.4 billion, which Bair has said could come from the $700 billion bailout Congress approved last month. "It is imperative to provide incentives to achieve a sufficient scale in loan modifications to stem the reductions in housing prices and rising foreclosures," the Federal Deposit Insurance Corp. said in a statement Friday. "A loss share guarantee on re-defaults of modified mortgages can provide the necessary incentive to modify mortgages on a sufficient scale."
Bair's move Friday sets up a public power struggle not often seen within an administration. The FDIC chairman has long pushed for the government to take a more active role in helping troubled homeowners. She initiated a similar plan at IndyMac, one of the largest mortgage lenders, after the agency took it over in mid-July. Bush administration officials, however, have resisted her efforts, instead unveiling a plan Tuesday to streamline modifications of loans held or guaranteed by Fannie Mae and Freddie Mac.
Though he praised Bair's proposal, Treasury Secretary Henry Paulson Wednesday said it was one of several under discussion. Bair supporters took that to mean the plan was essentially dead. Congressional Democrats, however, have continued to press for increased assistance to homeowners. They have publicly backed Bair, which could give her proposal the support needed for adoption. "[The Fannie/Freddie plan] should not be considered a replacement for the guarantee program authorized by the recently-enacted financial rescue law which the FDIC has agreed to operate," Sen. Christopher Dodd, D-Conn. said Tuesday, after the mortgage finance plan was announced.
"We are still awaiting agreement from the Treasury Department to move this program forward, despite indications given to me weeks ago that an agreement was imminent. I have been in contact with both Secretary Paulson and Chairman Bair on this issue, and I intend to keep pushing for more aggressive and effective action." Borrowers who are at least 60 days late on payments would qualify for this program.
Servicers would have to systematically review all the loans in their portfolios to determine whether they would recover more value by modifying the mortgage rather than foreclosing on the home. Loans would be adjusted by reducing the interest rate, extending the term or deferring part of the principal to the end of the mortgage. But unlike some other government programs, the FDIC proposal would not reduce the principal to bring it in line with the home's current value. Some consumer advocates consider principal reduction key to assisting borrowers in areas where property values have plummeted, leaving many with mortgages greater than their home's worth.
Under the Hope for Homeowner program implemented last month, mortgages would be written down to 90% of the home's current market value and borrowers would be refinanced into 30-year fixed-rate mortgages insured by the Federal Housing Administration. The FDIC's program, on the other hand, would not be as beneficial for so-called underwater homeowners. For situations where the mortgage is worth more than the home, the government's loss-sharing arrangement would gradually decline to 20% before ending for homes where the loan-to-value exceeds 150%. The loss-sharing arrangement would last for eight years.
Oil steady at $56
The price of oil fell Friday despite news that OPEC will hold an emergency meeting as investors remain worried about weak energy demand. Light, sweet crude for December deliver traded down $1.41 at $56.82 a barrel on the New York Mercantile Exchange and held steady in that price range. The contract rose $2.08 cents to settle at $58.24 a barrel Thursday after U.S. stocks snapped a 3-day losing streak.
An unnamed official confirmed the Organization of the Petroleum Exporting Countries will hold an emergency meeting in Cairo on Nov. 29 to discuss the rapid decline of the price of crude, according to published reports. OPEC cut oil output by 1.5 million barrels a day Oct. 24 in an attempt to prevent the price of oil from falling further.
Another OPEC production cut could have a "short-term impact" on the price of oil, said Tom Pawlicki, oil industry analyst at MF Global in Chicago. "At the same time, the economic news is so dire that it may not create a lasting bottom in the price of oil."
Indeed, the price of crude has come down 9% since OPEC scaled back output last month, suggesting the oil market's fear of weak demand trumps the cartel's efforts to control the price by limiting supply. Concerns that a looming global recession will continue to undermine demand for gasoline and other petroleum products has driven the price of oil down 60% since July's all-time high above $147 a barrel.
Housing market 'far worse' than figures suggest
House prices across the UK have already fallen far further than official data and market indicators suggest, Rightmove, the online estate agent warned yesterday, as it revealed that up to 300 estate agents were quitting its service every month. While the latest figures from leading mortgage lenders such as Halifax suggest that prices are down by 15 per cent from their peak, Rightmove said the falls were up to two-thirds higher.
Miles Shipside, the commercial director of Rightmove, said: "Estate agents tell us that the actual prices that are being achieved [initially between buyers and sellers] for property are down by about 20 to 25 per cent beneath peak asking prices. That has not come out in the national indices." His revelation suggests that house prices have not only fallen much further than the highly regarded surveys of Halifax and Nationwide, which both track house prices based on agreed mortgages, but could also be lagging behind the situation on the ground. Nationwide's latest survey said prices in October were down by 14.6 per cent on the same month last year, while the Halifax's revealed they were 15 per cent lower in the same month.
Seema Shah, property economist at Capital Economics, said: "We are expecting a trough of 35 per cent down by the end of 2009." Asked about house prices for next year, Mr Shipside said: "It hinges on unemployment and repossessions. If there are more repossessions then prices will drop further." His comments came as Rightmove said in a trading statement that the dire market had forced 250 to 300 estate agents to leave the market each month between August and October, although the monthly decline actually peaked in July. Rightmove's estate agency membership fell to 10,700 by the end of October, a 15 per cent decline from its peak of 12,600 a year ago.
The company said: "At least three out of every four estate agents who have left Rightmove over the last year have either gone out of business or were removed for non-payment (which in practice is frequently a precursor to going out of business)." Rightmove said the number of advertisers on its site at the end of October had also fallen, to 17,500, 9 per cent less than a year ago. Nevertheless, the company remains confident of meeting expectations for its full year, with Mr Shipside adding that he now believes the decline in the volumes of house sales in the UK has "probably reached the bottom" of the market. He added: "For those cash rich bargain hunters there is a good choice of good quality property around. And there is a view that it is a good time to buy a good quality property."
However, he warned: "It is still an unknown on prices. If you look at volumes [of sales] and mortgage approvals they are about half of what they were in the [early] 1990s [housing recession]. It is about the lack of credit." Mr Shipside said last week's 1.5 percentage-point cut in interest rates would be "good for confidence", but would not make a substantial difference to the market if it did not feed through to cheaper, and more, mortgages being made available. He added that "new build" properties are taking longer to sell. Mr Shipside said: "The flat market is flat."
Rightmove also said it was now seeing an increase in gazundering, the practice of a buyer waiting until both sides are poised to exchange contracts before lowering their offer. Mr Shipside said: "Obviously in a falling market holding deals together is particularly challenging." Last month, Rightmove said it would cut a fifth of its workforce in order to save £5m a year. Mr Shipside said yesterday that he did not anticipate further job losses.
Wall Street Banks Demand Better FDIC Guarantees
JPMorgan Chase & Co., Bank of America Corp. and Goldman Sachs Group Inc. are among banks that told the government its program to back their bonds is flawed because it doesn't have a strong enough guarantee. The Federal Deposit Insurance Corp. guarantee for repayments in default needs to be clearer, fees are too high and banks need more freedom on whether to opt in, according to a letter from law firm Sullivan & Cromwell LLP posted on the agency's Web site on behalf of nine banks. The comment period on the interim rules for the FDIC's Temporary Liquidity Guarantee Program ends today.
The comments shed light on why almost a month after the government placed its guarantee behind new bank bonds, no U.S. company has yet tested the market. By contrast, under a similar program in the U.K., banks have issued the equivalent of 13.9 billion pounds ($20.6 billion) of government-guaranteed bonds. "A guarantee obligation that is anything less than an obligation to pay all amounts due could severely curtail the demand for these securities and might impair a bank's access to guaranteed funding," New York-based Sullivan & Cromwell said in the Oct. 31 letter.
The letter cited the U.K. program as a model because it offers "an unconditional guarantee" of principal and interest when due. Without a similar guarantee, U.S. banks will be "at a significant disadvantage" to their U.K. and European counterparts because their government-backed debt will be more expensive for borrowers and less attractive to investors, the letter said. FDIC spokesman Andrew Gray said "the nature of the comment period is to get feedback from industry and other stakeholders."
Banks asked the FDIC to reduce the fee they must pay to preserve the option to issue both guaranteed and non-guaranteed debt. The FDIC wants to charge a pre-paid fee of 37.5 basis points on outstanding debt as of Sept. 30, scheduled to mature on or before June 30, 2009, in exchange for the freedom to issue both while participating in the program. The group of banks wants to reduce that to a 75 basis-point fee on 25 percent of the outstanding debt. A basis point is 0.01 percentage point. The other six banks represented in the Sullivan & Cromwell letter were Bank of New York Mellon Corp., Citigroup Inc., Merrill Lynch & Co., Morgan Stanley, State Street Corp. and Wells Fargo & Co.
Credit Suisse Group AG sent a separate letter to the FDIC on Nov. 4. Without rules that "fully and irrevocably" guarantee repayment, the size of the program and the number of banks that participate will be "significantly below the expectations of the FDIC, the industry, and all interested parties in the health of the U.S. banking system," wrote Fred Sherrill, managing director at Credit Suisse Securities USA LLC in New York. Interim rules for the government program fall short of traditional bond guarantees because they leave the timing of principal and interest payments in the event of a bank default open to changes by bankruptcy courts, Sherrill wrote. "We are optimistic that, with appropriate modifications, the program will be successful in helping to mitigate systemic fear in the interbank and capital markets," he wrote.
Standard & Poor's issued a report Nov. 10 supporting the banks' position on the guarantee. "We do not view the issue of timeliness as a mere technicality," according to the report from the New York-based unit of McGraw-Hill Cos. The FDIC said Oct. 14 it would guarantee three-year senior unsecured bank debt issued through June 30, 2009, as part of a sweeping plan by the U.S. Treasury that included expanded deposit insurance and $250 billion of direct capital injections for U.S. banks. Last week, the agency extended the deadline for banks to choose whether to participate to Dec. 5, so they could "fully consider" the final rules before making a decision, according to a statement.
Banks dominated U.S. corporate bond sales last year, accounting for 71 percent of $1.02 trillion of investment-grade new issuance, according to data compiled by Bloomberg. As the credit seizure deepened and yields over benchmark rates soared, banks were forced out of the debt market. No major U.S. bank has sold debt since Sept. 3.
CEOs Tell Chicago Mayor They Plan Huge Layoffs In November, December
The warning is out – Mayor Richard M. Daley says a parade of corporate chief executives have told him huge layoffs are planned around the city and will carry into next year. As CBS 2's Joanie Lum reports, when Daley made the announcement, workers around the city felt a chill, and they are wondering who will be laid off next. The news is especially alarming because the discussion concerns not just city jobs, but the private sector. Thus, it seems the City That Works is about to become the city that gets laid off.
Mayor Daley says corporate leaders told him huge layoffs will impact the city this month and next, and into the new year. He also says city, county and state governments should be prepared for their revenue to fall dramatically because of the souring economy. "This is going to be all year, so it's going to be a very frightening economy," Mayor Daley said. "Each one tells me what they're laying off, and they're going to double that next year. We're talking huge numbers of permanent layoffs for people in the economy. It's going to have a huge effect on all businesses."
The mayor said the gravity of the situation cannot be underestimated. "We never experienced anything like this except people who came from the Depression," Mayor Daley said. "When you have that many layoffs early – and they're telling me this is only the beginning of their layoffs – that is very frightening." Mayor Daley also warned that local governments will be in jeopardy and may not have enough money to meet payroll, although he is not worried about paying City of Chicago employees.
In addition, the federal bailout plan is changing, and the big three automakers are all warning they could go bankrupt, and lawmakers say if the auto industry goes down, the huge number of jobs lost would cause more house foreclosures. Upon hearing the mayor's grim news, workers were jittery, to say the least. "I'm an analyst for one of the largest credit bureaus in the city, and I'm really concerned with the economy right now; the structure that we're in," said Tonya Farr. "I don't want to be laid off, hopefully not."
"Even if you have a job it's scary. You don't know if it's going to last. You don't know if you're going to keep it or not?" said Michelle Thompson. "So, what are we to do?" Every sector of the job market is suffering. "I've been applying at millions of places, and it's just so hard to get a job. They're cutting hours like crazy – at McDonald's," said Ramona Patino.
Job placement analysts say end-of-the-year layoffs are at a five-year high. "The last quarter is often the heaviest time of the year for downsizing. Often, that means much more hiring at the beginning of the year as companies start to grow again and think about the future," said John Challenger of the placement firm Challenger, Gray and Christmas. "This year, it's going to be much more difficult because the economy is in recession. No one expects to come out of it by January or February."
Meanwhile, those who have jobs are just trying to hold on. "I'm budgeting my money. I paid my bills at the beginning of the month, and that's it. I ride the rest of the month on maybe $10 in my pocket a week," said commuter Kurt Korzi. "It's tough. It's really tough." "People can't afford to do certain things that they're used to doing, so if there's no revenue coming in, how can a business stay alive?" said Sonya Robinson. "They say that they're going to help us and technically, it's not helping us, because we're paying more taxes and working like a slave, and not getting anything out of it in return."
Challenger said the holiday season is looking bleak. "As more people become insecure about their jobs, they lose their jobs, they don't spend as much. That's bad for retailers," he said. "This holiday season is going to be very tough." The City Council will take a vote on the 2009 city budget Nov. 19. The budget contains layoffs, a slowdown in police hiring, and new taxes and fines – some bad news for Chicagoans who remain employed.
British Telecom to cut 10,000 jobs as it gears up for recession
BT Group is to cut 10,000 jobs by April as it tries to slash costs in the face of the looming recession. The company became the latest in a slew of telecoms groups to announce deep cuts and at the same time revealed that profits had fallen 11 per cent in the second quarter. BT said: "As part of our ongoing efficiency programmes, we expect to reduce our total labour resource by some 10,000 by the end of the current financial year."
BT stressed that of those cuts, 6,000 would be in "indirect" labour, such as agency, contractors, subcontractors and offshore workers, with the rest coming from permanent staff. BT employs 160,000, of which 50,000 are indirect workers. Ian Livingston, BT's chief executive, called the move "pre-emptive". He predicted the recession would run for two years but that "BT will come out of this a stronger and a better company". This comes just days after the mobile phone giant Vodafone announced it was to introduce a £1bn cost-cutting plan, which is expected to involve job losses, and Virgin Media announced a headcount reduction of 2,200 in the next three years.
BT said that while revenues were up 4 per cent to £5.3bn, pre-tax profits had fallen from £660m in the second quarter of 2007 to £590m, dragged lower by issues at its Global Services division. Mr Livingston praised three of the four divisions – Retail, Wholesale and Openreach – which delivered ahead of target, but he said: "Profits in Global Services are simply not good enough and we are taking decisive action to put the matters right." The group raised the problems at its technology services arm two weeks ago, in what constituted a profits warning, which sent its shares crashing to their lowest level since listing 24 years ago.
It blamed issues over efficiency, a decline in the UK business and negative currency movements for the 36 per cent drop in the division's earnings before charges in the second quarter. The problems prompted the departure of the division's chief executive, François Barrault, who was replaced by group finance director Hanif Lalani. Mr Lalani said he has identified £40m worth of savings to be made at the division. The company expects to grow revenue in this financial year, but added that earnings before interest, taxation, depreciation and amortisation would probably show "a small decline".
The shares jumped 9 per cent to 122.5p yesterday, as the results – which came in ahead of forecasts – calmed analyst and investor fears in the wake of the profits warning. Morten Singleton, analyst at Oriel Securities, said: "The bad news is out of the way... BT posted revenue and profit numbers ahead of our numbers and consensus from before the profit warning." The 5.9p interim dividend also came in higher than Oriel's expectation of 3.1p.
There was further good news over the company's pension scheme. BT has reached agreement with the unions over what Investec analyst Jonathan Groocock called "significant changes" which would reduce liabilities and are expected to reduce costs by £100m a year. Proposals included raising the retirement age to 65, increasing member contributions and changing from a final-salary link to average earnings. The pension also swung from a deficit in the first quarter to a £600m surplus.
Sun Microsystems to Cut Up to 6,000 Employees
Sun Microsystems Inc., the world’s fourth-largest maker of server computers, plans to cut as many as 6,000 workers amid the global credit crisis. The reduction, which will eliminate as much as 18 percent of the staff, will shave $700 million to $800 million from annual expenses, Sun said today in an e-mailed statement. The moves will cost as much as $600 million in the next 12 months.
The Santa Clara, California-based company is cutting back to cope with the “global economic realities,” Chief Executive Officer Jonathan Schwartz said. Sun last month posted its second loss in three quarters and said its financial-services customers were curbing orders until they have more liquidity. “We see the level of concern spreading around the world,” Schwartz said in a telephone interview. “Customers are saying, ‘I am in pain, and I need budget relief.’”
He sees that as a chance to spread adoption of Sun’s MySQL database applications and Java programming language, which are free. Sun sells servers and service contracts with the software. To take advantage of the opportunity, Sun said today it will reorganize its software business. Rich Green, executive vice president for software, will leave. Sun, down 77 percent this year, dropped 8 cents to $4 at 8:46 a.m. in trading before the open of the Nasdaq Stock Market.
Sun is the third company in Santa Clara, at the heart of California’s Silicon Valley, to cut jobs this week as technology companies cope with the worst sales slump since the dot-com bubble burst in 2000. Applied Materials Inc., the largest maker of chip-production machinery, announced plans to cut 1,800 jobs, and mobile-phone chip builder National Semiconductor Corp. said it will shed about 5 percent of the staff. The job cuts will take place worldwide, with most of the U.S. positions eliminated in Sun’s third fiscal quarter, spokeswoman Kristi Rawlinson said.
Schwartz has spent two years overhauling Sun, which posted five years of losses under former CEO Scott McNealy. The company continues to lose market share in servers, the computers that run corporate networks and account for almost half of revenue. Last quarter Sun had a $1.45 billion expense to write down the value of acquisitions made to broaden its product line. Five analysts recommend selling Sun shares, four suggest buying them and 12 have “hold” ratings, according to data compiled by Bloomberg.
Worldwide technology spending in 2009 will grow less than predicted, researcher IDC said this week, and computer-related companies are trimming forecasts. Intel Corp. slashed $1 billion from its fourth-quarter sales goals two days ago. Spending industrywide will rise 2.6 percent next year, down from an estimate of 5.9 percent, Framingham, Massachusetts-based IDC said. Growth in the U.S. will probably slow to 0.9 percent, less than a quarter the pace IDC forecast in August. Sun’s Slump Sales at Sun fell 11 percent to $1.76 billion in the period ended Sept. 28. Server sales fell 15 percent, and dropped in every region except for emerging markets.
Citigroup to Cut 10000 More Jobs, for 33000 Yearly Total
The job cuts keep coming in the financial services industry. Beginning this week, Citigroup will start cutting 10,000 global employees in its investment bank and other divisions, or 2.8% of its 352,000 work force, The Wall Street Journal reported, citing sources. Citi has already cut 23,000 jobs in the last four quarters, with a goal to bring Citi's work force down to 290,000 by next year, according to one of the Journal's sources.
In an additional effort to return to profitability, Citi plans to raise interest rates on millions of its 54 million credit card customers. Citigroup has been one of the hardest hit financial firms since the credit market turmoil began, with $68.1 billion in write-downs and credit losses, resulting in its stock price plummeting 80%.
Top Citi executives believe they will be able to turn around the company -- The Wall Street Journal reported that executives bought 1.2 million shares Thursday when the stock fell to $8.27 per share, its lowest level since the 1990s.
Worst May Be Yet to Come for Citigroup
After a year of red ink, a months-long plunge in its share price and a $25 billion government rescue, you might think the worst was over for Citigroup. It is probably not. Citigroup, which a decade ago set out to rewrite the rules of American finance, is bracing for still more pain now that a recession is at hand. Loans that the financial giant made to consumers in good times are going bad in growing numbers. For the moment, profits seem as elusive as ever, analysts say.
Once the most valuable financial company in America, Citigroup is withering along with its share price, which this week sank into single digits for the first time in a dozen years. The company is also shrinking in another painful way: by cutting, and cutting, and cutting jobs. Another round of pink slips is expected next week. As Vikram S. Pandit completes his first year as chief executive, many analysts say Citigroup has lost its way. Insiders say the company is racked by office politics at a critical moment in its history.
Mr. Pandit is struggling to regain his grip on the company, which operates in scores of countries, after his attempt to buy Wachovia was upended by Wells Fargo. That misstep left Citigroup grasping for a new strategy to lure deposits and build up its branch network in the United States. “Citi doesn’t have a credible management team, they don’t have a credible board,” said Christopher Whalen, managing partner at Institutional Risk Analytics. “If you look at their loss rate, it is almost inevitable that Citi is going to be asking the government for more money next year.”
Worries about Citigroup’s future were apparent in the stock market on Thursday. While the share prices of many of its rivals soared along with the broader market in a stunning afternoon rally, Citigroup’s stock fell nearly 2 percent by the end of regular trading. At its closing price of $9.45, the stock has lost almost 68 percent this year, making it the third-biggest loser in the Dow Jones industrial average, behind Alcoa and General Motors. Many Citigroup employees know their jobs are on the line. Executives said that as of the third quarter, the bank had announced plans to eliminate 40,100 jobs. That includes reductions resulting from the divestitures of the company’s German retail banking operations and its Indian outsourcing franchise.
But Citigroup still needs to hand out pink slips to 9,100 workers to meet its goals, and bankers are bracing for much of the bad news to arrive early next week, according to executives briefed on the situation. Investment bankers are expected to bear the brunt of the cuts because senior managers have been asked to reduce expenses significantly. But back-office functions, like the bank’s legal and human resources divisions, are also expected to be hard hit. The ax could keep falling. While there are no formal plans for further job cuts, executives say it is possible that Citigroup could shed an additional 25 percent of its work force by the end of next year.
Such a reduction would include layoffs, a hiring freeze and work force reductions related to businesses that the company is considering selling. Such a move would reduce the total number of employees to 264,000, from about 352,000 today. Christina Pretto, a Citigroup spokeswoman, said that the bank was carefully managing its employee levels as it revamps the company to operate more efficiently in the current downturn. “Nothing has changed,” Ms. Pretto said. Citigroup is also grappling with how to position its domestic consumer business, which faces rising loan losses and, analysts say, lacks the leadership and strategy it needs. Having lost Wachovia, Citigroup must now try to stitch together a group of small regional banks to catch up with Bank of America, JPMorgan Chase and Wells Fargo. Executives are looking at Chevy Chase Bank, a small lender in Maryland with $14 billion in assets, among several other institutions, according to people close to the situation.
But assembling a large franchise could take years, and digesting deals has never been one of Citigroup’s strengths. Even with all these problems, Citigroup’s board has been bickering over seemingly small issues, including which white-shoe law firm will represent it, according to a person close to the situation. Wachtell, Lipton Rosen & Katz had been representing the board, but that firm is representing Well Fargo in litigation over the Wachovia deal. Cravath, Swain & Moore is now being considered to represent Citigroup’s directors, but no decision has been made, according to a person close to the situation.
Citigroup has tried to put on a united front amid the turmoil. Richard D. Parsons, one of the company’s most outspoken directors, said on Thursday that the board was fully behind Mr. Pandit and Winfried F. W. Bischoff, its executive chairman, as it braced for a difficult 2009. Mr. Pandit, for his part, led a group of Citigroup executives in buying 1.3 million Citigroup shares as the stock tumbled on Thursday. It was the first time that Mr. Pandit, who had collected $165.2 million from selling his hedge fund to Citigroup before becoming chief executive, publicly disclosed using his own money to buy Citigroup stock. Ms. Pretto, the Citigroup spokeswoman, said the “purchases reflect their belief in the long-term strength and growth opportunities of the company.”
Citi Denies Search for New Chairman
As Citigroup shares sank to 13-year lows below $9 a share, the bank denied a report Thursday that it is looking for a new chairman. "Any report that the board is searching for a new chairman is false," said Citigroup spokeswoman Christina Pretto. The Wall Street Journal reported Thursday, citing people familiar with the matter, that some Citigroup board members are increasingly dissatisfied with the company's performance and are considering replacing Chairman Sir Win Bischoff. The board named Bischoff chairman in December after ousting former CEO and Chairman Charles Prince.
Citigroup's board issued a statement Thursday that it "reiterated its full support for the company's chairman" and "looks forward to his continued leadership." The board called Thursday's Wall Street Journal report "completely erroneous." Citigroup, which has suffered four straight quarters of losses due to bad bets on mortgages and other deteriorating loans, has seen its stock plunge to the lowest levels since May 1995. Shares closed down 2% to $9.45, after falling as low as $8.27.
Investors have gotten increasingly nervous that Citigroup lacks strong enough leadership to pull the company out of a mess of souring consumer loans and highly leveraged investments. CEO Vikram Pandit, while well-respected as an investment banker, never led a public company before taking Citigroup's reins in December. And the bank's board has little financial-services expertise, with the exception of Robert Rubin -- a Treasury secretary under President Bill Clinton -- who has said since joining Citi in 1999 that he does not want to run the bank.
A leading candidate for the chairman position, the Journal said, is Citigroup board member Richard Parsons -- Time Warner's chairman, who is part of President-elect Barack Obama's transition economic advisory board. Parsons was CEO and chairman of Dime Bancorp, a thrift bank, in the early 1990s. But some analysts doubt this experience in banking would be enough to lead Citi -- the most troubled of the four largest U.S. banks -- back to financial health.
"You need somebody who's done workout, somebody's who's dealt with a troubled institution. Ultimately, you might have to break it up anyway," said Christopher Whalen, managing director of Institutional Risk Analytics. "If you get the right person, it could be enormously helpful. But I just think it's kind of late." Bart Narter, a bank analyst at consulting and research firm Celent, said replacing the chairman would be an "important symbolic move," but that "putting a new captain on the oil tanker doesn't mean it's going to turn any faster."
The Journal also reported that Citigroup is in talks to buy the Maryland regional bank Chevy Chase Bank. Citigroup's Pretto declined to comment on the matter. A message left with a Chevy Chase Bank official was not immediately returned. Last month, Citigroup lost out on a deal to buy the much larger bank Wachovia. Wells Fargo nabbed the Charlotte, N.C.-based bank instead. After releasing its third-quarter results last month, CFO Gary Crittenden said in an interview with The Associated Press that when it comes to acquisitions, "we would continue to look, and see, obviously, what happens. But it would need to meet some pretty strict criteria."
Analysts have been less sure, however, that Citi should be making acquisitions. "Citi shouldn't be buying anything right now. They should be battening down the hatches," Whalen said. Chevy Chase Bank has $11 billion in deposits, according to data from the Federal Deposit Insurance Corp., and nearly 300 offices in the metropolitan area surrounding Washington, D.C. Celent's Narter said that arguably, now is a great time to be buying banks. But for Citigroup, he said, "given all the other issues they have, I don't know if I'd be focusing on an acquisition right now."
Citi, others, looking to buy Chevy Chase Bank
Chevy Chase Bank, part of the fabric of the Washington business community for nearly four decades, is in discussions with potential buyers, according to people familiar with the situation. The Bethesda financial institution has attracted the interest of several larger banks including Citigroup.
The discussions come at a time when the banking industry is in upheaval. There have been several high-profile mergers among financial institutions over the past two months as the credit markets have frozen and the economy contracts. "Usually when a bank is put up for sale it's very quiet," said Bert Ely, a local banking analyst. "But this time I'm hearing a lot about it."
Chevy Chase executive vice president Thomas H. McCormick issued a statement yesterday morning following a report in the Wall Street Journal that said Citigroup was in negotiations to buy Chevy Chase. "Chevy Chase Bank is a strong, successful bank with an enviable share of the Washington banking market," McCormick said in the statement. "Not surprisingly, rumors have arisen from time to time over the years about the interest of other banks in seeking to acquire Chevy Chase Bank. Chevy Chase Bank has never commented on such rumors."
Chevy Chase is the area's fifth-largest bank and the largest headquartered in the region with branches here, with $11.4 billion in deposits and $15 billion in assets. The bank is part of the sprawling Saul companies, which operate out of a towering office building in Bethesda presided over by patriarch B.F. Saul II, 76. Saul started Chevy Chase out of a trailer in 1969. Over the decades, the institution has made loans to millions of home buyers, businesses, real estate developers and automobile owners.
The company's imprint is all over the landscape, from its distinctive sand-colored, stand-alone brick branches to the sponsorship deals it has signed at the University of Maryland's Byrd Stadium and at the Verizon Center. Bank financing played a key role in suburban housing and retail developments all around the region. Like many other financial institutions, Chevy Chase staffed up its mortgage department in recent years as home values boomed. The bank underwrote billions of dollars in home loans throughout the country, including many in California.
But as housing prices plunged and demand for mortgages dipped, sales officers and account executives across the country, including in Texas and Florida, have been let go. Chevy Chase laid off 100 employees in its mortgage operations about a year ago. The bank currently carries on its books more than $4 billion in option-adjustable-rate mortgages, the type of financial instruments that helped cause Wachovia Bank to take a $32 billion loss this year.
In addition to curtailing its mortgage business, Chevy Chase a year ago let go 200 employees as it cut back its banking hours. The bank turned a small profit in the quarter ended June 30, according to regulatory filings. Chevy Chase contracted its operations further last summer, announcing that it was closing 54 mini-branches in Giant Food stores across the Washington region, ending a decade-long initiative to add banking to customers' shopping lists. The closings coincided with the expiration of a 10-year contract that Chevy Chase Bank signed with Giant.
The end of the Giant Food relationship and other actions, including the pending sale of a golf course in Fairfax County, have helped fuel rumors that Chevy Chase Bank was for sale, with some bemoaning the potential end of a era. "The bank was Frank Saul's baby," said Lewis Sosnowik, community bank analyst with Koonce Securities. "For Frank Saul to part with this is not a happy moment."
George Soros warns 'hedge funds will be decimated'
Hedge funds will be decimated by the global financial meltdown and the crisis will wipe out as much as three quarters of the money they manage, George Soros, the billionaire investor, predicted in Washington yesterday. His comments were made as he fielded hostile accusations in the US House of Representatives that hedge fund managers had enjoyed “unimaginable success” even though they were “virtually unregulated”.
Ordered to testify before the House Oversight and Government Reform Committee, the world’s wealthiest and most secretive hedge fund managers answered questions as lawmakers tried to work out who was to blame for America’s financial crisis. Apart from Mr Soros, those summoned to testify about the role of hedge funds, their tax status and regulation included John Paulson, who runs a hedge fund that bears his name and who was one of the first investors to bet that housing prices could decline on a national basis last year.
He was joined by Philip Falcone, senior managing director of Harbinger Capital Partners, James Simons, who runs Renaissance Technologies, and Kenneth Griffin, chief executive of Citadel Investment Group. Henry Waxman, a California Democrat and the committee chairman, said that he had singled them out because each earned more than $1 billion (£670 million) last year. Mr Waxman said that they had benefited from the tax system, which allowed their earnings to be taxed at the lower capital gains tax rate, rather than as income.
He said: “That means at least some portions of their earnings could be taxed at rates as low as 15 per cent. That’s a lower rate than many teachers, firefighters or plumbers pay.” The hedge fund industry – estimated to control about $2.5 trillion of assets, mainly outside regulatory supervision – has been blamed for volatility in stock markets and destabilising a number of banks. Hedge funds have also been accused of seeking to trash companies by short-selling their stock – a trade in which the dealer benefits if the share price falls.
The first cracks on Wall Street started to appear in June 2007 when UBS and Bear Stearns both admitted to massive losses within their own hedge funds. UBS was forced to close its hedge funds and Bear Stearns had to bail out its own. As Washington debates how to prevent another colossal financial crisis, some critics are calling for heavy regulation of hedge funds. However, Mr Soros cautioned against “going overboard with regulation”. He said: “Excessive deregulation has inflicted enormous losses on the general public and there is a real danger that the pendulum will swing too far the other way. The bubble has now burst and hedge funds will be decimated. It would be a grave mistake to add to the forced liquidation currently dislocating markets by ill-considered or punitive regulations.”
Hedge funds have lured a growing number of ordinary investors, pension funds and university endowment funds, so that millions of Americans unwittingly invest in the funds indirectly. Tom Davis, of Virginia, the committee’s senior Republican, said that hedge funds “now pose a very public peril when the bets go bad”. The funds, which are delivering their worst-ever returns this year, have been widely blamed for contributing to the downfall of both Bear Stearns and Lehman Brothers. But Mr Falcone defended the industry, saying: “The behaviour of institutions in several financial sectors contributed to the crisis, but, in my view, the hedge fund sector was not among them.”
He also defended short-selling, arguing that it was a valuable component of financial markets and did not drive companies out of business. Two months ago, the SEC briefly banned money managers from shorting 1,000 financial stocks. David Ruder, a former chairman of the US Securities and Exchange Commission, which in recent years tried and failed to force hedge funds to register with the agency, also played down the industry’s role in the credit crunch. He said: “They do not seem to have played a major role in the events precipitating the crisis.”
U.S. Treasuries Fall After Investors Shun 30-Year Bond Auction: 'Too Many Unknowns'
Treasuries fell, led by 30-year bonds, after investors shunned the government's $10 billion sale of the securities amid concern that U.S. debt sales will grow. The bonds drew a yield about 9 basis points above the level in pre-auction trading. At 4.31 percent, it was still the lowest since regular sales of the security began in 1977. Investors have been favoring shorter-term debt, which serves as a haven in times of turmoil and a bet the Federal Reserve will lower interest rates. The U.S. sold $34 billion in four-week bills yesterday at the lowest rate on record.
"The 30-year is not a central bank product, and there's no real interest from pension funds" at a yield below 4.5 percent, said Andrew Brenner, co-head of structured products in New York at MF Global Ltd., the world's largest broker of exchange-traded futures and options contracts. "There's just no interest in it."
The yield on the 30-year bond climbed 18 basis points, or 0.18 percentage point, the most since Sept. 30, to 4.35 percent at 4:17 p.m. in New York, according to BGCantor Market Data. The 4.5 percent security due in May 2038 plunged 3 1/32, or $30.31 per $1,000 face amount, to 102 1/2. Ten-year note yields increased 13 basis points, the most since Oct. 28, to 3.87 percent. The two-year note's yield rose 8 basis points, the most in three weeks, to 1.24 percent. The rate on the one-month bill was 0.05 percent, near yesterday's record low.
The bond auction followed yesterday's sale of $20 billion in 10-year notes. The $30 billion total of the two auctions is the biggest amount of the securities sold in a week since at least 1990, when Bloomberg began tracking the data. The gap between yields on two- and 10-year government notes widened to 2.64 percentage points, the largest since October 2003. Traders yesterday pushed two-year note yields to the lowest level in five years, while the Treasury's sale of $25 billion of three-year notes on Nov. 10 attracted the highest level of investor bids relative to the amount offered since 1998. "In the current market environment there are still too many unknowns," said William Larkin, a portfolio manager at Cabot Money Management in Salem, Massachusetts, which manages about $500 million in assets. "People are looking for the safety of the shorter-term securities."
Today's bond auction forecast to draw a yield of 4.224 percent, according to the average estimate of seven bond-trading firms surveyed by Bloomberg News. The bid-to-cover ratio, which gauges demand by comparing the number of bids to the amount of securities sold, was 2.07, below the average of 2.19 times in the nine auctions since the bond was revived in 2006. Indirect bidders, a class of investors that includes foreign central banks, bought 18 percent of the securities offered, down from 43 percent at the last sale. The sale was a reopening, meaning the bonds pay interest at the same rate and mature on the same date as those in the August auction. They mature in May 2038.
Futures on the Chicago Board of Trade show an 80 percent chance the Fed will lower its 1 percent target rate for overnight bank lending by a half-percentage point at its Dec. 16 meeting. The odds were 58 percent a week ago. The difference between what banks and the Treasury pay to borrow money for three months, the so-called TED spread, was 1.96 percentage points, compared with 4.57 percentage points a month ago. The federal budget deficit in October, the first month of fiscal 2009, climbed to a record $237.2 billion, spurred by U.S. purchases of stakes in some of the country's largest banks. It exceeded the budget shortfall for President George W. Bush's first full year in office.
Banks and securities companies globally have reported almost $1 trillion of losses and writedowns tied to a meltdown in the credit markets since the start of 2007. The U.S., Japan, the U.K. and the euro region are headed for their first simultaneous recessions since World War II, according to the International Monetary Fund. Initial claims for U.S. unemployment insurance rose last week to the highest level since September 2001, when the economy was last in a recession. They increased to a larger-than- forecast 516,000 in the week ended Nov. 8, from a revised 484,000 the prior week, the Labor Department said today in Washington. "The jobs data isn't having much impact on the market," said Theodore Ake, the head of Treasury trading in New York at Mizuho Securities USA inc., another primary dealer. "The weakness in the economy is not a surprise. We know we are heading into a recession."
Bernanke Says Central Bankers Ready for More Actions
Federal Reserve Chairman Ben S. Bernanke said central bankers worldwide are prepared to take additional actions as needed to unfreeze credit markets, citing continued strains even amid "tentative improvements." "The continuing volatility of markets and recent indicators of economic performance confirm that challenges remain," Bernanke said today at a panel discussion hosted by the European Central Bank in Frankfurt. "For this reason, policy makers will remain in close contact, monitor developments closely and stand ready to take additional steps should conditions warrant."
Bernanke led the ECB and other central banks last month in the broadest coordinated interest-rate cut in history. The Fed also removed limits on currency-exchange programs with four of its counterparts, including the ECB, and agreed to provide $30 billion each to the central banks of Brazil, Mexico, South Korea and Singapore. Economic data this week signaled that policy makers have failed to avert a global downturn. Gross domestic product in the 15 euro nations contracted 0.2 percent in the third quarter and the Organization for Economic Cooperation and Development predicted yesterday that the economies of its 30 developed member nations will shrink next year by 0.3 percent.
"Monetary policy actions have not resolved the ongoing strains in financial markets," Bernanke said in prepared remarks at the ECB conference, which is marking the 10th anniversary of the euro. ECB President Jean-Claude Trichet, Bank of Israel Governor Stanley Fischer, People's Bank of China Deputy Governor Su Ning and Banco de Mexico Governor Guillermo Ortiz are also scheduled to speak. Retail sales in the U.S. dropped in October by the most since records began in 1992, the U.S. Commerce Department said today. The 2.8 percent decrease was the fourth consecutive drop. Purchases excluding automobiles also fell by the most ever.
Bernanke said "financial markets remain under severe strain," while noting "tentative improvements in credit-market functioning." He didn't specify what new steps central banks could take. The Fed, ECB, Bank of England and other central banks have all lowered rates since the coordinated cut on Oct. 8. Central banks created the currency swap lines in response to "strong demand for dollar funding" in the U.S. and other countries, Bernanke said. The "recent sharp deterioration" in interbank and other funding markets, where some financial institutions normally got dollars, left some companies "without adequate access to short-term dollar financing," he said.
Since the coordinated rate reduction, the Fed has cut its benchmark rate another half-point to 1 percent. The central bank has provided more than $1 trillion in loans to financial institutions to mitigate the worst credit crunch in seven decades and head off a global recession. The Federal Open Market Committee next meets Dec. 16. Corporations with investment-grade credit ratings were paying a premium of about 6 percentage points above comparable Treasuries to issue debt as of Nov. 4, up from 5 points a month earlier and 2.5 points in May, according to Merrill Lynch & Co.
"Central bankers and other policy makers around the world must continue to work together to address disruptions in credit markets and to promote a vibrant global economy," Bernanke said. The U.S. economy may contract at a 3 percent annual pace this quarter, the median estimate in a Bloomberg News survey of 59 analysts this month. Economists don't expect growth to resume until the three months ending in September 2009. The Fed is forecast to reduce the federal funds target rate to 0.75 percent by the end of December and 0.50 percent in the first quarter. Fed governors and district-bank presidents updated forecasts at the FOMC's Oct. 28-29 meeting. Those will be released along with the meeting minutes on Nov. 19.
Yen Rises on Speculation G-20 Will Fail to Agree on Rescue Plan
The yen rose against the dollar and the euro on speculation a Group of 20 nations summit will fail to reach a consensus on how to kick-start the global economy. The Japanese currency advanced against the Australian and New Zealand dollars as investors pared higher-yielding assets before heads of state from the G-20 nations gather in Washington today for two days of talks on the credit crisis. The yen was also buoyed on speculation its 2.7 percent slide against the dollar and 4.8 percent tumble against the euro yesterday was excessive.
"I'm looking for the yen to strengthen against the dollar," said Takeshi Tokita, vice president of foreign- exchange sales in Tokyo at Mizuho Corporate Bank, a unit of Japan's second-largest publicly traded lender. "No one is sure what will come out of the G-20. It's likely that the U.S. and Europe won't see eye to eye on many of the problems the global economy is facing." The yen rose to 97.16 per dollar as of 10:42 a.m. in Tokyo from 97.68 late yesterday in New York. Against the euro, it was at 123.82 from 124.78. The euro fell to $1.2746 from $1.2769. The pound bought $1.4826 from $1.4841. The yen may rise to 95.50 today, Tokita said.
Japan's currency gained to 64.44 yen per Australian dollar from 65.07 late yesterday in New York. It also advanced to 55.22 yen versus the New Zealand dollar from 55.81. Against the dollar, the yen rose 1.2 percent this week, its biggest gain since Oct. 24, on speculation investors reduced carry trade purchases of higher-yielding assets funded with currencies with lower rates. The yen rose 1 percent against the euro, 3.2 percent against the Australian dollar and 5.9 percent versus the New Zealand dollar this week. Benchmark interest rates are 0.3 percent in Japan, 1 percent in the U.S., 3.25 percent in Europe, 5.25 percent in Australia and 6.5 percent in New Zealand.
U.S. President George W. Bush yesterday urged leaders of the world's biggest economies not to abandon free-market capitalism following the seizure in credit markets. G-20 leaders including Australian Prime Minister Kevin Rudd and French President Nicolas Sarkozy have used the crisis to demand greater government control of markets and to attack the U.S. for failing to rein in investors and speculators. Under debate are proposals ranging from curbing executive pay and restraining hedge funds to raising capital requirements for banks and subjecting credit-rating companies to stiffer oversight. U.S. stocks rallied the most in two weeks and crude oil rebounded from a 21-month low yesterday, sparking the yen's decline. "We had such a big move yesterday, Japanese exporters are likely to buy the yen on the cheap," said Osao Iizuka, head of foreign exchange trading at Sumitomo Trust & Banking Co. in Tokyo. "People are also eyeing the G-20 meeting."
Credit freeze: 2 months after Lehman
Saturday marks the two-month anniversary of Lehman Brothers' bankruptcy, which sparked an economic crisis of confidence. Lehman Brothers' epic collapse two months ago marked a stunning turning point in the financial markets from which Wall Street is still recovering. When investors woke up on Monday, Sept. 15, the landscape had totally changed: Lehman Brothers was bankrupt, Merrill Lynch was sold off, and the credit markets - which had been improving after Bear Stearns' bailout in March - were in crisis. Within two days, Libor, a key interbank lending rate, soared to an 8-month high of 3.06%.
Within a week, the market for commercial paper, a key form of business lending, had shrunk to a 2-1/2 year low of $1.7 trillion. And within 10-days, two key measures of risk sentiment - the Libor-OIS spread and the TED spread - were at all-time highs. Two months later, the credit environment has been slowly improving. Borrowing rates are retreating from historical highs, the commercial paper market is expanding and market gauges are showing a return of confidence. But most economists believe it's still a long road to recovery. "Letting Lehman go was a big mistake, because it was the catalyst that really triggered the refreezing of the credit markets," said Scott Anderson, senior economist at Wells Fargo. "Things are improving, but I don't think we're going to return to normal for quite a while."
Just two days after Lehman's bankruptcy, the government began to work on a massive financial rescue package. By October, the Federal Reserve and U.S. Treasury had four separate bank-liquidity programs in place that have lent out trillions of dollars to financial institutions. The most talked-about program is the Treasury's $700 billion Troubled Asset Relief Program started in early October. The Treasury has so far sent out $125 billion to banks in the form of capital injections, with the promise of more to come. Banks have been criticized by lawmakers and the public for not using their TARP money for lending, but Treasury officials have said that the program will take time to realize its goals.
Meanwhile, the Federal Reserve has purchased $257.3 billion of commercial paper since its Commercial Paper Funding Facility opened on Oct. 20. In the same time period, the commercial paper market has expanded, but only by $154 billion. Analysts say the main lenders to businesses still don't want to take on risky corporate debt and are opting for U.S. Treasurys instead. The Fed has been hoping that its participation would encourage private lenders to reenter this once safe market. The Fed has also stepped up lending programs that originated before Lehman's collapse. It expanded the amount it offers in its Term Auction Facility - a program that lends short-term money to banks in exchange for mortgage-backed securities - to $300 billion a month. And financial institutions continue to borrow hundreds of billions from the Fed's emergency lending window.
But for the past two weeks, Fed data has shown that banks are borrowing less from both the commercial paper facility and the discount window. Last week, the Term Auction Facility only attracted borrowers for 8% of its allotted bi-weekly loan. Some analysts have suggested that banks' borrowing needs have not decreased, but they are borrowing less from each facility because the government is providing funding from a variety of other programs. "It's almost like banks have a buffet of liquidity choices," said Matt McCormick bank analyst and portfolio manager at Bahl & Gaynor Investment Counsel. "The Fed's trying to bail out a leaky boat with eight different types of buckets - no one cares what you call those buckets as long as they keep bailing."
The government programs have gotten credit back on track from the month-long derailment sparked by Lehman's collapse. And while some analysts argue that the credit "crisis" is over, the credit "crunch" is still very much alive and will be a slow process to correct. "The government and investors want to be satisfied instantly, but they have to let things go through a normal business cycle," said McCormick. "The economy got beaten down to its foundation, and now we're building from bottom up again - I'd rather build slowly on much firmer setting than build quickly on made up statistics and shaky credit again."
Alan Greenspan, the former Fed chief, has said that we will know the credit markets have returned to normal when the Libor-OIS spread returns to just a hair above the anticipated Fed funds rate. That will show that banks are confident about the market conditions and have resumed normal lending practices. Libor-OIS was less than 0.8 percentage points before Lehman collapsed. It reached a record high of 3.64 on Oct. 10, and sits at 1.74 today. So according to Greenspan, we're only about half-way to recovery.
All the lending facilities and liquidity programs in the world won't encourage private lending on their own. Many have said the Fed can only push on a string. There is an inherent problem in comparing Nov. 14 with Sept. 14. The global economic climate has taken a sharp turn for the worse since September, the stock markets have fallen drastically and the United States is likely in a recession. None of that was true two months ago, which means the government is fighting an uphill battle to restore liquidity. In the days before Lehman declared bankruptcy, private lending was rebounding, and the credit markets were showing signs of improvement. Commercial paper was increasing to near one-year highs, risk indicators had fallen to normal market levels, and lending rates had hovered at around 3-1/2 year lows.
"One challenge we have in comparing today's situation with the situation before Lehman is that we weren't talking about a very very deep and extended recession in September," said John Silvia, chief economist for Wachovia. "Now we've been thrown that extra curve ball - not only has the liquidity issue changed but the economy has also changed." To bring the credit market back to normal in a difficult economic time, it may take more than lending programs to boost liquidity. Economists and lawmakers have suggested sweeping reforms, such as a clearinghouse for credit default swaps, private capital matches for TARP funds, a lending facility for consumer credit and a sweeping stimulus for taxpayers.
"The government has done just about everything it can do to provide liquidity," said Silvia. "The more fundamental problem going forward is what the regulatory framework is going to look like." But if you're looking for a timeframe for these new programs to begin, check back in January. "We need a substantial fiscal stimulus package," said Anderson. "Unfortunately, it doesn't look like much will get done until after the inauguration."
The Two Trillion Dollar Black Hole
Purge your mind for a moment about everything you've heard and read in the last decade about investing on Wall Street and think about the following business model: You take your hard earned retirement savings to a Wall Street firm and they tell you that as long as you "stay invested for the long haul" you can expect double digit annual returns. You never really know what your money is invested in because it’s pooled with other investors and comes with incomprehensible but legal looking prospectuses.
The heads of these Wall Street firms have been taking massive payouts for themselves, ranging from $160 million to $1 billion per CEO over a number of years. As long as new money keeps flooding in from newfangled accounts called 401(k)s, Roth IRAs, 529 plans for education savings, and hedge funds (each carrying ever greater restrictions for withdrawing your money and ever greater opacity) everything appears fine on the surface.
And then, suddenly, you learn that many of these Wall Street firms don't have any assets that anybody wants to buy. Because these firms are both managing your money as well as having their own shares constitute a large percentage of your pooled investments, your funds begin to plummet as confidence drains from the scheme. Now consider how Wikipedia describes a Ponzi scheme:“A Ponzi scheme is a fraudulent investment operation that involves promising or paying abnormally high returns (‘profits’) to investors out of the money paid in by subsequent investors, rather than from net revenues generated by any real business. It is named after Charles Ponzi...One reason that the scheme initially works so well is that early investors – those who actually got paid the large returns – quite commonly reinvest (keep) their money in the scheme (it does, after all, pay out much better than any alternative investment). Thus those running the scheme do not actually have to pay out very much (net) – they simply have to send statements to investors that show how much the investors have earned by keeping the money in what looks like a great place to get a high return. They also try to minimize withdrawals by offering new plans to investors, often where money is frozen for a longer period of time...The catch is that at some point one of three things will happen:(1) the promoters will vanish, taking all the investment money (less payouts) with them;
(2) the scheme will collapse of its own weight, as investment slows and the promoters start having problems paying out the promised returns (and when they start having problems, the word spreads and more people start asking for their money, similar to a bank run);
(3) the scheme is exposed, because when legal authorities begin examining accounting records of the so-called enterprise they find that many of the 'assets' that should exist do not."
Looking at outcomes 1, 2, and 3 above, here’s where we are today. The promoters have clearly not vanished as in outcome 1. In fact, they are behaving as if they know they have nothing to fear. As over $2 trillion of taxpayer money is rapidly infused through Federal Reserve loans and over $125 Billion in U.S. Treasury equity purchases to keep these firms from collapsing, the promoters are standing at the elbow of the President-Elect in press conferences (Citigroup promoter, Robert Rubin); they are served up as business gurus on the business channel CNBC (former AIG CEO and promoter, Maurice “Hank” Greenberg); they are put in charge of nationalized zombie firms like Fannie Mae (Herbert Allison, former President of Merrill Lynch); they are paying $26 million and $42 million, respectively, for new digs at 15 Central Park West in Manhattan, where their chauffeurs have their own waiting room (Lloyd Blankfein, CEO of Goldman Sachs; Sanford “Sandy” Weill, former CEO of Citigroup, who put his penthouse in the name of his wife’s trust, perhaps smelling a few pesky questions ahead over the $1 billion he sucked out of Citigroup before the Fed had to implant a feeding tube).
We are definitely seeing all the signs of outcome 2: the scheme is collapsing under its own weight; there are panic runs around the globe wherever Wall Street has left its footprint. But outcome 3 is the most fascinating area of departure from the classic Ponzi scheme. Legal authorities have, indeed, examined the books of these firms, except for one area we’ll discuss later. They found worthless assets along with debts hidden off the balance sheet instead of real depositor funds. Instead of arresting the perpetrators and shutting down the schemes, Federal authorities have developed their own new schemes and pumped over $2 trillion of taxpayer money into propping up the firms while leaving the schemers in place.
Equally astonishing, Congress has not held any meaningful investigations. This has left many Wall Street veterans wondering if the problem isn’t that the firms are “too big to fail” but rather “too Ponzi-like to prosecute.” Imagine the worldwide reaction to learning that all the claptrap coming from U.S. think-tanks and ivy-league academics over the last decade about efficient market theory and deregulation and trickle down was merely a ruse for a Ponzi scheme now being propped up by a U.S. Treasury Department bailout and loans from our central bank, the Federal Reserve.
Fortunately for American taxpayers, Bloomberg News has some inquiring minds, even if our Congress and prosecutors don’t. On May 20, 2008, Bloomberg News reporter, Mark Pittman, filed a Freedom of Information Act request (FOIA) with the Federal Reserve asking for detailed information relevant to whom the central bank was giving these massive loans and precisely what securities these firms were posting as collateral. Bloomberg also wanted details on “contracts with outside entities that show the employees or entities being used to price the Relevant Securities and to conduct the process of lending.” Heretofore, our opaque central bank had been mum on all points.
By law, the Federal Reserve had until June 18, 2008 to answer the FOIA request. Here’s what happened instead, according to the Bloomberg lawsuit: On June 19, 2008, the Fed invoked its right to extend the response time to July 3, 2008. On July 8, 2008, the Fed called Bloomberg News to say it was processing the request. The Fed rang up Bloomberg again on August 15, 2008, wherein Alison Thro, Senior Counsel and another employee, Pam Wilson, informed the business wire service that their request was going to be denied by the end of September 2008. No further response of any kind was received, including the denial. On November 7, 2008, Bloomberg News slapped a federal lawsuit on the Board of Governors of the Federal Reserve, asserting the following:
“The government documents that Bloomberg seeks are central to understanding and assessing the government’s response to the most cataclysmic financial crisis in America since the Great Depression. The effect of that crisis on the American public has been and will continue to be devastating. Hundreds of corporations are announcing layoffs in response to the crisis, and the economy was the top issue for many Americans in the recent elections. In response to the crisis, the Fed has vastly expanded its lending programs to private financial institutions. To obtain access to this public money and to safeguard the taxpayers’ interests, borrowers are required to post collateral.
Despite the manifest public interest in such matters, however, none of the programs themselves make reference to any public disclosure of the posted collateral or of the Fed’s methods in valuing it. Thus, while the taxpayers are the ultimate counterparty for the collateral, they have not been given any information regarding the kind of collateral received, how it was valued, or by whom.” As evidence that Bloomberg News is not engaging in hyperbole when it uses the word “cataclysmic” in a Federal court filing, consider the following price movements of some of these giant financial institutions. (All current prices are intraday on November 12, 2008):• American International Group (AIG): Currently $2.16; in May 2007, $72.00
• Bear Stearns: Absorbed into JPMorganChase to avoid bankruptcy filing; share price in April 2007, $159
• Fannie Mae: Currently 65 cents; in June 2007 $69.00
• Freddie Mac: Currently 79 cents; in May 2007 $67.00
• Lehman Brothers: Currently 6 cents; in February 2007, $85.00
What all of the companies in this article have in common is that they were writing secret contracts called Credit Default Swaps (CDS) on each other and/or between each other. These are not the credit default swaps recently disclosed by the Depository Trust and Clearing Corporation (DTCC). These are the contracts that still live in darkness and are at the root of why the Wall Street banks won’t lend to each other and why their share prices are melting faster than a snow cone in July.
A Credit Default Swap can be used by a bank to hedge against default on loans it has made by buying a type of insurance from another party. The buyer pays a premium upfront and annually and the seller pays the face amount of the insurance in the event of default. In the last few years, however, the contracts have been increasingly used to speculate on defaults when the buyer of the CDS has no exposure to the firm or underlying debt instruments. The CDS contracts outstanding now total somewhere between $34 Trillion and $54 Trillion, depending on whose data you want to use, and it remains an unregulated market of darkness.
It is also quite likely that none of the firms that agreed to pay the hundreds of billions in insurance, such as AIG, have the money to do so. It is also quite likely that were these hedges shown to be uncollectible hedges, massive amounts of new capital would be needed by the big Wall Street firms and some would be deemed insolvent. Until Congress holds serious investigations and hearings, the U.S. taxpayer may be funding little more than Ponzi schemes while companies that provide real products and services, legitimate jobs and contributions to the economy are left to fail.
HSBC may be forced to repossess its own home
The banking giant HSBC is considering repossessing its own Canary Wharf headquarters, as it holds talks with the troubled Spanish property company that owns the building. Metrovacesa, which bought the building from HSBC for more than £1bn in a sale and leaseback agreement in 2007, is facing increasing financial difficulties and looks unable to service the debt it raised from HSBC itself to buy the skyscraper.
HSBC helped Metrovacesa at the time by giving it a bridging loan of £810m, with the idea being that it would be refinanced. The crash in the real estate and mortgage markets completely changed the parameters in the debt market, however. The loan comes due on 28 November and it looks almost impossible that it will be rolled over. The heavily indebted Metrovacesa is trying to stay afloat after a huge crash in Spanish real estate.
The Sanahuja family, which owns more than 80 per cent of Metrovacesa, said this month it could exchange debt for a substantial swathe of the company's shares and some property, adding that creditors would be prepared to consider the deal. One option under discussion with HSBC would see the bank take the building back and write off the £810m loan. This would enable it to pocket the roughly £200m in cash paid by Metrovacesa for the 42-floor building, which is located on Canary Wharf's Canada Square. Construction work on the site was completed in 2002.
Another possibility is that HSBC would offset interest payments on the loan against its rent, as the figures are similar. Or it could again roll over the facility, although this seems unlikely. A spokesman for HSBC said: "We never comment on client business."
Trichet Says ECB Will Restore Confidence as Economy Contracts
European Central Bank President Jean- Claude Trichet said the bank's "considerable" policy action will help restore confidence in Europe's contracting economy. "Having taken a number of measures that are considerable as regards their importance, confidence will grow back," Trichet said in an interview with Bloomberg Television in Frankfurt today. He described the economy as being in a period of "stagnation with negative figures" after the region slipped into its first recession in 15 years.
Trichet has already indicated the ECB may cut interest rates again in December after two reductions in the key rate to 3.25 percent over the past month. Gross domestic product in the 15 euro nations shrank 0.2 percent for the second straight quarter in the three months through September, the European Union's Luxembourg- based statistics office said today. The news was "not surprising," Trichet said.
"We have said that the real economy was hit by the turbulences," he said. Restoring confidence "is a process that we will try to help ourselves; confidence in price stability, confidence of the households that their purchasing power will be preserved, confidence of the economic agents in general," Trichet said. "Confidence is the key word, motto, in the present period."
Factories Shut, China Workers Are Suffering
Wang Denggui, father of three, arrived more than a year ago in the palm-lined streets of this southern town with a single goal: toil in a factory to save for his children’s school tuition. But the plans of Mr. Wang and thousands of co-workers unraveled at noon on Nov. 1, when the Taiwanese chairman of their ailing shoe factory climbed over a factory wall to flee the country and his debts. That left several American shoe companies with unfilled orders and 2,000 workers without jobs. “He just ran without telling anyone,” Mr. Wang said.
For decades, the steamy Pearl River Delta area of southern Guangdong Province served as a primary engine for China’s astounding economic growth. But an export slowdown that began earlier this year and that has been magnified by the global financial crisis of recent months is contributing to the shutdown of tens of thousands of small and mid-size factories here and in other coastal regions, forcing laborers to scramble for other jobs or return home to the countryside. Furthermore, the slowdown inhibits China’s ability to work with other nations in alleviating the worldwide crisis.
The Pearl River Delta, known as the world’s factory, powered an export industry that pushed China’s annual growth rate into the double digits and provided work for migrants from interior provinces with poor farmland. But circumstances have changed quickly. The slowdown in exports contributed to the closing of at least 67,000 factories across China in the first half of the year, according to government statistics. Labor disputes and protests over lost back wages have surged, igniting fear in local officials.
After the shutdown of their shoe factory, called Weixu in Chinese and China Top Industries in English, Mr. Wang and some co-workers took to the streets in protest, demanding two months of back pay, or $440 on average. The government called in the riot police. Seven workers were thrown in jail and six were beaten, including Mr. Wang, he said. “I plan to return home once I get my money,” Mr. Wang said as he stood outside the factory on Tuesday, showing the bloody shin wound that he said resulted from a blow from a metal baton. (The police declined to comment.) “I’m over 50 years old, and I won’t be able to find work. I’ll just retire.”
Under pressure from Beijing to maintain social stability, local officials are also trying to tamp down unrest by doling out back wages. Here in Chang’an, after the worker protest, the government shelled out more than $1 million to pay back wages to most of the workers at the shoe factory. (Mr. Wang and some other laborers say they are still without back pay.) The slowdown in exports has accelerated a major shift in the nature of Chinese manufacturing: small factories that were already being pinched by rising costs of labor, transportation and raw materials, as well as by the appreciating yuan, are closing en masse. That is especially the case in these towns scattered around the city of Dongguan, known for churning out low-end products. Soon the labor-intensive factories that rely solely on migrant work could disappear from southern China, and foreign companies could contract with similar factories in Vietnam and other countries where costs are lower.
“There’s very serious damage being done down there, I don’t deny it, and I think it’ll get worse because we haven’t seen the full impact of the economic downturn in Europe,” said Arthur Kroeber, managing director of Dragonomics, an economic research and advisory firm based in Beijing. “I think next year we might see export growth in the country as a whole go down to 0 percent.” The export sector is still growing but has slowed considerably; year-on-year growth was at 9 percent in October compared with 26 percent in September 2007, Mr. Kroeber said. The social problems arising from the slowdown have stirred anxiety in the top leadership of the Communist Party, whose legitimacy is based on maintaining economic growth. Prime Minister Wen Jiabao is pushing for policies that will increase domestic consumer consumption to wean China off its reliance on exports. Last Sunday, the government unveiled a stimulus package worth $586 billion over the next two years — the largest ever announced in China — to help create jobs, mostly by building new transportation infrastructure.
Foreign governments expecting China to take the lead in addressing the global crisis will be disappointed, say analysts and scholars. Chinese officials say they are focused on trying to ease domestic problems and keeping the country’s annual growth rate above 8 percent, which they see as vital to generating enough new jobs. Some analysts say economic expansion could drop to as little as 5.8 percent in the fourth quarter this year, down from about 11 percent in 2007. “I think China foresees that it’ll need to spend a lot of money to get itself out of the current domestic situation,” said Victor Shih, an assistant professor of political science at Northwestern University who studies the political economy of China. “On the global financial crisis, China will not take a leading role.”
The mass layoffs have led to a profound change in the movements this year of migrant workers like Mr. Wang who spend virtually the entire year away from home. Many are heading home early for the Chinese New Year, in late January, and say they might not return to work in the coastal regions. A worker in the railway station in Guangzhou said that from Oct. 11 to Oct. 27, there were 1.17 million passengers on trains leaving the station, an increase of 129,000 over the same period last year. There have been reports of a similar jump in other regions. Once in the interior, the workers will have less incentive than in the past to return to the coastal provinces. Rising grain prices have made farming more profitable. The Chinese government announced a rural land reform policy last month that could spur some farmers to stay on their land and make better use of it.
A growing number of factories have opened in the interior provinces as well. Wages are still lower than on the coast, but have risen quickly in recent years. In Zhangmutou, a town here in the Dongguan area, many of the 7,000 workers who lost their jobs when a Hong Kong-owned toy factory called Smart Union shut down last month have returned home. Li Dongmei, a former human resources employee, said her two older brothers who worked in the factory had taken the 20-hour bus ride home to Hunan Province. Ms. Li, though, still lives across from the abandoned factory building because she is eight months pregnant. “This place isn’t too stable economically,” Ms. Li, 25, said as she sat on a terrace outside her cramped apartment. “Guangdong isn’t so good anymore.”
As was the case with the Weixu shoe factory, Smart Union closed without any notice, and hundreds of angry workers poured into the streets to demand that the local government pay them back wages. Many such factories were run by Taiwanese or Hong Kong managers who fled the mainland. Chinese police and courts have limited reach in Hong Kong, which has a separate legal system, and they have almost no ability to prosecute people in Taiwan, which is treated as a renegade province and does not have formal political or diplomatic relations with the mainland.
The wave of factory shutdowns is taking place at a time when migrant workers are more aware than ever of their legal rights and know how to put pressure on local governments. Two national labor laws were enacted in January that, among other things, require companies to pay severance and give out more long-term labor contracts. The laws could lead to more labor disputes and protests, said Mary Gallagher, director of the Center for Chinese Studies at the University of Michigan. “Increasingly, the migrant workers know their rights,” she said.
Here in Chang’an, nearly 200 workers showed up outside the south gate of the four-story Weixu factory on Tuesday to demand from the government severance payments that generally ranged from $1,500 to $3,700 each. They signed their names on a list and put a red fingerprint stamp next to each signature. “No one’s gotten this subsidy yet,” said a woman from Qinghai Province who spoke on condition of anonymity because local officials had scolded her for talking to a local newspaper. “The government has been helpful in giving us our back pay, but it hasn’t been helpful in paying the subsidy.”
The Taiwanese chairman of the shoe factory, Zhuang Jiaying, did not return calls seeking comment. The collapse of the factory started a domino effect: Related businesses, like a smaller factory that put labels on Weixu’s shoe boxes, have also failed. Hundreds of additional laborers have lost their jobs, and more than 200 creditors have yet to collect millions of dollars, said Yang Qiusheng, the manager of the factory that handled the labels. “I had to fire people who had worked for me for a long time,” he said. “When I see this shoe factory, this enterprise, I feel very sad and sorry. I never thought it would end like this.”
French Third-Quarter GDP Unexpectedly Increases
France's economy unexpectedly grew in the third quarter, dodging the recession that is hammering Germany as consumer spending gained and exports rebounded. Gross domestic product in the euro-region's second-largest economy rose 0.1 percent from the second quarter, when it shrank 0.3 percent, Paris-based national statistics office Insee said today. Economists expected a contraction of 0.1 percent, the median of 24 forecasts in a Bloomberg survey showed.
A recession may just be delayed by two quarters, economists such as Bank of America Corp.'s Gilles Moec said, as companies facing the global credit crunch and a slowdown in demand scale back investment and cut jobs. The French government last week slashed its growth forecast for this year and next, while the European Commission predicted the euro-area economy would stagnate next year. "The third quarter doesn't completely reflect the effects of the financial crisis," said Moec, who expected stagnation. "We've clearly been in recession territory since September."
Germany yesterday said GDP dropped 0.5 percent in the three months through September after a 0.4 percent decline in the second quarter. Spain and Italy reported contractions of 0.2 percent and 0.5 percent, respectively. The European economy fell into its first recession in 15 years, separate data today showed, with GDP of the 15-nation area area falling 0.2 percent in the third quarter.
In France, "the numbers are surprising. Everyone was waiting for a negative number," Finance Minister Christine Lagarde said on RTL radio today. "France is not technically in a recession." Still, business confidence fell to the lowest in almost 15 years in October as the global credit crisis worsened. Airbus SAS orders in the first 10 months dropped 34 percent as declining traffic and airline bankruptcies forced cancellations at the world's largest maker of commercial aircraft.
Car manufacturers are also struggling. Renault SA trimmed its full-year profit and sales forecasts and plans to cut 6,000 European jobs. Rival PSA Peugeot Citroen, has said it would slash production by about 30 percent because of a "collapse" in the global auto market. French manufacturers expect to decrease investment 3 percent next year, Insee said today in a separate report. They also scaled back their plans for this year from a July estimate, it said.
Consumer spending rose 0.2 percent after stagnating in the second quarter, the GDP report showed. Exports and imports both rose 1.9 percent after falling the previous quarter, with trade not contributing to expansion overall. Corporate investment rose 0.3 percent after a 1 percent drop, while household investment sank 1.6 percent. Companies' cost cutting has started to show in the labor market. Payrolls fell 0.1 percent in the third quarter, Insee said in a separate report today. The number of job seekers has increased for the past five months, prompting President Nicolas Sarkozy to pledge to add 100,000 government-subsidized positions.
The Organization for Economic Cooperation and Development yesterday cut its forecast for global growth in 2009, following the International Monetary Fund in forecasting economic contractions in advanced economies next year. "The OECD as a whole is currently in recession" and will start recovering in the second half of 2009, Jorgen Elmeskov, the OECD's director of policy studies, said yesterday. L'Oreal SA, the world's largest cosmetics maker, on Oct. 30 cut sales and profit forecasts for the third time in less than four months as European and U.S. consumers curbed their spending. "Since September, we have noted a clear slowdown in some markets in western Europe and North America, and have been confronted with a contraction of purchasing by some distributors in view of the current economic crisis," Chief Executive Officer Jean-Paul Agon said in a statement.
Consumers and companies may get a respite from the euro, which has dropped 20 percent against the dollar in the past four months, and from the falling oil prices that have collapsed to under $60 a barrel from a peak of more than $147 in July, easing inflation pressure and giving central banks from Washington to Beijing room to slash interest rates. "It's true that's an enormous shock but compared with 1993, monetary policy is not restrictive and emerging economies have reserves and can do support measures," said Laurence Boone, an economist at Barclays Capital in Paris. "We're going through the worst period, but let's not overdramatize."
Australia digs for victory
Two straight railway lines run through the red desert of the Pilbara region, in Western Australia, almost touching each other in places. One belongs to BHP Billiton, a big mining company, hauling iron ore in trains more than a mile long to ships bound for China and elsewhere in Asia. The other lugs ore for Fortescue Metals, a relative newcomer.
China’s demand for the Pilbara’s minerals to feed its insatiable steel mills has been a bedrock of Australia’s boom for much of this decade. With the onset of the global financial crisis, the region is now proving crucial to whether Australia can defy the fate of other rich countries and avoid a recession. At first the portents looked good. Australia prospered through the Asian financial crisis 11 years ago. Once derided as an “old economy” dependent on commodities, Australia’s tangible assets in fact underwrote a further stroke of luck as China’s rapid growth created an unprecedented market for iron ore and coal. China is now Australia’s biggest trading partner; it buys 40% of the Pilbara’s iron ore.
A few months ago, this seemed enough to protect Australia from the storms buffeting the world economy. No longer. On November 5th the federal Treasury shaved Australia’s 2008-09 growth forecast from 2.75% in May’s budget to 2%. It also cut by three-quarters the forecast budget surplus of almost A$22 billion ($15 billion). Some of this was the result of a A$10.4 billion stimulus package that Kevin Rudd, the prime minister, announced last month. But the Treasury also cited falling revenues linked to the global financial crisis, and a weaker outlook for growth and demand among Australia’s emerging-economy customers, including China.
Five days later the central bank delivered a bleaker prognosis. It forecast annual growth falling to just 1.5%. Some economists believe even this is optimistic. Only two months ago Glenn Stevens, the bank’s governor, lauded as “the largest shock of its kind” an improvement of almost two-thirds in Australia’s terms of trade over five years. The growth has been driven largely by demand from China, and especially by record rises the mining companies negotiated earlier this year in contract prices for iron ore and coal. Now, the bank declared, the terms of trade had peaked.
The same day as the central bank’s report, Fortescue and Rio Tinto, another mining company, announced they were cutting their Pilbara iron-ore production by 10% because of China’s slowing industrial output. Just as they did so, China announced a $586 billion spending plan to recharge its economy. Mr Rudd described it as “extraordinary” and “very good news” for Australia’s economy, too. In early October, as the full impact of the financial crisis sunk in, Mr Rudd, having sought reassurance from Wen Jiabao, his Chinese counterpart, that China’s demand for Australia’s commodities would stay strong, declared China “critical” for Australia’s economic performance. So China’s stimulus this week, inspiring visions of more iron ore needed for steel to build housing and infrastructure, has brought fresh hopes that the Pilbara once again will be the lucky country’s saviour.
A region slightly smaller than Spain, about 1,300km (675 miles) north of Perth, the Pilbara was first mined for iron ore in the 1960s when Japan was East Asia’s emerging industrial giant. Until recently, its reserves were pretty much carved up by a comfortable duopoly of Rio Tinto and BHP, two global giants. The China-based boom has been enlivened by the arrival of a third competitor in the form of Fortescue Metals, a Perth-based company started by Andrew Forrest, a former stockbroker.
Mr Forrest’s challenge to the big boys’ market control, and his colourful background, have made him something of a media darling. His great-great uncle was a pioneer, explorer and Western Australia’s first premier. Mr Forrest’s first bid as a commodities entrepreneur, through a nickel-mining venture, ended in tears seven years ago when his then company failed to meet promised production targets. Undeterred, he spotted a chance to make a fortune from iron ore. He noticed that, just as China’s boom started gathering steam earlier this decade, Australia’s share of the market was falling, and those of India and Brazil were rising.
Defying market sceptics, he raised almost A$3 billion, mainly from American bondholders, to launch Fortescue. In May, barely five years after he founded the company, it shipped its first iron ore to Baosteel, China’s biggest steel company. At that time, few people outside the business world, and his home state, had heard of Mr Forrest. Yet in the same month, Business Review Weekly, a Sydney magazine, declared him Australia’s richest person, with wealth of almost A$10 billion, mainly in Fortescue shares. Six months later, he has lost the status. In a sign of the mining boom’s rollercoaster ride, Fortescue’s share price, like those of other commodities companies, has fallen steeply since the financial crisis hit.
Mr Forrest maintains the wealth ranking means little to him. “I want to enjoy life, have fun and be useful,” he says in his Perth office, a relatively modest affair compared with the towers his two global competitors occupy up the street. Fun or not, they have been forced to take Mr Forrest seriously. Cloud Break, Fortescue’s only operating mine, lies in isolated desert, near the dry Fortescue River, about 270km south-east of Port Hedland (see map). When BHP refused Mr Forrest’s request for commercial access to its railway line, he built his own line next to it. Wayne Swan, Australia’s treasurer, ruled last month that both BHP and Rio Tinto must allow Fortescue access to their Pilbara railway lines to boost mining competition. The two big companies have indicated they may appeal against the ruling.
In what he calls “the most important part of anything I’ve ever stood for”, Mr Forrest has also persuaded Mr Rudd to back a scheme he initiated to create 50,000 jobs for indigenous Australians within two years across all industries, not just mining. The issue is especially sensitive in the ore-rich Pilbara, where aborigines comprise 20% of the population (compared with 2% Australia-wide). Mr Forrest grew up there, and saw to his dismay children “equal to me in the classroom and on the sports field” end up on welfare, while he and other whites forged ahead.
The job-creation plan now seems ambitious. The Treasury predicts the global slowdown will lift national unemployment to 5% next year, and to almost 6% in 2010. Rio Tinto, the Pilbara’s biggest operator, has 11 mines including Tom Price, the oldest and still one of the richest in ore quality. Just before the crisis, Sam Walsh, Rio’s iron-ore chief in Perth, declared it had invested all its Pilbara earnings from the past five years, around A$9 billion, into expanding its export capacity by 60%. This week, by contrast, Rio cut annual-production targets by 20m tonnes.
Despite the slump, the miners are staying outwardly optimistic. Tom Albanese, Rio’s chief executive, says gamely that China’s slowdown will be short and sharp. He expects “rebounding” demand in 2009. BHP, in the throes of a takeover bid for Rio, has announced no production cuts so far. Fortescue, possibly the most vulnerable of the three because of its sole reliance on iron ore, has delayed next year’s planned production target until 2010. Graeme Rowley, Fortescue’s executive director, argues nevertheless that China’s need for iron ore and steel to continue its “revolution” of building new cities means that “Australia will remain constructively and very positively part of China’s future”. The pace at which that happens will decide not just Australia’s capacity to avoid the worst of the global downturn. It may also determine the outcome of a David-and-Goliath battle of raw capitalism in the Pilbara.
Ways to avoid another stampede
World leaders gather on Saturday to address the global financial meltdown. They will discuss fiscal stimulus and monetary policy, and rightly so. But Japan’s bitter experience in the 1990s proves that fiscal and monetary policies are not enough. Just as important are microeconomic incentives such as rules for accounting, disclosure and compensation. Unless the micro incentives are right, the macro outcome will be wrong. In my opinion, the global financial meltdown had less to do with macro?economic errors – although such errors occurred – than with distorted and in?compatible micro incentives. Here are 11 reforms that will damp the tendency of financial markets to stampede.
First, adjust capital adequacy ratios to restrain the lending cycle. For example, the 4 per cent target for the tier one capital ratio for banks might be raised to 8 per cent in booms but lowered to 3 per cent in recessions. Cycle-dependent capital ratios would reduce the tendency of banks to lend too generously in booms and too timidly in recessions.
Second, design performance benchmarks that discourage herd behaviour. Benchmarks usually reward fund managers for their performance against a reference index. Such benchmarks can trigger bubbles or stampedes. If a stock is included in the reference index and is rising, fund managers have a strong incentive to buy – even if valuations are too high already. Requiring absolute benchmarks (for example, seek 10 per cent, plus or minus 2 per cent, with a penalty for deviation in either direction) might quell the herd instinct. Relative reference indices should not be used as performance benchmarks, especially for compensation.
Third, base mark-to-market rules on the duration of liabilities. When an institution relies mostly on long-term funding, mark-to-market of assets need not be strict or frequent. Such institutions can take the long view, stabilise markets and raise returns for investors. However, when an institution relies heavily on short-term funding, mark-to-market of assets must be strict and frequent. Otherwise the capital of the institution will be vulnerable. Thus, mark-to-market rules should be based not only on the character of individual assets, but also on the duration of the liabilities of each institution.
Fourth, impose leverage limits to counter the funding cycle. In recent years, some financial institutions became overleveraged as a result of competitive pressures on regulators to lift leverage limits. Such limits should be reinstated on an internationally consistent basis. When times are good, the leverage limits should be lowered in order to prevent overshooting. When times are bad, the limits should be raised in order to spur recovery.
Fifth, expand suitability rules to all financial sectors. These protect investors from lack of information, inexperience and myopia. In the securities business, brokers must have a reasonable basis for recommending a security to a customer, in light of the customer’s circumstances. Similar rules are needed across financial institutions, especially for mortgages.
Sixth, enforce cross-country consistency. In globalised capital markets, rule changes in one country can de?stabilise other countries, as shown recently by changes in deposit insurance coverage and by capital injections. Categories requiring cross-border consistency include deposit insurance, short-selling rules, money market collateral rules and leverage limits.
Seventh, mandate the exchange of personnel between regulators and regulated institutions. Too often, personnel in financial institutions fail to understand the regulators’ viewpoints and needs. Senior financial industry personnel should be required to have regulatory experience. Conversely, regulators often fail to understand the pressures and incentives in financial institutions. Moreover, regulators in one country often fail to understand rules in others. Senior regulators should be required to have market and inter?national experience.
Eighth, eliminate conflict of interest in the business models of rating agencies. Rating agencies are often paid by issuers. There is therefore a temptation to give high ratings. Rating agencies may use generous assumptions or models that are biased towards an outcome that is profitable to the agency. Thus, agencies should be paid by investors, who will demand timely ratings that reflect reality, and not by issuers.
Ninth, professionalise external directors. In many cases, external directors of companies are friendly with internal board members and thus avoid making frank criticism. External board members may lack expertise in the business or independent information on which to question staff analysis. These problems could be solved by creating professional external directors, much like external auditors.
Tenth, consolidate settlement of over-the-counter trading and credit default swaps. The dispersion of OTC transactions makes it virtually impossible to follow flows. This is a particular problem in the CDS market. Regulators and investors need a better grasp of such flows to pre-empt problems. Contract standardisation is crucial. Finally, standardise cross-border collateral agreements. Common rules are needed so that banks can pledge collateral with confidence across countries and be confident that contracts are enforceable. Absent such rules, interbank markets are more likely to freeze or stampede at the first sign of trouble.