Ralph Coffin jumping his horse over Rolls-Royce on Rabbit, Washington
Ilargi: Yesterday, with regards to the $326 billion Citi bail-out, I wrote that the floodgates were now open. Today brings the confirmation: The Federal reserve, which doesn't have to ask Congress for permission, presents another $600 billion plan, to be piled on top of all that's come before. But it's still your money that's being spent, the principle remains the same.
Fannie and Freddie will get the biggest chunk, so they can keep on buying up failed and failing mortgages. Anything to save the banks, which have no definitely been declared more important and indispensable than teh US citizens. When everything is added up, we are now at $7.7 trillion, and counting; Obama already has a $500 billion -minimum- new program waiting in the wings.
They are not going to stop this madness on their own initiative, the presence of Geithner, Rubin and Summers guarantees a save the beached bank politics well into 2009. This is not good for you, the taxpayer, you don't benefit from Wall Street bail-outs. You don't need Goldman or JPMorgan to survive. Preserving the current system doesn't help you, it only helps the current system. And it won't save the banks either, it only helps them cover up losses for a bit longer.
The open floodgates wash away what little wealth was still left in America. The fall will be that much steeper and faster, and especially more painful.
I will be gone for a while starting today, more looking from the outside in than doing day-to-day work. I hope the team I have assembled in the interim will please you. My friend OC will be the editor, Stoneleigh will keep a close eye on what goes on, 5-6 people will contribute, and I will not be entirely absent either.
You might want to think about participating in and donating to our upcoming Automatic Earth Christmas fundraiser. This site costs a lot of money to make, and it doesn't come back (though I am very gratefull for all donations received so far, don't get me wrong). I don't want to make it a pay-site, but at the same time something's got to give. We have saved a lot of people a lot of money and trouble, but have no way to get any -what i would consider- fair payment for it. And that is fine, as I’ve said before, it's my free choice, but it can't last.
So allow me to suggest something, and please think it over. There are a lot of regular, returning, daily, readers here. Most of them, if you'd suggest it to them, would agree that what The Automatic Earth provides is worth $1 per day, or even $0.50.
Why not, since ‘tis the season to be jolly, add up what you feel that daily value is to you, and donate it once per month or per week, or in a lump sum for the next few months, or even add it up retroactively? It would make my work, and, believe me, that is a lot, much easier. I now often have to be a contortionist just to keep the wagons on the track.
It would make this site, and all the labor that goes into it, a lot more pleasurable, while the cost to you would be more or less negligible. 50 cents a day should be reasonable for most.
Stranded Wind: Main Street is gone and Pain Street has taken its place. This is the inescapable conclusion for anyone not living under a rock or in a gated community, and word will reach those isolated few soon. My travels over the last year have taken me everywhere from lower Manhattan to Mount Moriah, Missouri, population one hundred forty three. No one is spared the suffering.
I was in Manhattan for a little yacht ride with some investment bankers a few months back – prior to the unwinding really starting in September. The hedge fund operators aboard, young, formerly brash financiers were almost embarrassed to admit what they did for a living. I'm working a project with one of them now and we're keeping notes on each vendor we talk to as we're not sure if the ones we select are still going to be there when we're ready to break ground on that particular project.
Mount Moriah, a wide spot in the road between Princeton and Bethany, has been on a downward slide for two generations due to the brain drain and aging of rural America. The town hit its nadir last summer, with the closure of the local diner, the last business standing on the little town square.
I've been to Boston for conferences twice this last week, pulling out past a complete but unstocked gas station that will never actually be opened; it's been standing ready for the last five or six months but the plastic wrap on the pumps remain and the shelves are empty. The sixth ring of hell is Boston traffic, so I pull up short at Riverside and ride the MBTA subway into town. There used to be staffed information kiosks in the larger stations, but they're all closed up with signs indicating how to get to the two locations within the system where help is still available. There were no musicians in evidence when I spent a week there this summer, but every station now has a guitar player with a hat on the ground to collect tips.
Most worrying of all, my phone rang Monday and it was Bryan Lutter, South Dakota farmer, agronomist, and agricultural market watcher. "Neal, we're out of propane!" I figured he was experiencing personal financial stress and I offered some consolation. "No, we're out! Everybody's out … all three elevators in the area can't get fuel to dry the corn crop." Their crop is coming in wet this year, 22% moisture as opposed to the more normal 18%, and it must be dried to 13% or 14% for storage no propane at this time of year means crops left standing in the field overwinter with the hopes of harvesting in spring. Today I happened to talk to one of the staffers who works for Steve King, IA-05's Congressman, and he confirmed that this is a systemic problem – a friend in the region with a propane business is running trucks all over to get enough fuel for the elevators they service.
That last bit isn't peak oil, it's credit issues getting loose in farm production. People will starve over this stuff starting some time in 2009 – wheat farmers couldn't finance the high price of ammonia this year and crop protein percentages will be down from 14% to perhaps 8% to 10%. This isn't a big deal for developed nations … yet … but the fifty percent of Egyptians who live on $2/day and receive subsidized bread? We've not seen famine like what is pending outside sub-Saharan Africa since China's misnamed Great Leap Forward.
US Pledges Top $7.7 Trillion to Ease Frozen Credit
The U.S. government is prepared to provide more than $7.76 trillion on behalf of American taxpayers after guaranteeing $306 billion of Citigroup Inc. debt yesterday. The pledges, amounting to half the value of everything produced in the nation last year, are intended to rescue the financial system after the credit markets seized up 15 months ago. The unprecedented pledge of funds includes $3.18 trillion already tapped by financial institutions in the biggest response to an economic emergency since the New Deal of the 1930s, according to data compiled by Bloomberg.
The commitment dwarfs the plan approved by lawmakers, the Treasury Department’s $700 billion Troubled Asset Relief Program. Federal Reserve lending last week was 1,900 times the weekly average for the three years before the crisis. When Congress approved the TARP on Oct. 3, Fed Chairman Ben S. Bernanke and Treasury Secretary Henry Paulson acknowledged the need for transparency and oversight. Now, as regulators commit far more money while refusing to disclose loan recipients or reveal the collateral they are taking in return, some Congress members are calling for the Fed to be reined in.
“Whether it’s lending or spending, it’s tax dollars that are going out the window and we end up holding collateral we don’t know anything about,” said Congressman Scott Garrett, a New Jersey Republican who serves on the House Financial Services Committee. “The time has come that we consider what sort of limitations we should be placing on the Fed so that authority returns to elected officials as opposed to appointed ones.” Bloomberg News tabulated data from the Fed, Treasury and Federal Deposit Insurance Corp. and interviewed regulatory officials, economists and academic researchers to gauge the full extent of the government’s rescue effort.
The bailout includes a Fed program to buy as much as $2.4 trillion in short-term notes, called commercial paper, that companies use to pay bills, begun Oct. 27, and $1.4 trillion from the FDIC to guarantee bank-to-bank loans, started Oct. 14. William Poole, former president of the Federal Reserve Bank of St. Louis, said the two programs are unlikely to lose money. The bigger risk comes from rescuing companies perceived as “too big to fail,” he said. The government committed $29 billion to help engineer the takeover in March of Bear Stearns Cos. by New York-based JPMorgan Chase & Co. and $122.8 billion in addition to TARP allocations to bail out New York-based American International Group Inc., once the world’s largest insurer.
Citigroup received $306 billion of government guarantees for troubled mortgages and toxic assets. The Treasury Department also will inject $20 billion into the bank after its stock fell 60 percent last week. “No question there is some credit risk there,” Poole said. Congressman Darrell Issa, a California Republican on the Oversight and Government Reform Committee, said risk is lurking in the programs that Poole thinks are safe. “The thing that people don’t understand is it’s not how likely that the exposure becomes a reality, but what if it does?” Issa said. “There’s no transparency to it so who’s to say they’re right?” The worst financial crisis in two generations has erased $23 trillion, or 38 percent, of the value of the world’s companies and brought down three of the biggest Wall Street firms.
The Dow Jones Industrial Average through Friday is down 38 percent since the beginning of the year and 43 percent from its peak on Oct. 9, 2007. The S&P 500 fell 45 percent from the beginning of the year through Friday and 49 percent from its peak on Oct. 9, 2007. The Nikkei 225 Index has fallen 46 percent from the beginning of the year through Friday and 57 percent from its most recent peak of 18,261.98 on July 9, 2007. Goldman Sachs Group Inc. is down 78 percent, to $53.31, on Friday from its peak of $247.92 on Oct. 31, 2007, and 75 percent this year.
Regulators hope the rescue will contain the damage and keep banks providing the credit that is the lifeblood of the U.S. economy. Most of the spending programs are run out of the New York Fed, whose president, Timothy Geithner, is said to be President- elect Barack Obama’s choice to be Treasury Secretary. The money that’s been pledged is equivalent to $24,000 for every man, woman and child in the country. It’s nine times what the U.S. has spent so far on wars in Iraq and Afghanistan, according to Congressional Budget Office figures. It could pay off more than half the country’s mortgages.
“It’s unprecedented,” said Bob Eisenbeis, chief monetary economist at Vineland, New Jersey-based Cumberland Advisors Inc. and an economist for the Atlanta Fed for 10 years until January. “The backlash has begun already. Congress is taking a lot of hits from their constituents because they got snookered on the TARP big time. There’s a lot of supposedly smart people who look to be totally incompetent and it’s all going to fall on the taxpayer.” President Franklin D. Roosevelt’s New Deal of the 1930s, when almost 10,000 banks failed and there was no mechanism to bolster them with cash, is the only rival to the government’s current response. The savings and loan bailout of the 1990s cost $209.5 billion in inflation-adjusted numbers, of which $173 billion came from taxpayers, according to a July 1996 report by the U.S. General Accounting Office, now called the Government Accountability Office.
The 1979 U.S. government bailout of Chrysler consisted of bond guarantees, adjusted for inflation, of $4.2 billion, according to a Heritage Foundation report. The commitment of public money is appropriate to the peril, said Ethan Harris, co-head of U.S. economic research at Barclays Capital Inc. and a former economist at the New York Fed. U.S. financial firms have taken writedowns and losses of $666.1 billion since the beginning of 2007, according to Bloomberg data. “This is the worst capital markets crisis in modern history,” Harris said. “So you have the biggest intervention in modern history.” Bloomberg has requested details of Fed lending under the U.S. Freedom of Information Act and filed a federal lawsuit against the central bank Nov. 7 seeking to force disclosure of borrower banks and their collateral. Collateral is an asset pledged to a lender in the event a loan payment isn’t made.
“Some have asked us to reveal the names of the banks that are borrowing, how much they are borrowing, what collateral they are posting,” Bernanke said Nov. 18 to the House Financial Services Committee. “We think that’s counterproductive.” The Fed should account for the collateral it takes in exchange for loans to banks, said Paul Kasriel, chief economist at Chicago-based Northern Trust Corp. and a former research economist at the Federal Reserve Bank of Chicago. “There is a lack of transparency here and, given that the Fed is taking on a huge amount of credit risk now, it would seem to me as a taxpayer there should be more transparency,” Kasriel said. Bernanke’s Fed is responsible for $4.74 trillion of pledges, or 61 percent of the total commitment of $7.76 trillion, based on data compiled by Bloomberg concerning U.S. bailout steps started a year ago.
“Too often the public is focused on the wrong piece of that number, the $700 billion that Congress approved,” said J.D. Foster, a former staff member of the Council of Economic Advisers who is now a senior fellow at the Heritage Foundation in Washington. “The other areas are quite a bit larger.” The Fed’s rescue attempts began last December with the creation of the Term Auction Facility to allow lending to dealers for collateral. After Bear Stearns’s collapse in March, the central bank started making direct loans to securities firms at the same discount rate it charges commercial banks, which take customer deposits. In the three years before the crisis, such average weekly borrowing by banks was $48 million, according to the central bank. Last week it was $91.5 billion.
The failure of a second securities firm, Lehman Brothers Holdings Inc., in September, led to the creation of the Commercial Paper Funding Facility and the Money Market Investor Funding Facility, or MMIFF. The two programs, which have pledged $2.3 trillion, are designed to restore calm in the money markets, which deal in certificates of deposit, commercial paper and Treasury bills. “Money markets seized up after Lehman failed,” said Neal Soss, chief economist at Credit Suisse Group in New York and a former aide to Fed chief Paul Volcker. “Lehman failing made a lot of subsequent actions necessary.”
The FDIC, chaired by Sheila Bair, is contributing 20 percent of total rescue commitments. The FDIC’s $1.4 trillion in guarantees will amount to a bank subsidy of as much as $54 billion over three years, or $18 billion a year, because borrowers will pay a lower interest rate than they would on the open market, according to Raghu Sundurum and Viral Acharya of New York University and the London Business School. Congress and the Treasury have ponied up $892 billion in TARP and other funding, or 11.5 percent. The Federal Housing Administration, overseen by Department of Housing and Urban Development Secretary Steven Preston, was given the authority to guarantee $300 billion of mortgages, or about 4 percent of the total commitment, with its Hope for Homeowners program, designed to keep distressed borrowers from foreclosure.
Most of the federal guarantees reduce interest rates on loans to banks and securities firms, which would create a subsidy of at least $6.6 billion annually for the financial industry, according to data compiled by Bloomberg comparing rates charged by the Fed against market interest currently paid by banks. Not included in the calculation of pledged funds is an FDIC proposal to prevent foreclosures by guaranteeing modifications on $444 billion in mortgages at an expected cost of $24.4 billion to be paid from the TARP, according to FDIC spokesman David Barr. The Treasury Department hasn’t approved the program.
Bernanke and Paulson, former chief executive officer of Goldman Sachs, have also promised as much as $200 billion to shore up nationalized mortgage finance companies Fannie Mae and Freddie Mac, a pledge that hasn’t been allocated to any agency. The FDIC arranged for $139 billion in loan guarantees for General Electric Co.’s finance unit. The tally doesn’t include money to General Motors Corp., Ford Motor Co. and Chrysler LLC. Obama has said he favors financial assistance to keep them from collapse. Paulson told the House Financial Services Committee Nov. 18 that the $250 billion already allocated to banks through the TARP is an investment, not an expenditure. “I think it would be extraordinarily unusual if the government did not get that money back and more,” Paulson said.
In his Nov. 18 testimony, Bernanke told the House Financial Services Committee that the central bank wouldn’t lose money. “We take collateral, we haircut it, it is a short-term loan, it is very safe, we have never lost a penny in these various lending programs,” he said. A haircut refers to the practice of lending less money than the collateral’s current market value. Requiring the Fed to disclose loan recipients might set off panic, said David Tobin, principal of New York-based loan-sale consultants and investment bank Mission Capital Advisors LLC. “If you mark to market today, the banking system is bankrupt,” Tobin said. “So what do you do? You try to keep it going as best you can.” “Mark to market” means adjusting the value of an asset, such as a mortgage-backed security, to reflect current prices.
Some of the bailout assistance could come from tax breaks in the future. The Treasury Department changed the tax code on Sept. 30 to allow banks to expand the deductions on the losses banks they were buying, according to Robert Willens, a former Lehman Brothers tax and accounting analyst who teaches at Columbia University Business School in New York. Wells Fargo & Co., which is buying Charlotte, North Carolina-based Wachovia Corp., will be able to deduct $22 billion, Willens said. Adding in other banks, the code change will cost $29 billion, he said. "The rule is now popularly known among tax lawyers as the ‘Wells Fargo Notice,’” Willens said.
The regulation was changed to make it easier for healthy banks to buy troubled ones, said Treasury Department spokesman Andrew DeSouza. House Financial Services Committee Chairman Barney Frank said he was angry that banks used the money for acquisitions. “The only purpose for this money is to lend,” said Frank, a Massachusetts Democrat. “It’s not for dividends, it’s not for purchases of new banks, it’s not for bonuses. There better be a showing of increased lending roughly in the amount of the capital infusions” or Congress may not approve the second half of the TARP money.
Fed Commits $800 Billion More to Unfreeze Lending
The Federal Reserve took two new steps to unfreeze credit for homebuyers, consumers and small businesses, committing up to $800 billion. The central bank will purchase as much as $600 billion in debt issued or backed by government-chartered housing-finance companies. It will also set up a $200 billion program to support consumer and small-business loans, the Fed said in statements today in Washington.
With today’s announcement, the central bank is starting to use some of the unorthodox policy tools that Chairman Ben S. Bernanke outlined as a Fed governor six years ago. Policy makers are aiming to prevent a financial collapse and stamp out the threat of deflation. “They’re trying to put funds into the system, trying to unfreeze these markets,” said William Poole, the former St. Louis Fed president, in an interview with Bloomberg Television. “Clearly, the Fed and the Treasury are beginning to take a large amount of credit risk.”
The Fed will purchase up to $100 billion in direct debt of Fannie Mae, Freddie Mac and the Federal Home Loan Banks and up to $500 billion of mortgage-backed securities backed by Fannie, Freddie and Ginnie Mae, the statement said. “This action is being taken to reduce the cost and increase the availability of credit for the purchase of houses, which in turn should support housing markets and foster improved conditions in financial markets more generally,” the Fed said.
Fannie and Freddie bonds rallied. The yield premium on Fannie Mae’s five-year debt over similar-maturity Treasuries tumbled 21.5 basis points to 114.7 basis points as of 8:35 a.m. in New York, according to data compiled by Bloomberg. A basis point is 0.01 percentage point. “The cheaper that they could issue their debt, the more aggressively they should be able to buy mortgages in the secondary market,” said Alan Bosworth, director of agency trading at Vining Sparks in Memphis, Tennessee.
Separately, under the new Term Asset-Backed Securities Loan Facility, the Fed will lend up to $200 billion on a non-recourse basis to holders of AAA rated asset-backed securities backed by “newly and recently originated” loans, such as for education, automobiles, credit cards and loans guaranteed by the Small Business Administration, the Fed said. The ABS program is similar to the Fed’s effort to bring down the cost of financing for commercial paper, the short-term debt companies issue to finance payrolls and other expenses, because it goes beyond banks.
“What the Fed has been trying to do is get a sense of what works and what doesn’t work,” said Derrick Wulf, who helps manage $70 billion in mostly fixed-income assets at Dwight Asset Management Co. in Burlington, Vermont. “One of the things that has worked is the commercial paper facility.” Wulf added that “it can certainly improve credit conditions for consumers.” The Treasury will provide $20 billion of “credit protection” to the Fed in the lending program, using funds from the $700 billion financial-rescue package. The Treasury said in a statement that the facility may expand over time and cover other assets, such as commercial and private residential mortgage- backed debt.
On the ABS facility, the Fed is trying to avoid having “continued disruption of these markets” that would limit lending and “thereby contribute to further weakening of U.S. economic activity,” the central bank said. Under the new lending program, known as the TALF, the New York Fed will auction a fixed amount of loans each month for a one-year term. Assets will be held in a special-purpose vehicle to be created by the Fed. The program will stop making new loans on Dec. 31, 2009, unless the Fed Board of Governors extends it.
Lenders providing credit under the TALF “must have agreed to comply with, or already be subject to,” executive- compensation restrictions in the October bailout law, the statement said. The Fed will start buying the direct debt of government- sponsored enterprises -- Fannie, Freddie and a dozen federal home loan banks -- through primary dealers in government debt from next week. The purchases of mortgage-backed securities will be done through asset managers, and officials aim to begin the effort by year-end. Purchases of both types of debt “are expected to take place over several quarters,” the Fed said.
US total bail-out cost threatens to top $6 trillion
The potential cost for the government's efforts to contain the financial crisis is steep and climbing, and now tops $6 trillion. That figure includes large commitments of funds by the government to guarantee certain debts, and those funds may never actually be spent. But still, the overall figure reflects the huge liabilities the government is taking on in response to the meltdown. The government's latest effort to address the financial crisis is a $20 billion investment in banking giant Citigroup Inc., along with an agreement to guarantee hundreds of billions of dollars in possible losses. The step, announced late Sunday, is the latest in a long list of government moves:
• March 11: The Federal Reserve announces a rescue package to provide up to $200 billion in loans to banks and investment houses and let them put up risky mortgage-backed securities as collateral.
• March 16: The Fed provides a $29 billion loan to JPMorgan Chase & Co. as part of its purchase of investment bank Bear Stearns.
• May 2: The Fed increases the size of its loans to banks and lets them put up less-secure collateral.
• July 11: Federal regulators seize Pasadena, Calif.-based IndyMac, costing the Federal Deposit Insurance Corp. billions to compensate deposit-holders.
• July 30: President Bush signs a housing bill including $300 billion in new loan authority for the government to back cheaper mortgages for troubled homeowners.
• Sept. 7: The Treasury takes over mortgage giants Fannie Mae and Freddie Mac, putting them into a conservatorship and pledging up to $200 billion to back their assets.
• Sept. 16: The Fed injects $85 billion into the failing American International Group, one of the world's largest insurance companies.
• Sept. 16: The Fed pumps $70 billion more into the nation's financial system to help ease credit stresses.
• Sept. 19: The Treasury temporarily guarantees money market funds against losses up to $50 billion.
• Sept. 29: The Fed makes an extra $330 billion available to other central banks, boosting to $620 billion the amount available to the Fed through currency "swap" arrangements, where dollars are traded for foreign currencies. It also triples to $225 billion the amount available for short-term loans to U.S. financial institutions.
• Oct. 3: President Bush signs the $700 billion economic bailout package. Treasury Secretary Henry Paulson says the money will be used to buy distressed mortgage-related securities from banks.
• Oct. 6: The Fed increases a short-term loan program, saying it is boosting short-term lending to banks to $150 billion. It says that by year's end, $900 billion in potential overall credit will be outstanding. It also says it will begin paying interest on reserves that banks keep with the Fed in hopes of coaxing banks into keeping more money on deposit at the central bank.
• Oct. 7: The Fed says it will start buying unsecured short-term debt, so-called "commercial paper," from companies, and says that up to $1.3 trillion of the debt may qualify for the program.
• Oct. 8: The Fed cuts its benchmark interest rate a half percentage point, to 1.5 percent. It follows a one-quarter point cut on April 30 and a three-quarter-point reduction on March 18.
• Oct. 8: The Fed agrees to lend AIG $37.8 billion more, bringing total to about $123 billion.
• Oct. 14: The Treasury says it will use $250 billion of the $700 billion bailout to inject capital into the banks, with $125 billion provided to nine of the largest: Bank of America Corp., which received $15 billion; Bank of New York Mellon Corp., $3 billion; Citigroup Inc., $25 billion; Goldman Sachs Group Inc., $10 billion; JPMorgan Chase & Co., $25 billion; Merrill Lynch & Co. Inc., $10 billion; Morgan Stanley, $10 billion; State Street Corp., $2 billion; and Wells Fargo & Co., $25 billion. The $10 billion for Merrill has been deferred until its purchase by Bank of America closes.
• Oct. 14: The FDIC says it will temporarily guarantee up to a total of $1.4 trillion in loans between banks.
• Oct. 21: The Fed says it will provide up to $540 billion in financing to provide liquidity for money market mutual funds.
• Oct. 29: The Fed cuts its benchmark interest rate to 1 percent, matching the low point reached in 2003. The rate hasn't been lower since 1958.
• Nov. 10: The Treasury and Fed replace the two previous loans provided to AIG with a new $150 billion aid package that includes an infusion of $40 billion from the government's bailout fund.
• Nov. 12: Paulson says the government will no longer buy distressed mortgage-related assets, formerly the centerpiece of the bailout, and instead will concentrate on injecting capital into banks.
• Nov. 17: Treasury says it has provided $33.6 billion in capital to another 21 banks, with the largest stake being $6.6 billion to Minneapolis, Minn.-based U.S. Bancorp. So far, the government has invested $158.6 billion in 30 banks.
• Nov. 23: The Treasury says it will invest another $20 billion in Citigroup Inc., on top of $25 billion provided Oct. 14. The Treasury, Fed and FDIC also pledge to backstop large losses Citigroup might absorb on $306 billion in real estate-related assets. Citigroup will assume the first $29 billion in losses, and after that the government will absorb 90 percent of losses and the company 10 percent. In return, the government will receive $7 billion in preferred shares and warrants for more than 250 million additional shares.
Bill for The Financial Crisis Now 7.7 Trillion: How To Spend the Next Trillions So They Work
7.7 trillion won't be the final tally, either. Given how much the Fed, Treasury and other federal entities have pledged it's really hard to understand how little they've accomplished. 7.7 trillion is, well, real money but credit in the real economy is still constricting and jobs are melting away faster than an ice cube in a blow torch.
The money has largely been wasted because it was used mostly to lend companies money for lousy assets rather than being used to set a floor under housing prices by resetting such prices with new mortgages, then determing prices for various options through either using cash flow (a security paying $10/year for 10 year is worth $100 discounted by expect inflation) or by resetting those without cash flows by discounting face at the likely default rate, which can be determined simply enough by looking at the market for liquid securities and seeing what sort of default rate is assumed for securities with the same return. Since most Credit Default Swaps have very very high implicit returns, they'd probably have default rates in the 20%+ range. That's fine, discount them that way.
Inasmuch as this is a confidence crisis, and it isn't primarily, until everyone knows what the actual damage is and where the floor is, the lack of confidence won't go away. More to the point, until financial institutions know they aren't going to be able to buy up rivals for cents on the dollars, they're going to horde money.
Taking over a few banks and using them to lend directly to the public at whatever rates the Fed thinks are appropriate (a few percentage above prime) is, at this point, the only way to get lending going. It sure wouldn't cost more than 7.7 trillion, but even if it did, it would actually accomplish the goal of getting real credit into the real economy.
This game of giving bankers money to do what they want with (i.e., horde it) has not solved the economies real problems. It has, however, cost ridiculous amounts of money, much of which will never be seen again.
There's an old saying that if you want something done right, you have to do it yourself. It's past time for the government to do it themselves. Use the banks they've taken over to start making loans, issuing credit cards, offering reset rate and face mortgages. If the banks still in private hands don't join in, they'll lose all that business, probably more or less permanently, since the banks doing the lending will keep the customers.
Add in a home ownership loan corporation style plan which buys and resets mortgages to fixed rates at lower face amounts (30% of average income in the area, at most) to set a floor under the housing carnage, force securities to actually be priced at something reasonable, then insure those prices through the government, and you'll have unfrozen the credit markets, restored quite a bit of confidence and actually received something for all the money you've received, rather than just allowing executives at banks to keep their jobs despite their corruption, venality and incompetence.
Uk borrowing hits post-war record
Alistair Darling yesterday became the Chancellor with the worst economic forecasting record and the worst borrowing record in modern history. The Government used its pre-Budget report to slash its UK growth forecasts by the biggest amount since it started projecting annual output in the 1970s and acknowledged for the first time that Britain is facing a recession. The economy will shrink by 1pc next year, it said, rather than the 2.5pc growth projected in the Budget earlier this year.
In what was billed as the most important Treasury statements in decades, Mr Darling ordered a slew of tax cuts and spending increases worth some £25.6bn over the next year and a half in an effort to prevent the slowdown deepening. Millions of shoppers will benefit as value-added tax is reduced from 17.5pc to 15pc from next week. The Chancellor initiated a bonfire of previous policies, effectively permanently reversing the abolition of the 10p tax rate, while postponing planned increases on vehicle excise duty and the rate of corporation tax paid by small companies.
Michael Saunders, UK economist at Citigroup, said: "This massive stimulus should prevent a complete meltdown of the UK economy, but probably will not prevent a nasty recession." The measures, designed to focus specifically on next year, will be paid for with a £12.3bn series of tax increases and spending cuts from 2010 onwards. Most significant of all is a half percentage point increase in National Insurance rates for both employees and employers, a measure which equates in short to an extra penny on the basic rate of income tax. Those earning over £100,000 will also see their tax bill increase as their personal allowances are cut, and those earning more than £150,000 will have to pay a new 45pc rate of income tax.
Nevertheless, even these increases will be insufficient to fund the drastic series of tax cuts, and as a result the Government is borrowing record sums. After more than doubling to £78bn this year, the fiscal deficit will balloon to £118bn, or 8pc of gross domestic product, next year - the highest level in post-war history. As had been widely expected, the Chancellor abandoned the borrowing rules laid down by Gordon Brown in 1998. The UK's national debt, currently at just below the 40pc of GDP level laid down by the sustainable investment rule, will balloon to 57.1pc - the highest level since the 1970s.
Almost as striking as the scale of the deficits is the amount of time they will persist on the Government's balance sheet, economists said. The Treasury will generate deficits in excess of 3pc of national income - the generally-accepted "reasonable" level - until 2013. The deficits are caused by a massive drop in tax revenues as well as the extra tax cuts announced by the Chancellor. Neither did the Chancellor make explicit commitments to re-embrace the fiscal rules, save for pledging to return to a balanced budget by 2015-16.
Although the pound rose higher against the dollar in the wake of the statement, the cost of insuring against the UK defaulting on its sovereign debt increased sharply, with credit default swap spreads up from around 70 basis points to 86 by last night - double the size of America and Germany's. Economists questioned why the Chancellor had not been clearer about how he would achieve the return to balanced books. "The increase in National Insurance contributions and the higher rate of income tax don't seem to be enough" said Andrew Goodwin, an economic adviser to the Ernst & Young ITEM Club.
Marc Ostwald, strategist at Monument Securities, highlighted that even in 2015 it looked likely that the public finances would be in no better shape than they were last year. "The end effect is little obvious benefit to the economy, a borrowing binge, and the gilt market has a lot more bad news to price in," he said. Shadow chancellor George Osborne warned that the Chancellor was "bringing this country to the verge of bankruptcy". Simon Ward, economist at New Star, added that the Treasury's economic forecasts, which project a sudden improvement in UK economic growth in 2010 and 2011, could be overly optimistic, with major implications for the rest of the PBR calculations.
He said: "A key risk is that the economy has not regained sufficient momentum by 2010 to withstand programmed large tax rises. Government debt will embark on an explosive path if these increases are postponed." The portrait of the UK economy painted by the PBR document is of an economy facing a mild recession, as opposed to the deep and lasting one projected by a growing number of City economists. The cut in VAT rates will also contribute to lower shop prices, with the retail price index set to drop into negative territory next year, causing deflation of 2.25pc. Martin Weale at the National Institute of Economic and Social Research, said that the Chancellor's outlook for the economy still looked unrealistic.
"The PBR estimate of trend growth looks very optimistic, and the recovery into 2010 they forecast is hopeful. In the medium term, too the borrowing forecasts still look optimistic," he said. Howard Archer, chief economist at Global Insight, said: "Seeing a projected Public Sector Borrowing Requirement of £118bn (8pc of GDP) in 2009-10 is somewhat alarming, particularly when there are suspicions that this is based on too optimistic a recovery profile."
Britain Offers $30 Billion Stimulus Plan
Trying to spend its way out of its first recession in 17 years, the British government announced on Monday a plan to cut taxes and increase public spending despite a budget deficit that was among the largest of any developed nation. As part of the £20 billion, or $30 billion, package presented to Parliament by the chancellor of the Exchequer, Alistair Darling, the government plans to reduce sales tax to 15 percent, from 17.5 percent, for 13 months through 2009; help homeowners struggling with their mortgage payments and further support pensioners and small businesses.
As a result, Britain's budget deficit will rise to £118 billion, or 8 percent of gross domestic product, in 2010, Mr. Darling said. Such a deficit would not only be the widest of any of the seven industrialized nations but would be far above Mr. Darling's earlier predictions of 2.6 percent of gross domestic product. "The budget will protect businesses and people now while putting public finances on the road for the future," Mr. Darling said. "If we do nothing, we'd have a longer and deeper recession."
To pay for the plan, the government plans to increase taxes on the upper middle class — those who earn more than £150,000 a year — to 45 percent from 40 percent, which was the highest tax bracket for the last 20 years, from April 2011. In addition, national insurance contributions will be increased for everyone. The plans caused uproar among opposition party leaders and the Parliament's speaker had to call for order three times after shouting interrupted Mr. Darling's speech.
Some economists said the stimulus package was necessary to support the economy, which the International Monetary Fund said would be hit harder than any of its European neighbors because of its reliance on the housing market and the financial services industry, both of which are suffering the most. "It won't stop us going into bad times but it's better than doing nothing," said Alan Clarke, an economist at BNP Paribas in London. "We should have been in a better position going into a recession in the first place."
Since gaining some acclaim for his bank rescue plan, Prime Minister Gordon Brown has been among the biggest advocates of temporarily increasing spending in an effort to keep the recession from turning into a depression. Previous downturns showed that "a failure to take action at the start of the downturn has increased both the length and depth of the recession," Mr. Brown told business leaders on Monday. Other countries, including Australia and China have recently announced stimulus plans. In Britain, further interest rate cuts by the Bank of England in the coming months, which most economists expect, could also help.
Some investors have grown increasingly concerned about the ability of the British economy to digest a ballooning budget deficit with no prospect of when the government will be able to fix the imbalances. The larger the deficit, the longer it could take Britain to recover. As a result, the pound has already dropped 25 percent against the dollar and 14 percent against the euro this year.
The government expects the economy to shrink from 0.75 percent to 1.25 percent in 2009 before starting to recover after the summer of 2010, a forecast some economists called optimistic. Mr. Darling said he expected to balance the budget by 2016. The plans to increase taxes in the long term while cutting taxes and raising spending in the short term were heavily criticized by the opposition party. George Osborne, the Conservative party's candidate for chancellor of the Exchequer, called Mr. Darling's plans "reckless" and a "failure of public policy."
"Like a gambler who can't give up, he thinks he can borrow himself out of trouble," Mr. Osborne told Parliament. "He did not fix the roof when the sun was shining." While Mr. Darling said that the current economic and financial turmoil started in America and that Britain was dealing with the same problems other developed economies are, Mr. Osborne said blaming America for Britain's difficulties is "total nonsense."
Citi's 'slow, grudging nationalization'
In just a few days Citigroup went from trouble to trauma as its stock price plunged amid sweeping layoffs and deep losses on some of its more esoteric assets. When news reports swirled that the megabank was considering a sale of part or all of the company, it was clear that Citi was singing from the same hymnbook as firms like Lehman Brothers, Wachovia and AIG had before they fell. The public's only question: What would the end game look like? Now we have our answer - a government agreement to shoulder hundreds of billions of dollars in possible losses and inject billions of dollars into the bank.
FORTUNE checked in with bank analyst Christopher Whalen, co-founder of Institutional Risk Analytics and a prescient critic of Citigroup since 2003, when he said its riskier, higher-return strategy made it more vulnerable than its banking peers.
Does this plan solve Citi's problems?
This does nothing more than temper the problem, but, no, it hasn't solved anything. We have three main issues to deal with at Citi. The first two are the operational issues and obvious losses that are well known and that the bank and Wall Street have been grappling with for years. The third is the potential for huge losses on off-balance sheet assets that we can't see. We will see that no one will trust the situation at Citi because of these huge question marks that still remain.
How does this rescue plan differ from the other bailouts we've seen in the past few months?
The accurate term for what the government has done is "open bank assistance." It's similar to what the FDIC had to do when it was clear that Wachovia could no longer go on, except there is not a ready buyer in this case. The other big financial institutions have had parties willing to pick up the assets, but you won't see that with Citi. This bailout is more like a resolution. That means that the government essentially has to take control of Citicorp and become more and more involved with its operations until the bank ultimately is nationalized.
But the markets rallied and people seemed to think that Citi now has time to right its ship. How can you talk about nationalization?
Listen, no government organization wants to run Citi, nor do they have the ability to do so, so they keep the bank open and put money in. Treasury and both political parties will pretend that we can buy the assets and the taxpayer will emerge whole; and that may happen. But it will take years, and in the meantime the government will continue to inject money into Citi, play a larger role in its management and oversee the liquidation of its assets. Make no mistake. This is nothing more than a slow, grudging nationalization.
Who will lose money on this deal?
What the markets told us last week is that the common shareholder will someday be wiped out. The stock is up now but that's nothing more than relief. Wall Street will eventually respond to the essential problems that remain at Citi. Then the government will have to replace the common equity and drop the pretense that the taxpayer is nothing more than a passive investor helping out a bank and admit that we'll be the owners. Who knows whether the government will lose money.
Is Citi solvent?
If you combine opaque structured-finance products with current fair-value accounting rules, almost none of the big banks are solvent because that system equates solvency with asset liquidity. So at this moment Citi isn't solvent. Some argue that liquidity, not solvency, is the problem. But in the end it doesn't matter. Fear will drive illiquidity to such a point that Citi could be rendered insolvent under the current fair-value accounting system.
What big risks remain?
They have lots of capital markets exposure to deal with. The old off-balance-sheet game is over. They've already brought some of that stuff back onto their balance sheets, and eventually it will all have to come back on. Who knows how big those losses will be?
What steps should Citi take now that the government intervention has bought it some time?
One interesting play would be to get rid of its consumer business in its 30 markets outside the U.S., which is exceedingly expensive and higher risk to run. But more immediately and most important, Citi needs to put a real banker in charge, not someone like Vikram Pandit, who comes from the fund side. J.P. Morgan has problems too, but people have faith in Jamie Dimon because he knows how to run a bank. The same goes for [Bank of America CEO] Ken Lewis. Fund managers believe losses can become gains and wait them out. Bankers see losses as losses and avoid them.
Are you surprised that Pandit wasn't forced to step down as part of the government aid plan?
I'm astounded that he managed to stay on. He has to go if Citi is going to be able to make hard and necessary choices.
Any ideas whom to bring in?
Tell Citi to call Herb Allison [the former Merrill Lynch banker and TIAA-CREF CEO who was appointed to lead Fannie Mae after the government takeover]. Maybe he's tired of Washington, D.C., and wouldn't mind stepping in to help
What The Citi Deal Doesn't Do
Yes the government can buck up investors, but it can't fix everything at Vikram Pandit's megabank. Citigroup's stunningly complex rescue deal with the federal government buys it enough time to restore confidence, but leaves many issues unresolved. The company still faces surging credit costs, potential losses from loans on its books and a massive restructuring project aimed at eliminating 53,000 employees by the spring. Its management remains intact even after the government rescue, but it is still unclear what the Citigroup of the future will look like.
Chief Executive Vikram Pandit wants to shed $500 billion of unwanted assets (he's 35% of the way there), exit unprofitable businesses and redirect Citi, all at a time when profits from its mainstay corporate and investment bank are hurting from the softening economy. "We are committed to streamlining our business and providing outstanding banking services to our clients around the world," Pandit said in a statement Monday. "We will continue to focus on opportunities and alternatives to further enhance the company's overall position and value."
The government will buy $20 billion in preferred shares in Citi, nearly doubling its equity investment in the company since October. It is also guaranteeing losses on $306 billion of assets in exchange for a $7 billion fee. Citi has to cut its dividend to 1 cent and will absorb the first $29 billion of losses on the troubled mortgage and other assets, with the government stepping in after that. The guarantee is believed to cover most of an estimated $314 billion of residential and commercial mortgage loans and securities and some of $9.4 billion in related hedges, according to analysts at CreditSights. Those assets have weighed on Citigroup all year as the credit markets seized up.
But that leaves unguaranteed another $362 billion of credit card and consumer loans and $428 billion in corporate loans, asset-backed securities, derivatives and other assets. "We believe these assets are not guaranteed by the U.S. government for the most part and are not immune to weakness in the overall economy," CreditSights says. The government rescue, announced late Sunday night, has at least stopped the freefall in Citi's shares, which after losing 60% last week gained more than 50% Monday and lifted shares of other banks and the markets overall.
In reality, very little about Citi has changed since the government first bought $25 billion in preferred shares in October as part of its $250 billion plan to inject capital in banks. Those troubled assets were certainly on Citi's books back then, but being selected as part of the capital purchase plan meant the Treasury believed Citi to be healthy and necessary to market functioning. Any number of factors could have sparked the crisis of confidence in Citi over the last few weeks, and none other than Saudi Arabia's Prince Alwaleed Bin Talal has some theories. In a television interview Monday, he blamed the Federal Deposit Insurance Corp. for not insisting that a deal it negotiated with Citi to buy Wachovia go through. Instead, the FDIC backed off its support for that deal and let Wachovia be acquired by Wells Fargo.
Without Wachovia, Citi, with its more limited U.S. deposit base relative to its peer banks, appeared vulnerable. Then the Treasury Department backed off on a plan to use the $700 billion Troubled Asset Relief Plan to buy troubled mortgage assets from banks, opting instead for the capital injection plan. Those two fateful decisions dealt a nearly lethal one-two punch on Citi, according to Alwaleed, one of Citi's most important investors since the early 1990s who last week raised his stake to 5% from just under 4%.
Alwaleed also blamed Citi's previous (mis)management. During the television interview on CNBC Monday, he related a story about former Citigroup chairman Sanford I. Weill apologizing to him for naming Charles Prince chief executive in the fall of 2003. "Frankly speaking, the destruction of wealth was his fault," Alwaleed said of Prince's tenure as chief executive. Prince was forced out a year ago. Citi frantically tried to stop the damage from last week's sell off, arranging several conference calls and meetings with employees and investors and buying full-page advertisements in major newspapers to communicate a message of strength.
It is not known whether depositors--Citi has hundreds of billions of uninsured deposits on its books, mostly overseas--took their money elsewhere last week, though analysts said Monday they believe the bailout would put anxiety to rest. "We believe this deal will reduce the probability of a depositor or counterparty revolt," said David Trone from Fox-Pitt Kelton. Restoring confidence has been a vexing problem for Treasury Secretary Henry Paulson and other government officials throughout the 17-month-old credit crisis. At first, reluctant to intervene and rescue a faltering financial company, Paulson has been forced back on his word more than a few times in recent months.
After letting Lehman Brothers collapse into bankruptcy in September, Paulson stepped in to rescue American International Group, ultimately with more than $150 billion of guarantees, loans and other programs. It also took over Fannie Mae and Freddie Mac, at a cost of $200 billion. Before the Citigroup rescue, the cost so far from the financial crisis has been $5 trillion, according to CreditSights, including $1 trillion of short-term loans from the Federal Reserve, a $1.5 trillion bank debt guarantee program and actions to stabilize individual companies. That doesn't factor in the costs of other programs, including a mortgage modification plan outlined earlier this month.
At a press conference Monday, President Bush suggested more government assistance could be coming. "The first step is to secure our financial system," Bush said after meeting with Paulson. "If need be, we're going to make these kind of decisions to safeguard our financial system in the future."
After Citi, is Bank of America next?
A government rescue plan has eased investors' concerns about Citigroup Inc, but mines lurking in the balance sheets of rivals including Bank of America Corp could still tempt short-sellers. Bank of America, the No. 3 U.S. bank by assets, has loaded up on mortgages as the world's largest economy wrestles with the worst housing market since the Great Depression. The Charlotte, North Carolina-based bank further heightened its exposure to home loans by acquiring Countrywide Financial Corp, the largest U.S. independent mortgage lender and agreeing to buy Merrill Lynch & Co, which owns the world's largest retail brokerage.
If losses on mortgages and other debt securities mount significantly, the bank may see the ratio of equity to risk-weighted assets, known as Tier-1 capital, dwindle to alarmingly low levels. "I would expect there are more banks who are in dire straits and more who can expect to be helped," said Michael Farr, president of investment management company Farr, Miller & Washington in Washington, D.C. "The share price makes it look like Bank of America might be next in line," he said. Before Monday's stock market rally, Bank of America shares had lost 52 percent in November alone, making them the second biggest decliner for the month in the KBW Banks index after Citigroup.
Analysts at independent research company CreditSights forecast that in a scenario where the commercial and residential real estate markets really tank beyond banks' expectations, Bank of America would have a Tier-1 capital ratio of 7.15 percent. The minimum that regulators seek to consider a bank "well capitalized" is 6 percent, but any ratio near or below 7 percent tends to spook investors. CreditSights also expressed concern about Wells Fargo & Co, which it said would have a Tier-1 capital ratio of 6.98 percent under its worst case scenario. Wells Fargo recently agreed to buy Wachovia Corp.
Under the same assumptions, and before the government's latest investment, Citigroup would have a Tier-1 capital ratio of 8.64 percent. To be sure, by some measures Citigroup looks worse than Bank of America and Wells Fargo, most notably the ratio of tangible assets to tangible equity, a metric on which some investors have focused. Citigroup's tangible assets are about 42 times shareholder equity minus intangible assets, compared with 11 times for Bank of America. The U.S. banking system is broadly undercapitalized, perhaps to the tune of more than $1 trillion, and the only investor that can bail it out is the U.S. government, analysts said.
"The banks already have an enormous hole to plug, and the recession will make that hole larger," noted Daniel Alpert, investment banker at Westwood Capital in New York, estimating banks may need to write down $1 trillion more in bad debt, in addition to the roughly $750 billion announced so far. Bank of America, through its acquisition of Countrywide, has more than $250 billion in residential mortgages and while it has stopped offering some of the most toxic types of mortgages, chargeoffs in the portfolio are increasing. Wells Fargo inherited a portfolio of more than $260 billion in consumer loans when it acquired Wachovia, and JPMorgan Chase & Co acquired exposure to some of the most risky classes of mortgages, in addition to its own large consumer loan portfolio, when it bought Washington Mutual Inc.
Still, there are big differences. Critically for Citigroup, investors lost confidence in the company and its management after it failed to buy Wachovia Corp, thereby losing an important potential source of deposit-based funding, analysts said. "The difference between Citi and the other three is that Citi clearly had more suspect management," said Mal Polley, chief investment officer at Stewart Capital Advisors in Pittsburgh. "They had not done enough to take the fat out of the system and right the ship," he added.
But management at Bank of America and Wells Fargo, and even JPMorgan, widely regarded as the bank that has best survived the credit crisis to date, will need to allay investors' concerns about their capital position as financial conditions worsen. And if their losses are big enough, or investors fear they will be big enough, Bank of America and Wells Fargo could turn to the same place Citigroup did: the U.S. government. "I definitely think other companies will need this help," said Paul Miller, analyst at Friedman, Billings, Ramsey & Co in New York.
Why the banks need stronger medicine
The feds have poured $45 billion into Citi, but so far even costly half-measures haven't worked during this crisis. The latest round of government help for Citi buys the troubled bank some time. But the financial sector will need much stronger medicine before a recovery can get under way. The feds agreed Sunday night to guarantee $306 billion worth of troubled assets for the troubled New York bank. The Treasury also poured $20 billion into Citi via a purchase of preferred stock, adding to the $25 billion stake the government took in October via the Troubled Asset Recovery Program.
The capital infusion and asset guarantees reduce the threat of a sudden collapse at Citi (C, Fortune 500), the biggest U.S. bank by assets with more than $2 trillion on its balance sheet. The moves also help the rest of the banks by showing that the government won't permit another disorderly failure along the lines of September's collapse of broker-dealer Lehman Brothers, which set off a flight from risky assets that continues to this day. Still, the fact that Citi needed a new lifebuoy from the government less than a month after getting an infusion via the TARP capital purchase program shows how the entire financial system is laboring under an unmanageable debt load.
The problem, analysts say, calls out for much larger infusions of taxpayer funds, in the name of stabilizing the financial system - as well as restructurings that give officials time to completely fix problems at troubled institutions. "'Over-levered' is the purest description of the U.S. financial system today," Friedman Billings Ramsey analyst Paul Miller wrote in a report last week. "At eight of the largest financial institutions, tangible equity equals 3.4% of assets, which implies 29x leverage. If this wasn't bad enough, <we expect that current tangible common equity will be essentially wiped out by losses from existing loan and security books."
Indeed, with house prices falling after a decade-long run-up and unemployment last month hitting a 14-year high, U.S. banks face increasing loan losses on mortgages, commercial real estate and credit cards. FBR's Miller writes that the eight biggest U.S. firms - Citi, Bank of America, JPMorgan Chase, Goldman Sachs, Morgan Stanley, Wells Fargo, AIG and General Electric's financial services arm - need at least $1 trillion in new capital to weather the coming recession without the prospect of an institutional failure. He says the most likely scenario is that these eight giants will face losses of around $400 billion over the life of their existing loan portfolios - but cautions that those losses could reach almost $600 billion. "If our models are too conservative with respect to losses," he writes, "more capital will be needed going forward."
Investors have become accustomed to banks' voracious need for capital at a time of global deleveraging. Firms around the globe have raised hundreds of billions of dollars in new capital over the past year. But the deepening problems at one of the biggest capital-raisers - Citi, which has brought in $50 billion from private investors in addition to the funds it has gotten from the government - suggest that merely raising more money isn't going to be enough to see many firms through the worst of the downturn.
"We estimate C's risky assets to be roughly $120 billion," Oppenheimer analyst Meredith Whitney writes Monday, "but the company has almost $600 billion in consumer and card loans. We are unclear exactly which assets were targeted in the $306 billion." Even with more capital in hand, the banks' problems aren't just going to go away. Indeed, the KBW Bank stock index was down 37% this month heading into Monday, in a vicious selloff that started after Treasury Secretary Henry Paulson distributed the first round of TARP checks to the biggest banking companies.
One reason is that the piecemeal approach to government support - $25 billion here, $20 billion there - isn't going to persuade investors to pour new money into an institution such as Citi with a balance sheet measuring in the trillions, says Mark Sunshine, president of middle market lender First Capital. He says that for truly troubled institutions such as Citi, with risky assets running into the tens of billions of dollars in a souring economy, the only answer is full government nationalization.
Once the government takes a bank over and wipes out its shareholders, he says, officials can wrap bad assets into a so-called bad bank to be run off over a period of years, then repackage the good bank and sell it off to private investors. He rejects halfway measures such as loan guarantee programs and partial nationalizations such as the feds tried with AIG, Fannie Mae and Freddie Mac. Until there's clarity as to which banks are truly solvent and which are subject to a government takeover, Sunshine says, Treasury Secretary Henry Paulson's hope of attracting private capital back into the finance sector will remain a pipe dream.
"The fastest way to attract capital is to seize the troubled banks," says Sunshine. "You've got to serially take over every one of them." That said, Sunshine doesn't believe many of the biggest institutions would need to be nationalized. He says big banks other than Citi appear to be much less apt to be overwhelmed by souring loans, and believes the cost of dealing with the troubled banks could run much lower than the $1 trillion price tag projected by FBR's Miller. The problems in the banking sector are made that much more pressing, Sunshine adds, by the fear of deflation now looming over the market in the wake of last week's rare decline in the consumer price index.
Sunshine says that unless the government stops the deflationary worries through aggressive monetary policy and heavy fiscal stimulus, the banking problems will only get worse. Government officials fear deflation because it increases the value of cash, which encourages hoarding that reduces economic activity, increasing the debt burden felt by firms and individuals. "Having deflation is like pouring hydrochloric acid over your loan portfolio," he says.
Goldman, Morgan Stanley Lead FDIC-Backed Debt Sales
Goldman Sachs Group Inc. plans to sell $5 billion of notes backed by the government, while Morgan Stanley and JPMorgan Chase & Co. are preparing offerings, as banks take advantage of a new U.S. program to guarantee debt. The three New York-based banks are the first to start offerings since the Federal Deposit Insurance Corp. last week completed rules to strengthen its guarantee. The backing lets banks sell AAA rated debt, allowing them to attract investors after being unable to sell bonds since September.
The guarantee opens a new avenue for bank funding amid a credit seizure that has sent investment-grade financial debt yields up more than five percentage points this year to a near- record high of 7.28 percentage points above Treasuries, according to Merrill Lynch & Co. index data. Banks may raise $400 billion to $600 billion under the FDIC program within six months, Barclays Capital analysts estimated in October.
“This is extremely helpful to them,” said Matthew Eagan, a vice president and portfolio manager at Loomis Sayles & Co. in Boston which manages more than $100 billion in assets. “They have a bunch of debt that’s coming due over the next three years, and normally they’d be in the market opportunistically issuing debt.”
The FDIC said Oct. 14 it would guarantee three-year senior unsecured bank debt issued through June 30, helping the banks refinance maturing debt. Bank and finance companies have $240 billion coming due from December through June 2009, according to Eric Rosenthal at Fitch Ratings in New York. That compares with maturities of about $213.9 billion in the same period a year earlier.
“Short-term dislocations for the banks will be helped by this,” said Timothy Policinski, managing director at Fort Washington Investment Advisors Inc. in Cincinnati, which manages about $23 billion in fixed-income assets. “It’s important for the banks.” The risk of U.S. companies defaulting on their debt fell for a third day, with contracts on the Markit CDX North America Investment Grade Index of 125 companies in the U.S. and Canada decreasing 11.5 basis points to 245 basis points as of 9:23 a.m. in New York, according to broker Phoenix Partners Group. A basis point on a credit-default swap contract protecting $10 million of debt from default for five years is equivalent to $1,000 a year.
Credit-default swaps are financial instruments based on bonds and loans that are used to speculate on a company’s ability to repay debt. They pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements. An increase indicates deterioration in the perception of credit quality; a decline, the opposite. Goldman’s notes, due in June 2012, may price to yield 85 basis points more than the midswaps rate, a benchmark for corporate borrowing in Europe. Proceeds will be used for general corporate purposes. A basis point is 0.01 percentage point.
The three-year swap rate is currently about 2.39 percent, so the debt is expected to yield about 3.24 percent. By comparison, Goldman’s $2.23 billion of 5.7 percent notes due in September 2012 traded yesterday at 90 cents on the dollar to yield about 8.8 percent, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
Goldman “wants to take advantage of this cheap funding,” Eagan said. “They can use this program to issue low cost debt. They can use it until they don’t need it anymore, which could be for a while.” Goldman last sold dollar-denominated debt on April 22, raising $1.5 billion in a reopening of 6.15 percent notes due in 2018, according to data compiled by Bloomberg. The senior notes priced to yield 237.5 basis points more than Treasuries of similar maturity, according to the data.
Morgan Stanley and JPMorgan both plan benchmark sales, which typically means at least $500 million. Morgan Stanley’s notes will mature in either two or three years, or possibly both. JPMorgan plans to sell three-year notes. Its debt will be denominated in dollars, pounds and euros. GE Capital Corp., the lending arm of Fairfield, Connecticut- based General Electric Co., filed an amendment today to an original filing that will allow it to sell FDIC-backed bonds.
“I think that we’ll start to see other banks take advantage of this as well,” Eagan said.
Why Citigroup got Detroit's money
Poor Detroit. The heads of the Big Three automakers had to subject themselves to two days of Congressional grilling last week while they begged for a $25 billion loan. And what did General Motors, Ford and Chrysler get? Nothing. Nada. Zilch. They were told to go home and write up a viable business plan and to show that they wouldn't be coming back for more money a year down the road. (Adding insult to injury, Motown's hapless football team, the Detroit Lions, is still searching for its first victory. Ouch.)
Meanwhile, Citigroup, which just a month ago received $25 billion, had no trouble securing another $20 billion Sunday night. CEO Vikram Pandit didn't even have to fly his jet to Capitol Hill with hat in hand. (And oh yeah: the two New York football teams are a combined 18-4, with the Jets on Sunday upsetting the previously undefeated Titans. The Giants are also the defending Super Bowl champs. Go Big Blue!) Why the apparent unfairness?
Daniel Alpert, managing director of Westwood Capital, an investment bank in New York, said that saving a bank like Citigroup has to take precedence over the auto industry. Even though a collapse of one or more of the Big Three could have major negative implications on the economy, particularly the unemployment rate, he said preventing a Citigroup bankruptcy could forestall an even worse shock to the already fragile financial system. "This is dramatically different. Essentially, what the government needed to do is under no circumstances allow Citigroup to fail. You can't have a financial world without the major banks," he said.
David Resler, chief economist with Nomura Securities International, added that he thinks bankruptcy could be an option for the Big Three whereas a bankruptcy for a bank would mean liquidation, similar to what happened with Lehman Brothers in September. And that is not something he thinks the government would allow to happen. "Citi stands at the center of the financial system. It's a huge company whose relations are intricately woven throughout the entire economy. The intent is shoring up the system in this near-term crisis, not necessarily one company," Resler said.
Sure, there are some who argue that bankruptcy for an automaker would also be its death knell. But even if one or more of the Big Three go away, some suggest that the government may allow this simply because the Big Three deserves to fail because of decades of mistakes. "There is nothing that Detroit has done in the past 20 years to gain any support from Washington or the public," said Bob Andres, chief investment strategist for Portfolio Management Consultants, the investment consulting unit of Chicago-based asset management firm Envestnet, which has $90 billion in assets.
"There has to be an end. The government can't own everything in the country. They may have to draw a line and unfortunately Detroit may be it," he added. Still, it's not as if Citigroup also didn't make serious mistakes. And some argue that the guarantee of future loan losses may have been sufficient to prove to the market that Citigroup wouldn't fail and there was not really a need to give the bank even more cash. "I'm a bit dumbfounded as to what the urgency was," said Keith Hembre, chief economist with First American Funds in Minneapolis.
Still, strange as it may seem, it's politically easier to deny Detroit than Wall Street. The Big Three is being singled out as the poster child for mismanagement and is being forced to jump through hoops to get money while the banks don't have to do much other than moan about short sellers targeting their stock to get more funding. At the end of the day, Alpert said that there are so many companies lining up for assistance, the government is going to have to prioritize and at least give the appearance that it isn't giving out cash willy-nilly.
"Washington is Oz right now. Everybody is marching in asking for a heart, a brain or a lot of cash," he said. "What Congress told the Big Three is to go back and bring them the broom of the Wicked Witch of the West."
Saving Citi May Create More Fear
One bailout was not enough for Citigroup. And it may not be enough for other big banks. While Citigroup's second multibillion-dollar rescue from Washington hit Wall Street like a shot of adrenaline on Monday, many analysts worried that the jolt would soon wear off. Citigroup has been stabilized, but the outlook for the financial industry as a whole is bleak.
With the red ink deepening, other banks may eventually turn to the government to soak up some of their losses. Taxpayers could end up guaranteeing hundreds of billions of dollars of banks' toxic assets. Indeed, Treasury Secretary Henry M. Paulson Jr. is expected to announce a new plan on Tuesday to bolster the consumer-finance market.
"When all else fails, government does come in," said David A. Moss, a public policy professor at Harvard Business School. On Monday, Wall Street put aside its worries, at least for a day. Citigroup's share price, which had plunged to a mere $3.77 on Friday, shot up to $5.95. Shares of its biggest rivals — banks which, with the government's help, are emerging to dominate the industry — also soared. Bank of America jumped 27 percent, JPMorgan Chase leapt 21 percent and Wells Fargo gained nearly 20 percent.
In the short term, the latest effort to steady Citigroup has removed the risk that a sudden failure of the giant bank would send losses cascading through the financial industry. But longer term, the new bailout could haunt regulators and taxpayers. The move ultimately may encourage banks to take more risks in the belief that the government will step in if they run into trouble.
With a recession looming, if not here already, banks big and small are bracing for more loans to sour, particularly those related to commercial real estate, autos and credit cards. Many are making fewer loans, even though the industry has received nearly $300 billion from the government. Before long, anxious investors may start wondering which banks will be vulnerable next. If confidence fades, other big lenders will probably seek deals like Citigroup's, in which the government has pledged to pick up potentially $290 billion in additional losses. Regulators drafted the plan with an eye to using it as a template for future bailouts.
There are other worries for Citigroup's big rivals. Almost overnight, Citigroup went from being the sick man of the industry to an institution with an edge over its competitors. The government is guaranteeing $250 billion of risky assets and pumping an additional $20 billion into the bank. With the government behind it, Citigroup may now be able to borrow money in the capital markets at lower interest rates than its peers.
"Citi has a decided advantage over them because of the loss-sharing agreement," said John Kanas, the former chief executive of North Fork Bank of Long Island. While banks may hold out for now, it may be only a matter of time before they too line up, several analysts said. Indeed, a big question is how Bank of America, JPMorgan Chase and Wells Fargo will respond. Spokesmen for Bank of America and JPMorgan Chase declined to comment on Monday. A Wells Fargo spokesman did not return telephone calls.
Each of these giant banks, like Citigroup, is sitting on piles of residential mortgages, credit card debt, and corporate and commercial real estate loans that are rapidly losing value. Each is trying to absorb new businesses that were recently acquired. "Everyone is in the same soup," said Meredith A. Whitney, a banking analyst with Oppenheimer who has been bearish on the industry for more than a year. "Citigroup has a host of problems, but Citi's problem assets are not dissimilar from its rivals."
Smaller banks could be even more disadvantaged. Depositors now have stronger incentives to put their money in bigger banks, given the government's demonstrated willingness to intervene. "It's got to be frustrating for small banks. They don't get special treatment," said David Ellison, a mutual fund manager who specializes in financial companies. "If you are a big bank, you get special treatment. That is why everyone wants to be so big."
To level the playing field, some analysts say, the government may be forced to guarantee hundreds of billions of dollars of assets on all banks' balance sheets. That would be the third iteration of the government's financial rescue. "It looks like TARP 3.0," Ms. Whitney said, referring to the Treasury Department's $350 billion bailout fund known as the Troubled Asset Relief Program. "TARP 1.0 was buying illiquid assets from banks. Now, they are backstopping assets and really putting taxpayers on the line for much of this."
While taxpayers are at risk for the payment, the latest government rescue plan may work out well for Citigroup, analysts said. The plan has given investors some certainty about the potential losses at the bank. Most of the terms are relatively good for Citigroup and its existing shareholders. While the bank had to reduce its dividend to a penny, it is getting money from the government relatively cheaply. The preferred shares that the government is buying, for example, carry a relatively small 8 percent dividend payment and only slightly erode the value of shares held by existing investors. Even though the American government can secure a nearly 8 percent stake, overtaking an Abu Dhabi investment fund and a Saudi prince as Citigroup's largest shareholder, it will not have any seats on the board.
Other strings that the government attached are not onerous. New limits on executive pay still leave Citigroup with room to maneuver, even though regulators must approve compensation. A required program to modify home mortgages is similar to an effort that Citigroup voluntarily announced earlier this month.
But Citigroup faces bigger problems down the road, especially if it needs additional capital. The company was forced to turn to the government again because it could not raise capital from private investors. "If you look at the track record for raising equity, it has been a difficult exercise" for financial institutions, said Gary L. Crittenden, Citigroup's chief financial officer, in an interview on Monday.
And Citigroup still has many problems. Vikram S. Pandit, the chief executive, is making some progress in controlling costs and managing its sprawling operations, but the environment is tough. Executives say they have no plans to change their strategy. Mr. Crittenden said that the bank intended to keep itself intact and stay on the course it had been pursuing since at last spring and even longer under prior management, but that as a matter of practice the bank did not rule out any options.
But if the bank's losses keep mounting, and Citigroup needs yet another lifeline, the government may not be so generous. It might, for example, demand common shares — a move that could wipe out existing stockholders.
What's ahead for GM?
Nobody from Detroit got a particularly warm welcome in Washington last week, but the reception was coolest for General Motors, the largest and most vulnerable automaker. As GMers admit off the record, Chairman and CEO Richard Wagoner turned in a dismal performance during two days of congressional testimony. He served up the same kind of boilerplate that GM has been offering analysts and journalists for months: We promise to make better cars, more economical cars, more alternative fuel cars.
And he presented a laundry list of steps the company has taken to regain profitability, like reducing manufacturing capacity, suspending dividend payments and eliminating health care coverage for salaried retirees. But with a straight face, he blamed GM's problems not on its products, its business plan or its long-term strategy but on "the global financial crisis." He didn't bother to acknowledge that GM has lost an astonishing $72 billion in the past four years on his watch - including $51 billion before the crisis hit in 2008.
Wagoner also flunked the public relations part by arriving in Washington on board his corporate jet - couldn't he at least have hitched a ride with Ford or Chrysler? - and failed to step up when asked to demonstrate a sign of financial sacrifice. With the company in danger of running out of cash before the inauguration of President-elect Obama, what should Wagoner do now? Start burning the deck chairs. GM needs to make some visible and effective efforts to cut costs and raise cash. Mounting a bare-bones exhibit at the Los Angeles auto show is a start. But GM has been dangerously slow about identifying surplus assets like Hummer and putting them up for sale.
Show some sacrifice. GM is currently planning to go ahead with its scheduled Christmas shutdown from Dec. 24th until January 5th. That's great - GM employees will be on paid holiday while the rest of us are working. GM should get them back to their jobs and have them come up with more ways to raise cash. Develop a plan and sell it hard. Wagoner tried to bluff the government into a bailout without showing any of his cards. That didn't work, so now he needs to up the ante. When Chrysler was on the ropes in 1979, CEO Lee Iacocca put together a display of new models and took it on the road to demonstrate that Chrysler had a future. Wagoner needs to do the same thing.
He's working on it. A GM spokesman says, "We intend to deliver a plan to Congress that shows them a viable General Motors." But what is GM's future? Certainly not as a manufacturer selling eight - count 'em eight - brands of cars at a time when Toyota , its closest competitor, gets by with three. GM needs to address that issue immediately, even if it secretly believes that eliminating brands and their dealers is the wrong thing to do. Some have suggested that GM become, in effect, an arm of the federal government, performing the energy independence work that Obama has promised. But having seen GM fail at profitably making and selling automobiles, something it has been doing for 100 years, I'm frightened about the possibility that it should try its hand at something new.
By now, it is clear to almost everyone that the U.S. doesn't need three independent car companies any longer. There isn't enough business for all of them. What Wagoner should do is design a new structure that will allow the three of them to combine forces. It is clear that Cerberus is anxious to give up its ownership of Chrysler at any price. The hard part will be convincing the Ford family to relinquish its control of Ford Motor. Here is how Wagoner can do it: Looming in 2020 are stringent new federal fuel economy regulations that will require cars that get 35 miles per gallon. The current mandate is 27.5 mpg.
Meanwhile, California and a dozen other states are licking their lips in anticipation of a waiver from the Environmental Protection Agency that will allow them to demand cars that get 43 miles per gallon. Having underinvested for years, it is going to be exceedingly difficult for Ford to meet that target. But by sharing technology with GM, it may have a chance. If he can turn the Detroit Three into the Big One with a new environmental mandate, Wagoner will have developed a compelling rationale for a Congressional bailout. It is worth a shot. Nothing else has succeeded so far.
G.M.’s Pension Fund Stays Afloat, Against the Odds
When General Motors left Washington empty-handed last week, among the lingering questions was whether its huge pension fund could topple and crush the government’s pension insurance program. When any pension fund fails, usually as part of a bankruptcy, the government takes over its assets as well as its payments to retirees. In G.M.’s case, its plan would dwarf the nation’s pension insurance fund.
Still, G.M. appears to have enough money in the pension fund to pay its more than 400,000 retirees their benefits for many years — even with the markets swooning around it. That is largely because of the conservative way G.M. has managed the fund recently, and it explains why G.M. has not joined the long list of companies pressing Congress for pension relief.
But this glimmer of hope in a bleak auto landscape could change drastically, particularly if G.M. struggles along for a few more years, only to go bankrupt. The company’s blue-collar work force is still building up new benefits with every additional hour worked, and the pension fund will have to grow smartly to keep up with those costs.
If G.M. continues paying people to retire early, the costs will grow even more, because the plan will have to pay retirees for more years than it budgeted. And G.M. is not contributing additional money to the plan right now. Already, G.M. says it will be paying retirees about $7 billion a year for the next 10 years. The fund’s assets were worth $104 billion at the end of 2007, more than enough to cover its obligations of $85 billion. Since then, the assets have declined and the obligations have grown, each by undisclosed amounts. The company says it does not plan to add any money to the fund for the next three or four years.
Even if G.M. were forced into bankruptcy, the government might insist that it keep the fund, and cover any shortfalls with its own money. “We would maintain that it can afford to keep its plan intact,” said Charles E. F. Millard, director of the Pension Benefit Guaranty Corporation, the federal agency that takes over failed plans. “Based on past history, we think that argument has a reasonable chance of success.” Whatever its ultimate fate, the G.M. fund may illustrate, against the odds, that it is still possible to offer traditional, defined-benefit pensions even in a historic bear market.
The other American automakers, Chrysler and the Ford Motor Company, also operate pension funds. Ford said that its fund, which is about half the size of G.M.’s, had a small surplus at the end of 2007. Since then, however, it is thought to have suffered a bigger percentage of losses than G.M.’s fund, because it uses a different investment strategy. Little is known about the Chrysler pension fund today because the company stopped making mandatory pension disclosures when it was taken private in August 2007.
Along with pensions, G.M. has promised to provide health care to retirees, but those medical benefits are not guaranteed by the federal government. The total cost of these benefits in today’s dollars was estimated at $60 billion at the end of 2007, and G.M. had set aside only about $16 billion to cover the cost.
That year, G.M. and the United Automobile Workers agreed to let G.M. cap its health obligations to retirees by creating a separate entity to manage the retiree health plan, and making a big payment. The automaker has said it will make the payment in January 2010, and its retiree health obligations will end then. In the meantime, G.M. has issued securities to cover part of the cost and is holding them in a subsidiary created for that purpose.
The G.M. pension is viable today because of the company’s response to the firestorm at the beginning of this decade, said Nancy C. Everett, chief executive of G.M. Asset Management. The unit manages the company’s domestic and foreign pension funds, as well as other big pools of company money. In the two years after the tech crash of 2000, most American pension funds suffered their worst squeeze ever. Although the stock market swings are even more severe now, pension funds have been buffered somewhat by relief provisions written into the pension law signed in 2006.
At the time of the tech crash, most pension funds had invested heavily in stocks, and stocks lost billions of dollars in value. At the same time, interest rates fell to unusually low levels, causing a painful mismatch, because low rates make retirees’ benefits more expensive for pension funds to pay. G.M.’s pension fund finished 2002 with a shortfall of almost $20 billion, by far the biggest of any American company. “That was the genesis of General Motors thinking differently about how to manage the fund,” said Ms. Everett, who was running the Virginia state employees’ pension fund at the time. She joined G.M. in 2005.
Until then, most pension officials thought stocks were their best choice, because stocks were expected to generate more over the long run than bonds. And pension funds were thought to have a long time horizon. Stocks have also been a favorite pension investment because of a much-criticized accounting rule that rewards the corporate bottom line when pension managers invest more aggressively. The big mismatch of 2002 showed pension officials that stocks could produce more volatility than a mature pension fund like G.M.’s could bear. The company could not wait for stock prices to come back up eventually, because it had 400,000 retirees waiting to be paid about $7 billion every year.
With that in mind, G.M. sold more than $14 billion of bonds in 2003 and put the proceeds into its pension fund, making up for the preceding years’ losses. It also put in the proceeds of the sale of its Hughes Electronics subsidiary, for a total contribution of more than $18 billion. That was far more than the minimum required that year. The big contributions got rid of the fund’s shortfall. (They also gave G.M.’s bottom line a lift, thanks to the accounting rule.)
Then, over several years, G.M. overhauled its investment portfolio, replacing billions of dollars worth of stocks with bonds, and adding derivatives to make the duration of the bonds better match the schedule of payments to retirees. Bond prices can swing too, but G.M. plans to hold the bonds for their interest, not sell them. Ms. Everett said the company believed the interest payments would be more than enough to produce the $7 billion owed to retirees every year.
Currently, 26 percent of G.M.’s pension fund is invested in stocks — well below the typical pension fund’s allocation. David Zion, an analyst at Credit Suisse who tracks corporate pension funds closely, estimates that G.M.’s pension assets have declined by about 15 percent so far this year, compared with a 24 percent decline for the typical pension fund at America’s 500 largest companies. It will be several more months before the size of the losses is known for sure, because companies disclose precise pension numbers just once a year.
When asked why G.M. did not eliminate stocks from its pension fund completely, Ms. Everett cited the controversial accounting rule. “There’s two sides to this issue,” she said. “One is making sure your pension fund is adequately funded, and the other is that pension income does come into play when you’re looking at the company’s income statement.” No company is eager to eliminate pension income if competitors still have theirs.
The Financial Accounting Standards Board has been working on revisions to keep pension activity from affecting the corporate bottom line, but it is not finished yet. G.M. has a free pass on the funding rules for the next few years. It holds a so-called credit balance — a running tally of the contributions made in past years that were larger than the law required. In 2006, G.M.’s credit balance was worth $44 billion. The company is using that balance to offset contributions it would otherwise have to make. Over time, the size of the credit balance will fall.
Ms. Everett said modeling exercises showed that a 26 percent allocation to equities was the likeliest way to produce adequate investment returns while also preserving the pension fund’s surplus. She said managing the surplus was her top priority. If G.M. had to make a pension contribution, it would not have the cash on hand to do it. The company has said it will run out of cash early next year.
Meanwhile, the cost of restructuring the company could put a heavy burden on the pension fund. G.M.’s contract with the U.A.W. offers special benefits to workers whose plants are shut down or who are forced to retire early. Invoking these special benefits could make the plan’s obligations soar.
Geithner Struggled to Get Movement on Swap Dangers
Timothy Geithner was among the first policy makers to shine a light on the unregulated $47 trillion credit-default swap market back in 2005. The New York Federal Reserve president has struggled since then to get dealers to carry out reforms. The industry has yet to launch a structure to safeguard against market-wide losses in case a dealer fails, though its leaders expect to get one off the ground by the end of the year. Geithner, selected yesterday by President-elect Barack Obama to be his Treasury secretary, has made clear that such a step is crucial to help contain the mushrooming credit crisis.
“In classic Tim and New York Fed style, the work has been done behind the scenes, among technocrats, largely by consensus,” said Adam Posen, a former Fed official who is now at the Peterson Institute for International Economics in Washington. “The downside is that it takes awhile to get consensus.” Geithner may not have the luxury of time in his new job as he faces a credit crisis that has morphed into a global recession. As Obama’s chief economic spokesman, it will be up to Geithner to take the lead in quelling the turmoil in financial markets and turning the economy around.
A protégé of former Treasury Secretary and Citigroup Inc. director Robert E. Rubin, Geithner worked on the Asian financial crisis of 1997-1998 and helped stave off a Mexican default earlier that decade. In the current crisis, Geithner, 47, was the Fed’s point man in the rescues of Bear Stearns Cos. and American International Group Inc., and tried to stem market turmoil after the decision to allow Lehman Brothers Holdings Inc. to fail. In August, he put his staff to work figuring out how much capital major banks would need if the economy worsened, foreshadowing the steps Treasury Secretary Henry Paulson later took to invest some $125 billion in the country’s largest banks.
Geithner’s skills and limitations as a consensus-builder perhaps show up most clearly, though, in his handling of credit- default swaps, where he played a leading role in trying to make the market safer and more stable. Trading in credit-default swaps, which were conceived to protect bondholders against default, exploded 100-fold the past decade as investors increasingly used them to speculate on creditworthiness. The contracts pay the buyer face value in exchange for the underlying securities or the cash equivalent should the borrowers fail to adhere to their debt agreements.
The big problem Geithner faced in trying to get a handle on the market: It was unregulated, so he lacked authority to make changes on his own and had to depend on his powers of persuasion. The New York Fed chief began pressing banks in September 2005 to reduce trading backlogs that could prove dangerous should a crisis hit. An average 17 days’ worth of unsigned trades had piled up on dealers’ books, threatening to undermine the market if a wave of defaults hit. A lax system for unwinding and reassigning trades left dealers at times unsure of who was on the other side of their trade.
It took dealers a while to respond. A year later, they had cut the backlog of unsigned trades by 70 percent and doubled the number of deals that were electronically processed. “It was like herding cats,” said Brad Bailey, director of business development at Jersey City, New Jersey-based brokerage Knight Capital Group and a former derivatives trader, who praised Geithner for making the effort and getting results.
The New York Fed chief has run into similar problems in trying to get the industry to set up a central counterparty that would absorb losses on trades in the event a dealer went bust. After the collapse of Lehman Brothers in September sent market participants scrambling to cover an estimated $2 trillion of trades, the New York Fed chief stepped up pressure on the dealers to act.
On Oct. 7, he summoned the dealers and fellow regulators to the New York Fed. This time, he included futures exchanges at the meeting -- Chicago-based CME Group Inc., Intercontinental Exchange Inc., NYSE Euronext and Frankfurt-based futures exchange Eurex -- in a bid to put competitive pressure on the dealers to come up with a satisfactory plan. The strategy worked. After three meetings in two weeks, the dealer-owned Clearing Corp. agreed to be acquired by Intercontinental Exchange, one of the exchanges vying for a piece of the market. That paved the way for the launch of at least one clearinghouse by the end of the year.
“The Fed can only be commended for being ahead of the game among regulators globally,” said Mark Yallop, chief operating officer of London-based ICAP Plc, the world’s biggest broker of trades between banks and a minority owner in Clearing Corp. Not everyone agrees. Julian Mann, a mortgage- and asset- backed bond manager at First Pacific Advisors LLC in Los Angeles, criticized Geithner for not doing enough.
“He oversaw the massive expansion in the credit-default swaps market, which arguably is what is behind much of the crisis today,” said Mann, whose firm manages about $9 billion. Vincent Reinhart, a former senior Fed official now at the American Enterprise Institute in Washington, said that Geithner was quick to recognize some of the problems with the swaps market, though it was tough for him to persuade the industry to carry out reforms while business was booming. “It shows the limits of what he could do,” Reinhart said, referring to the fact that the market is unregulated. “He had to try to induce good behavior rather than command it.”
Detroit: Wait until after next year
Congress wants the Big Three to give it a plan for profitability before approving a bailout. This could be within reach...but not until 2010. A profitable U.S. auto industry just around the corner? Given the crisis hitting the industry, it sounds about as realistic as flying cars. Congressional leaders are demanding to see details by Dec. 2 about how U.S. automakers will start making money again before they'll agree to even have a vote on the $25 billion federal loan package the industry is seeking.
Many critics of the bailout suggest that automakers have shown no indication of how they'll return to profitability. Some argue the Big Three U.S. automakers are doomed to fail even if they get loans from the government. But General Motors, Ford Motor and Chrysler have already made sizable cuts in production and staffing throughout the year. Additional cuts will come in the next few months, and some as soon as later this week. While it's tough to offer guarantees of profitability with so much uncertainty about the economy, if the automakers get the federal help they are asking for, the Big Three could be back in the black as soon as 2010.
With that in mind, here's what GM, Ford and Chrysler are likely to point out in their business plan to Congress. GM , Ford and Chrysler have been downsizing for years and have all continued to make even deeper cuts this year which will save them billions of dollars. GM plans to cut more than 7,000 salaried and contract employees this year as it aims to trim nonunion labor costs by 30%, or about $2 billion annually. Those departures did not begin until this quarter and most of the remaining employees should leave by the end of the year. So some of the savings won't take effect until next year. And the cost of the severance and retirement packages is causing steeper losses in this year.
Ford and Chrysler plan similar size cuts in their non-union staff. Chrysler plans to identify by Wednesday 5,000 salaried and contract staff who will leave the company, about 25% of that remaining workforce. Even hourly workers, despite their union protection, are being affected. So far this year 14,000 hourly staff have left GM, while Ford has trimmed about 7,000 and Chrysler about 8,000 in the last year. Much of those cuts have come through buyouts, but union members are also finding they have weaker job protection than they did before the 2007 labor contract.
"There is a cost to downsizing," said David Cole, chairman of the Center for Automotive Research, a Michigan think tank that supports the bailout. "But the payback is pretty rapid, as long as you can make it to that point." And more cuts are coming. GM is set to close three plants in December. That will eliminate more than 6,000 additional jobs. Chrysler is set to close its Newark, Del., plant in December, which employs about 1,000 people. This is the area where the automakers may see some of the biggest savings, assuming they can make it to 2010.
GM is expected to save about $3 billion a year by having the cost of retiree health care shifted to union-controlled trust funds. Ford is likely to save about $2 billion. Estimates at closely-held Chrysler are tougher to come by, but some think it could translate to $1 billion a year or more in savings for the company. The companies will have to fund those trust funds to meet an estimated $100 billion in unfunded obligations that they face between them. But the United Auto Workers union has agreed to let the companies delay making payments into the fund during the current cash crisis.
The United Auto Workers union also agreed in the 2007 contract to a two-tier wage structure for all new hires. As part of that deal, which has already kicked in, new hires receive none of the expensive benefits, such as retiree health care coverage, which have been a competitive drain on the automakers. This should allow the Big Three's plants to have a similar cost structure to those operated in the United States by the Asian automakers once the last of the current autoworkers retire.
All three companies are closing plants and other manufacturing facilities as they try to bring their capacity in line with reduced demand . This is a process that started years ago but has accelerated this year. GM has announced it is eliminating 12 production shifts, which will bring their North American capacity to only about 3.7 million vehicles. Beyond the reduced operating costs from plant closings, the most important advantage for automakers might be cutting into the glut of cars and light trucks that are piling up in the face of weak demand. That excess capacity forces the automakers to offer cash back, financing and other incentives to try to move the unsold cars.
Edmunds.com estimates that incentive costs for the U.S. automakers this year is roughly $2,000 a vehicle more than in 2002, a period when the U.S. economy was just coming out of recession and unemployment was still rising. If the automakers could just get back to those levels, it would save them about $12 billion as a group, even if sales remain at current depressed levels. In addition to cutting capacity, the Detroit automakers are also converting existing SUV plants so they can produce smaller cars, which are now in greater demand.
Still, even with the tens of billions of dollars in planned savings, it's tough to see the U.S. automakers pulling out of this crisis if sales remain at their current levels, the worst in at least 25 years. Industrywide U.S. auto sales toppled to a seasonally-adjusted annual sales rate of 10.5 million in October. Full-year sales are likely to come in at just over 13 million and are forecast to be about 12 million in 2009. "No one, not even Toyota is cash flow positive if sales are 10 million vehicles a year," said Shelly Lombard, the automotive credit analyst for Gimme Credit.
She said that even before the recent cuts, GM and Ford were on target to be able to make money in a 15-million annual sales market. With the additional cuts prompted by this crisis, they are probably close to making money in a 14 million sales environment, she said. Fortunately for them, a 14 million sales level is very achievable. Sales stayed above 16 million every year since 1999 before this year and haven't below 14.7 million since 1993.
Sales should rebound to about 14 million in 2010, according to forecasts, and climb back over 15 million the following year. Industry officials and experts concede that it is difficult to make predictions that far out in the current economic environment. But if sales don't rebound, it's not hard to figure out what will happen to the Big Three --- even with a federal bailout and all the planned cost savings. "If the sales number is still 12 million a year or two from now, they're dead," said Lombard.
UK mortgage lending predicted to fall below zero
British households will pay back more money to banks and building societies than they take out in new mortgages next year for the first time on record, a Government report has forecast. The Crosby report into mortgage financing, named after its author the former HBOS chief Sir James Crosby, said repayments and redemptions will outpace lending in 2009 as the slump in the housing market deepens.
It comes as latest lending figures show there has been a 52 per cent fall in mortgage lending over the past year. Sir James said that, in the current economic climate, it would be hard for banks to finance loans. "Therefore I believe that new net mortgage lending is likely to fall below zero in 2009, with only a modest recovery likely in 2010," he said. Experts warned that such a fall would prolong the recovery in the mortgage and housing sectors.
Ray Boulger, of mortgage brokers John Charcol, said: "It means the recovery in the market is going to be delayed." "For the banking sector to see a recovery and begin lending again, the property market must stabilize," he said. Lenders have tightened their lending criteria significantly during the past year, reserving their best rates to lower risk customers who have a large deposit of at least 40 per cent.
Mortgage lending fell from £3.5 billion in September to £2.9 billion in October, according to the British Bankers' Association. David Dooks, statistics director of the BBA, said: "Comparison of current lending levels with last year is obscured by the very different economic conditions that exist now, reflecting a much reduced appetite for borrowing."
BOE Governor warns banks on lending
Speaking to the Treasury Select Committee, the governor of the Bank of England said "this was more important than anything else at present".
He said the government "may have to intervene directly" to ensure the banks start to increase their lending. Mr King added that nationalising banks could not be ruled out. "I think given what we have seen it would be an extremely brave person that would rule anything out," he said when asked whether nationalising banks was a possibility. "It's very unlikely to be the first option. Remember that the government now owns the majority holding in shares in more than one bank."
In the more immediate term, Mr King said UK banks may require additional government funds than they have already received. However, he added that he hoped the current rescue package would start to work. So far the government has pledged to spend up to £37bn to buy stakes in three banks - Royal Bank of Scotland, Lloyds TSB and HBOS.
The Bank of England has lent further billions of pounds to the wider banking sector. Mr King's testimony came a day after Chancellor Alistair Darling presented his pre-Budget report. The governor said he welcomed the chancellor's £20bn stimulus package, which includes a cut in Value Added Tax (VAT) to 15% from next Monday. Mr King said the move was "perfectly reasonable and appropriate" given the "extraordinary circumstances".
Turning his attention to inflation, Mr King warned that the risk it could fall below 2% in the medium term has "increased significantly" in recent weeks. He said this was due to the sharp fall in global oil and commodity prices, and declining consumer demand. UK inflation fell to 4.5% from 5.2% in October. The government wants inflation to be as close as possible to 2%. This Bank of England targets the Consumer Price Index, which excludes the effects of mortgage interest payments. "We will take whatever action is necessary to ensure that inflation is close to target in the medium term," Mr King said.
UK interest rates are currently at 3% following a 1.5 percentage point cut at the start of this month, and many economists are forecasting a further cut in interest rates in December. While Mr King would not directly comment on future rate movements, analysts said he did little to cool expectations of a further reduction next month.
Is Britain Going Bankrupt?
The bond vigilantes are restive. We are not yet facing a replay of the 1970s 'Gilts Strike', but we are not that far off either. There is now a palpable fear that global investors may start to shun British debt as the budget deficit rockets to £118bn -- 8pc GDP -- or charge a much higher price for to cover default risk. The cost of insuring against the bankruptcy of the British state has broken out -- upwards -- over the last month. Yes, credit default swaps (CDS) are dodgy instruments, but they are the best stress barometer that we have.
Today they reached 86 basis points, near Portuguese debt in the league table. For good reason. Alistair Darling has had to admit that the British economy faces the most sudden economic collapse since World War Two, and the worst budget deficit of any major country in the world. Ok, this is a lot lower than Iceland, Ukraine, Hungary, and other clients of the IMF, but is significantly higher than Germany (35), USA (43), and France (49).
After trading at similar levels to our AAA-rated peers for years, we started to decouple in August and then began to soar in October. We reached a fresh record the moment the Chancellor told the House of Commons that the budget would not return to its already awful condition until 2016. Should we be worried? Yes. Marc Ostwald from Insinger de Beaufort said Gilt issuance would reach £146bn in fiscal 2008/2009. Britain will have to borrow £450bn over the next five years. This is an utter fiasco.
With deep embarrasment, I plead guilty to supporting the Brown-Darling fiscal give-away -- though with a clothes peg clamped on my nose. As the Confederation of British Industry and many others have warned, we face an epidemic of bankruptcies unless we tear up the rule book and take immediate counter-action. The Bank of England's drastic rate cuts are a necessary but not sufficient stimulus. Monetary policy is failing to get traction because the credit system has broken down. We face the risk of a rapid downward spiral if we misjudge the threat at this dangerous moment, as we sit poised on the tipping point. Besides, the whole world is now resorting to fiscal stimulus in unison under IMF prodding. Sticking together is imperative. If countries reflate in isolation, they can and will be singled out and punished. That is the lesson of 1931.
But this is not to excuse the Brown Government for the total hash it has made of the British economy. It presided over a rise in household debt to 165pc of personal income. How could the regulators possibly think this was in the interests of British society? What economic doctrine justifies such stupidity? Why were 120pc mortgages ever allowed? Indeed, why were 100pc mortgages ever allowed? Debt is as dangerous as heroine. Labour ran a budget deficit of 3pc of GDP the top of cycle. (We had a 2pc surplus at the end of the Lawson bubble, so we go into this slump 5pc of GDP worsee off). The size of the state has ballooned from 37pc to 46pc of GDP in a decade, and will inevitably now rise further.
It is because Gordon Brown exhausted the national credit limit to pay for his silly boom that today's fiscal stimulus -- just 1pc of GDP (China is doing 14pc) -- is enough to rattle the bond markets. Our national debt will jump in what is more or less the bat of an eyelid from under 40pc of GDP to nearer 60pc -- according to Fitlch Ratings. It is enough to make you weep. But is this bankruptcy territory? Not yet. Britain will remain at the mid to lower end of the AAA club.
A Fitch study today estimates the "fiscal cost" of the bank bail-outs (which is not the same as just adding guarantees to the national debt) is 6.9pc of GDP for Britain -- compared to Belgium (5.7pc), Germany (5.8pc), Netherlands (6.3pc), and Switzerand (12.9pc). We are not alone in this debacle. If and when the storm blows over, Britain should still have a lower national debt than Germany, France, or Italy. It will certainly have a better demographic structure that most of Europe (except France and Scandinavia), and less catastrophic pension liabilities than most. The situation is desperate, but not serious -- as the Habsburgs used to say. Fingers crossed.
Home Prices for 20 U.S. Cities Decline Most on Record
House prices in 20 U.S. cities declined in the year ended in September at the fastest pace on record as rising foreclosures pushed down property values. The S&P/Case-Shiller home-price index dropped 17.4 percent in September from a year earlier, more than forecast, after a 16.6 percent decline in August. The gauge has fallen every month since January 2007, and year-over-year records began in 2001.
Mounting foreclosures are contributing to the drop in home prices, while adding to the inventory of unsold homes on the market. Lower property values are weighing on household wealth, causing consumers to cutback on spending and increasing the likelihood that the U.S. economy will contract for a second consecutive quarter.
“The onslaught of foreclosures hitting the market is certainly one reason prices are falling and will continue to fall,” said Guy LeBas, chief economist at Janney Montgomery Scott LLC in Philadelphia, who forecast a 17.1 percent drop. “We need to purge the excesses of the last several years, and the only way to do that is to suffer through these home price declines.” Home prices decreased 1.8 percent in September from the prior month after declining 1 percent in August, the report showed. The figures aren’t adjusted for seasonal effects so economists prefer to focus on year-over-year changes instead of month-to-month.
A government report showed the U.S. economy shrank in the third quarter faster than previously estimated as consumer spending plunged by the most in almost three decades. Gross domestic product contracted at a 0.5 percent annual pace from July through September, the most since the 2001 recession, according to revised figures from the Commerce Department today in Washington. The government’s advance estimate issued last month showed a 0.3 percent decline.
S&P/Case-Shiller also released quarterly figures for nationwide home prices. That measure showed a 16.6 percent drop in the three months through September from the previous three months, compared with a 15.1 percent drop in the second quarter. Economists forecast the 20-city index would fall 16.9 percent from a year earlier, according to the median of 28 estimates in a Bloomberg News survey. Projections ranged from declines of 16 percent to 17.2 percent. Compared with a year earlier, all areas in the 20-city survey showed a decrease in prices in September, led by a 31.9 percent drop in Phoenix and a 31.3 percent decline in Las Vegas.
Separately, S&P/Case-Shiller released a new component that tracks condominium values in Boston, Chicago, Los Angeles, New York and San Francisco on a monthly basis dating back to 1995. The seasonally adjusted index shows September prices in the five cities declined 10 percent from a year ago, led by a 20 percent drop in Los Angeles.
“The turmoil in the financial markets is placing further downward pressure on a housing market already weakened by its fundamentals,” David Blitzer, chairman of the index committee at S&P, said in a statement. Robert Shiller, chief economist at MacroMarkets LLC and a professor at Yale University, and Karl Case, an economics professor at Wellesley College, created the home-price index based on research from the 1980s.
Reports this month showed mounting foreclosures are pushing prices down and hurting demand. Existing home sales, which account for about 90 percent of the market, dropped in October and prices fell by the most on record, the National Association of Realtors said yesterday. The median price of an existing home plunged 11.3 percent in October from a year earlier and fell to the lowest level since March 2004, according to the Realtors. Sales of distressed properties accounted for 45 percent of last month’s total, up from about 40 percent in September, the agents’ group also said. Foreclosure filings were up 25 percent in October from a year ago, according to RealtyTrac Inc., the Irvine, California-based seller of default data.
Karl Case, the Wellesley College economics professor who co-created the index, said lower-priced homes have to be cleared from the market through foreclosure auctions to make way for recovery. “The lower tier of borrowers, who are struggling to make ends meet, that’s the part of the market that needs to get cleared by auctions,” Case said in an interview with Bloomberg Radio. “That’s the difficult part.”
The drop in home construction has subtracted from growth since the first quarter of 2006. The downturn is likely to remain a drag on the economy until the home sales and prices improve. D.R. Horton Inc., the largest U.S. homebuilder, reported its sixth straight quarterly loss today. The Fort Worth, Texas- based company said orders fell 38 percent while the cancellation rate was 47 percent.
The black hole in financial markets
Subprime mortgages were the beginning, not the end, of a global financial crisis, and in recognition of this fact equity markets have crashed. The proximate cause of this week's retreat in equity markets to the lowest levels since the 1990s was the collapse of loans to American commercial real estate, which in turn implies the collapse of insurance companies and pension funds. Americans who relied on private pension funds, whether through their employer or insurance companies, will lose part or all of their pensions.
That is why it is so difficult to rescue General Motors, which has said that it may not last the year without official help. Not only stocks, but many of the fixed-income assets owned by insurance companies have fallen by half during 2008, including commercial mortgage-backed securities, and the capital securities of some commercial banks. Citigroup's preferred shares issued last March traded on November 20 at 50 cents on the dollar.
The problem now becomes self-feeding. The collapse of equity and credit values destroys the value of corporate pensions, requiring corporations with defined benefit plans that still cover 20 million workers to divert profits to their pension funds. The impairment of the credit of insurance companies, in return, eliminates a major source of long-term credit provision.
About US$800 billion of commercial mortgages has been packaged into bonds, owned mainly by insurance companies and pension funds. As the value of commercial real estate collapsed, the equity prices of insurance companies collapsed as well, by more than two-thirds between September 20 and the November 20 market close, while bank stocks fell "only" by half.
Even more alarming than the collapse in equity prices is the collapse of the credit of some of America's largest insurers. It now costs more than 10 percentage points above the benchmark London interbank rate to buy five-year credit protection on the Hartford group, for example.
Like subprime loans, more than a third of which are in default, commercial real estate loans bore "outlandish" forecasts for growth and property appreciation, Bloomberg News reported on Thursday. Two multi-hundred-million dollar loans to developers in Arizona and California were near default this week, Bloomberg reported, provoking the latest round of selling of commercial mortgage-backed securities. These loans (and many others) assumed double-digit revenue growth on the part of the borrowers, which makes them as dubious as the so-called liar's loans in the residential mortgage market.
Americans are beginning to understand how much of their economy depended on the housing bubble. Shopping malls sold goods to consumers who took on more debt because the appreciation of their homes made them feel wealthier. Office buildings filled with workers who sold real estate, processed home mortgages, and traded mortgage-backed securities. The US economy appeared to prosper by purchasing goods from China, and then borrowing the money back and using it to buy homes at higher prices. This, to be sure, exaggerates the problem, but the point nonetheless is valid.
The collapse of housing prices in the US leads to a collapse of consumer spending, which with a slight delay leads to a rise in unemployment, which in turn erodes the value of commercial property, and so forth.
Now that American equity prices have retreated to levels not seen since 1997, it is a fair question to ask whether the profitability of the US economy was as strong as the market seemed to think. During the tech boom of the late 1990s, to be sure, the market was willing to buy stocks with no visible profits at all. During the 2000s, financial companies comprised about 40% of all corporate profits, and these turned out to be largely illusory.
American equity returns over the very long term seem disappointing. An investor who bought the S&P 500 index in 1950, and sold it on November 20, would have earned a real compounded annual return of just 2% after capital gains tax (excluding dividends). An investor who bought at the peak of the 1960s equities boom in 1965 and sold on November 20 would only break even after inflation and capital gains tax.
In short, Americans have discovered that what they thought was a stable net worth (home equity and an equity portfolio) was no such thing, and that such obligations as pensions and life and health insurance are far less secure than they thought. The shock has forced a sudden shift in their behavior towards precautionary savings, which is why the US economy appears to have fallen off a cliff in October.
The US Treasury is the only entity in the United States with an unchallenged capacity to borrow, and the rush into precautionary savings was reflected in the largest-ever increase in government bond prices - by more than eight points for the 30-year bond - in American history. For the time being, the likelihood is that global demand for precautionary savings will keep Treasury yields low, even while the US government finances an unprecedented deficit - perhaps as large as $2 trillion during calendar 2009.
The liquidation of risk assets in favor of safe assets, and the shift from consumption to savings, will continue until Americans have restored some part of their lost wealth. Given that incomes will decline (through rising unemployment and lower compensation), Americans will be swimming against the current as they try to repair the household balance sheet. That portends a very long and painful economic downturn, worse than the 1979-1982 crisis that preceded the Ronald Reagan reforms.
President-elect Barack Obama is the only man in town with a checkbook, and by virtue of the Treasury's near-monopoly of financial power, will take office as the most powerful peacetime president in US history. Faced with the collapse of private pension, health care and financing systems, Obama will have every reason to use his mandate to socialize medicine, pensions and many other aspects of US economic life. The American economy may be hard to recognize afterwards.
It's do-or-die time for malls
In five short days, it could be the beginning of the end for some of the nation's malls. "Certainly malls are going to be very damaged by Christmas. It could be all over for some of them very soon," said Britt Beemer, founder and chairman of America's Research Group. Black Friday - or the day after Thanksgiving - is traditionally one of the busiest shopping days of the year.
Retailers typically mark the start of the holiday gift shopping period with much fanfare and gimmicks, all in an effort to bag big sales on that day. This year, there's a much more serious undertone to Black Friday. For malls, it's not about holiday festivities but about survivability by year-end. It's already been a very crippling year for retail sales. A worsening economy has forced more Americans to seriously retrench their discretionary purchases.
As store sales fell at record levels last month, more retailers have either filed for bankruptcy or shuttered their business for good. Since several of these retailers have stores in malls, mall vacancies have increased by the most since early 2002, according to the real estate research firm Reis. At the same time, Americans are forgoing mall trips in favor of shopping at discount stores closer to home. This downward spiral has already claimed one notable name - No. 2 mall operator General Growth Properties (GGP) - which has said it is on the brink of bankruptcy.
Beemer said his surveys of consumers going into the holiday shopping season indicate that there's not much respite ahead for malls or their retail tenants. He expects holiday sales for November and December combined will fall 1% or more this year. The two-month period can account for as much as 50% of retailers' annual profit and sales. "I predict that no more than 38% of Americans will walk into a mall over the coming weeks. But that doesn't mean they will buy something," he said. Instead, he said he's confident saying that another 40% of Americans will go to Wal-Mart where "90% of them will complete their Christmas shopping."
"I think Wal-Mart will get more of the shopping traffic and sales than all the malls combined," Beemer said. To his point, ShopperTrak, which tracks traffic at more than 50,000 malls, estimates that holiday shopping traffic will fall 9.9% this year. "Currently we're anticipating the lowest retail sales and total U.S. traffic numbers we've seen since we started compiling this data in 2001," said Bill Martin, co-founder of ShopperTrak. [This] will most likely leave retailers scrambling to entice consumers into their stores early and often during the holidays," Martin said.
Some malls are opening for business on Thanksgiving Day this year because their retail tenants don't want to wait until Black Friday to jumpstart sales. For the first time in its history, all of the 11 shopping centers owned by Craig Realty will open at 11 p.m. on Thanksgiving Day. At one of those centers - Los Angeles-based Citadel Outlets - the Old Navy store is opening as early as 9 p.m. Thursday and both the Tommy Hilfiger and Guess stores are opening at 10 p.m., according to spokeswoman Anita Boeker. "The earliest that we've opened our centers is midnight. But our tenants are much more aggressive this year. They are nervous," she said.
Michigan-based mall operator Taubman Centers is hoping to pull in wary gift shoppers by offering them inducements such as free breakfast, "relaxation lounges" with free massages, and even giving away Nintendo Wiis to early bird shoppers at some of its locations. "These are challenging economic times. Everyone is feeling it and we want to be the [shopping] destination of choice on Black Friday," said spokeswoman Karen MacDonald.
Steve Tanger, president of Tanger Outlets, said all of the company's centers are opening at the stroke of midnight, as Friday begins. Tanger said he's "reasonably optimistic" about the holiday season even though traffic at Tanger centers has been flat to slightly down so far this year. "We're 27 years in this business. People are worried about their economic situation this year, but I think they will still give gifts," Tanger said, adding that he's hopeful that the pullback in gas prices should give consumers a little more money in the pocket.
Garo Kholamian, owner and president of mall developer GK Development, said that his centers are holding up well so far because they are located in smaller, regional markets. "People don't want to drive far to bigger malls. That's working to our advantage," he said. He said all of GK's retail centers "will be going all out for Christmas." "We're not too worried about traffic, but how much people will be spending," Kholamian said. There's a good reason for Kholamian to worry, said Beemer. "If people don't spend money in malls, stores can't pay the high rent," he said. "If more stores close, what we'll have next year are more dead malls."
Aussie charities brace for crisis-driven rush by low- and middle-income earners
LOW- and middle-income earners will increasingly turn to welfare agencies as the financial crisis bites, with housing, employment and financial counselling services most in demand. The squeeze on the nation's worst-off, who never made it out of poverty during the economic boom and who require assistance from the welfare sector, is becoming more acute.
A paper by Access Economics, to be presented to the Rudd Government in Canberra today during a national summit on welfare services, warns of the looming crunch as people facing severe financial stress seek help. The paper, titled The Impact of the Global Financial Crisis on Social Services and commissioned by the four major church providers -- Anglicare, the Salvation Army, Catholic Social Services and Uniting Care -- argues that welfare services should be factored into any government economic stimulus package.
"Investment in such services is a benefit not just to those in such desperate need of services, but reduces long-term social costs and enhances the overall productivity of the economy," the paper says. "Investment in social services and social infrastructure should therefore be considered as an essential part of further fiscal stimulus measures."
The paper notes that pressure on welfare services was building even before the global financial crisis began. "Even during the recent period of buoyant economic conditions, agencies were reporting growing demand and the emergence of a new clientele of 'midstream' wage earners facing severe financial stress," it says.
"Instability in the financial sector and its flow-on effects to the rest of the economy can only exacerbate these problems, putting an even greater strain on what are already overstretched social services." The paper, to be presented to federal Community Services Minister Jenny Macklin today, notes the predicted rise in unemployment to 5.4 per cent next year, with subsequent effects in the housing and emergency relief sectors. Catholic Social Services Australia executive director Frank Quinlan said yesterday he feared for those who never made it out of poverty during the boom years -- the core constituency of welfare agencies, who often need intensive and complex services.
"The long-term unemployed with mental health and drug issues, with unstable accommodation arrangements and a range of credit problems, they need intensive input to help overcome their disadvantage rather than just manage it," Mr Quinlan said. "We are looking to make the case to government that as we talk about investing in fiscal stimulus measures and infrastructure spending, we must see that our services are in fact a form of social infrastructure. "In addition to being the sort of things a civil society does for its citizens, they are also an investment in the long-term productive capacity of the economy."
Downturn spreads to health care
A string of flush years, low interest rates and the prospect of steadily rising demand set off a building spree. Sound familiar? In this case, though, the scenario isn't residential housing. It's health care.
The six health systems in the Milwaukee area are on track to spend more than $1.3 billion expanding or building new hospitals. They have spent millions more to buy physician practices, hire physicians and open new clinics. It's made for a heady time, and it follows years of rising revenue and strong profits. But all that may be in the past. Once considered relatively immune to economic downturns, the health care industry faces its share of challenges in coming years.
Access to long-term credit is limited or non-existent. Bad debts are up sharply. The number of people seeking charity care is expected to increase as more people lose their jobs and their health insurance. And investment portfolios, a significant source of profits for some health care systems, have taken huge hits. "A lot of this wasn't there six month ago," said Gordon Mountford, managing director of the health care consulting practice of Huron Consulting Group in Chicago. So far, the economic downturn has taken its biggest toll on investment portfolios. Here's a sampling:
• ProHealth Care reported non-operating losses of $37.5 million for its fiscal year ended Sept. 30, compared with gains of $27.3 million in fiscal 2007, a $64.8 million swing. Its total profits - including health care operations and investments - fell 76% to $17.2 million from $71.7 million a year earlier.
• Children's Hospital of Wisconsin and its foundation reported non-operating losses of $44.8 million in the first nine months of this year, compared with gains of $44.9 million for the nine months last year, an $89.7 million swing. It had an overall loss of $13.8 million, compared with a profit of $44.9 million for the nine-month period last year.
• Froedtert & Community Health reported non-operating losses of $64.5 million in the first nine months of this year, compared with gains of $21.6 million a year earlier, a swing of $86.1 million. Its overall losses totaled $37 million in the first nine months of this year, compared with a profit of $80.1 million a year ago.
All this was before the stock market's crash in October or its new lows last week. Children's Hospital estimates its losses doubled last month, and it has a relatively conservative portfolio. "Everybody's balance sheet is weaker today," said Jim LeBuhn, who follows the nonprofit health care sector for Fitch Ratings. Each of those three health care systems has a large investment portfolio - reserves they've built for future projects and for unexpected events, such as an economic downturn. They also have the highest credit ratings of health systems in the Milwaukee area.
In addition, the losses stem partially from a new accounting rule that requires the health systems to report investment losses or gains in their income statements. Still, the losses suggest that the health systems' investment portfolios won't be generating profits in the near term. "That money is not there anymore," said Mountford of Huron Consulting Group. It already has led to belt-tightening, prodding health care systems to look for projects that could be postponed.
"We are taking a more cautious approach about everything we do," said Robert Mlynarek, chief financial officer for ProHealth. "No doubt about it." That belt-tightening could affect the broader economy. The six health care systems and the Medical College of Wisconsin combined employ more than 20,000 people in the Milwaukee area. No one is projecting large job cuts. Columbia St. Mary's eliminated 74 jobs this month as part of a systemwide initiative to control costs. But the health system employs more than 5,300 people.
In addition, the challenges facing health systems in the Milwaukee area are dwarfed by those facing other sectors of the economy. From 1985 through 2006, health care spending nationally grew on average 2.1 percentage points a year faster than the economy, and the health systems' revenues continue to rise. They also are coming off a string of strong years.
But some health systems have seen their operating income - the money they make treating patients - fall. Froedtert & Community Health's operating income, for example, was down 54% in the first nine months of this year. And Moody's Investors Services this month revised its outlook for health care from stable to negative, citing higher levels of bad debt and charity care, higher borrowing costs and other concerns.
The health care marketplace also has changed since the last severe recession in the early 1980s. For one thing, more people are covered by health plans with high deductibles. That has been cited as one reason for the increase in bad debt. There also are indications that some people are holding off on elective procedures. "All these changes are coming at the same time," said Mountford of Huron Consulting Group.
There's more. Health systems, like their corporate counterparts, may have to set aside more money for their pension plans because of the stock market crash. "That will be a real challenge in the coming year," said LeBuhn of Fitch Ratings. And the credit crisis has brought an additional complication: There are almost no buyers for long-term bonds with fixed interest rates.
This has yet to cause serious problems for health systems in the Milwaukee area. But William Petasnick, chief executive of Froedtert & Community Health, likens the bond market to airplanes stacked up at O'Hare Airport in Chicago on a Friday afternoon. This has hit at a time when health care systems in the Milwaukee area have expanded or are doing so and will face more competition in coming years.
Aurora Health Care is building a $189 million hospital in the Town of Summit in western Waukesha County. The hospital is within five miles of Oconomowoc Memorial Hospital, which is spending $58 million to expand. Aurora also plans to build a hospital for an undisclosed price in Grafton. That hospital will be within five miles of Columbia St. Mary's hospital in Mequon, which recently completed a $72 million expansion.
Wheaton Franciscan Healthcare recently completed an $89 million outpatient center with some overnight beds in Franklin. And ProHealth has announced plans to build a hospital in Mukwonago projected to cost $75 million to $90 million. All the new hospitals are projected to lose money for the first several years. In addition, the health systems in the Milwaukee area, particularly Aurora, have spent heavily in the past year to buy physician practices and hire physicians.
Those investments were made when the economic outlook was decidedly less bleak. The question now is whether the downturn will make it harder to fill those beds, operating rooms and clinics. "We obviously see much tougher operating environment for health care going forward," said LeBuhn of Fitch Ratings.
German Government 'Has to Step into the Breach'
Ever since the world economy began to slump, Berlin has been besieged by demands to intervene. For years there has been deep resistance to stimulus programs in the Federal Republic -- but now even German thinking has started to change. In matters of principle, German Finance Minister Peer Steinbrück of the left-leaning Social Democrats (SPD) is a man of almost Lutheran conviction. He sees economic stimulus programs as the work of the devil. “No matter how large a package the government launches, it cannot subsidize the economic crisis away,” he told a group of industry leaders in Berlin last Friday, “and I also have no intention of doing so.”
The economic stimulus package approved by the German government three weeks ago -- not surprisingly -- was a half-hearted effort. It provides for only about €5 billion ($6.25 billion) a year. This explains why Merkel and Steinbrück remain skeptical about proposals by the EU Commission to introduce a comprehensive €130 billion growth plan. Although the chancellor and finance minister continue to hesitate, around the world a new understanding has emerged of what the state can and should do to help markets, especially when it comes to stabilizing the economy. Many economists and institutions that had once lashed out against government interventions are now calling for the state to play a more active role, especially in Germany.
The current situation is marked by a massive drop in demand that could worsen. Banks are approving fewer loans, companies lack money for investments, and consumers are holding back on purchases. Similar cycles have been observed in other industries, and German economist Peter Bofinger sees an alarming downward spiral. “There was no way to foresee that we would be hit this hard,” he says, adding that the German government should boost its “limited” economic program. Bofinger, who has close ties to trade unions, has been advocating such measures for a long time. What is new is that such points of view in Germany have become mainstream.
“In a situation like this the government has to step into the breach,” says Fuest, who adds that Germany can afford a stimulus package because its budget is largely balanced. However, aid packages must be designed for a specific objective. For cash injections to have the greatest possible impact, they should be rapidly implemented and limited to a specific time frame, to avoid burdening public coffers with endless new debt. According to the latest research, if the wrong criteria are targeted, government programs can cause more harm than good.
The most effective solution recommended in a study by the Brookings Institution, a Washington-based think tank, involved reducing taxes for low-income families. What the experts are considering is a mixture of additional investments and short-term tax relief measures, primarily for low and middle-income families. The problem is that only half of all households in Germany still pay any income tax whatsoever. The other half earns so little that they are fully exempt.
Should the economy slide into a recession, subsidies for individual companies or sectors would be the wrong approach. In this case, government institutions will have to stem the tide with nationwide measures. The central bank will have to maintain low interest rates while the government launches bold economic initiatives. “In this exceptional crisis situation, it is the job of the state to build confidence in the economy,” says Economic Minister Glos, which is why he says the government must proceed “with greater determination.”
UK Pre-Budget report: Middle classes facing tax rises to fund record debt
The middle classes are facing significant tax rises as the government runs up the largest level of debt borrowed in British history, Alistair Darling announced yesterday. Millions of higher rate taxpayers - those earning more than £40,000 - will be worse off after the Chancellor unveiled plans to raise the level of National Insurance payments. People with salaries of more than £150,000 will see a further 5p rise in their income tax rate - a decision that brings to an end Gordon Brown's 11-year-old commitment to not raise the top rate of tax.
In an extraordinary statement, Mr Darling ripped up Labour's previous economic policies as he revealed that Britain's debt is set spiral to previously unseen levels as the recession devastates the economy. Next year the economy will shrink by 1.25 per cent, the Chancellor said. Within five years government debt will be equivalent to more than half of Britain's entire gross domestic product. By the end of this financial year the government will be forced to borrow £78 billion. This is more than Britain had to borrow to fight the Second World War, the Tories claimed.
Mr Darling revealed the grim forecast as he announced an emergency £20 billion series of measures designed to drag the country through the worst effects of the downturn. As part of the statement the Chancellor - who faced jeers in the Commons over his claims that Britain was well-placed to survive the recession - unveiled plans that would see:
* Rises in income tax and National Insurance that will contribute to an extra £7.5 billion to the Treasury. Someone earning £75,000 will be £250 a year worse off.
* A rise in duty on on petrol, alcohol and tobacco.
* A temporary reduction in VAT from 17.5 per cent to 15 per cent to try to encourage shoppers to spend.
* Rises in long-haul flight tax for holidaymakers.
* A reduction in proposed increases to car tax.
George Osborne, the shadow chancellor, accused Labour of finally conforming to type and running out of money. He said: "It is confirmation of the time-old truth that in the end all Labour Chancellors run out of money and all Labour governments bring this country to the verge of bankruptcy. He offers temporary tax giveaways paid for by a lifetime of tax rises on the British people. The national debt doubled and the future mortgaged to bail out the mistakes of the past. This is exactly the road Britain is now on with this Prime Minister and this reckless Budget. Far from being an action plan, it represents the greatest failure of public policy in a generation."
At the Budget in March, Mr Darling forecast that borrowing would peak this year at £43 billion, equal to 2.7 per cent of the entire economy. That was the biggest annual borrowing figure since Labour came to power in 1997, Yesterday Mr Darling revealed that he will have to borrow £78 billion this year. Next year it will rise to a staggering at £118 billion, the equivalent of 8 per cent of national income.
Pakistan Obtains $7.6 Billion Bailout Loan From IMF
Pakistan obtained a $7.6 billion bailout from the International Monetary Fund to help prevent the country defaulting on its debt. The State Bank of Pakistan, which this month raised its benchmark interest rate to 15 percent from 13 percent, has committed as part of the aid to “further tighten monetary policy as needed,” the IMF said in a statement in Washington yesterday. South Asia’s second-largest economy will be able to immediately draw upon $3.1 billion of the loan, it said.
President Asif Ali Zardari, facing pressure from the U.S. to step up the fight against Taliban and al-Qaeda insurgents along the border with Afghanistan, needs IMF financing to prop up Pakistan’s ailing economy. The nation’s foreign-exchange reserves have shrunk 75 percent in 12 months to $3.45 billion and economic growth is forecast to slump to a seven-year low. Pakistan’s rupee gained 0.44 percent against the dollar to a seven-week high of 78.70, as of 11:15 a.m. in Karachi. The currency has declined as much as 26 percent this year as foreign investors spooked by the global credit crunch withdraw funds from emerging markets. The yield on the benchmark 9.6 percent bond due August 2017 held at 15 percent.
The loan from the IMF “will ease constraints on foreign currencies and it will boost the confidence of overseas and domestic investors,” said Samiullah Tariq, an economist at InvestCapital & Securities Ltd. in Karachi. “Now investors know that there will be a lot more fiscal discipline.” He said he expects rupee to strengthen to 75 against the dollar in a month. The IMF has approved more than $40 billion of loans in recent weeks to prevent the global financial crisis and recession from undermining the stability of developing nations. Ukraine, Serbia and Iceland have already got funds from the IMF. Belarus has requested $2 billion and Turkey may also agree to emergency funding.
“The Pakistani economy was buffeted by large shocks during fiscal year 2007 and 2008, including adverse security developments, higher oil and food import prices and the global financial turmoil,” said IMF Deputy Managing Director Takatoshi Kato. “By providing large financial support for Pakistan, the IMF is sending a strong signal to the donor community about the country’s improved macroeconomic prospects.” Pakistan expects the IMF loan will help it win additional aid from a group of other lenders and donor nations, including the U.S., U.K., China and Saudi Arabia. The group’s Nov. 17 meeting in Abu Dhabi adopted a “work plan” for financial help to Pakistan, the Foreign Ministry has said.
To secure the IMF loan, Pakistan agreed to a “significant tightening of fiscal policy” and an end to central bank financing of the government. Pakistan plans to reduce its budget deficit to 4.2 percent of gross domestic product in 2009 from 7.4 percent in the past financial year, according to the Washington-based lender. The cost of insuring a $10 million Pakistani government bond against the risk of default has more than doubled since the end of September to $2.28 million a year from $987,000 per annum, according to CMA Datavision.
Last week Pakistan’s government said the country’s $150 billion economy was expected to expand 4.3 percent in the fiscal year ending June 2009. Growth is easing after central bank Governor Shamshad Akhtar on Nov. 12 increased interest rates by the most in more than a decade to curb inflation, which jumped to a 30-year high of 25.33 percent in August. Pakistan completed its last IMF program in 2004 with a credit rating from Standard & Poor’s of B+, four levels below investment grade. S&P cut the nation’s rating to CCC on Nov. 14, one day before the latest IMF loan was announced, citing a risk of default on external debt payments.
Trade Drop Could Set Developing Countries Back Years
A looming drop in world trade could “set developing countries back for many years” and erase recent gains in development, a senior World Bank official warned ahead of a United Nations international conference in Qatar. Danny Leipziger, Vice President of the Poverty Reduction and Economic Management network at the World Bank, says the financial crisis has already affected trade and could undermine progress achieved in Africa and elsewhere in the last six years.
Low-income countries, weakened by high food and fuel prices over the last year, “have little to fall back on in terms of sheltering the vulnerable. With a global downturn a certainty, we are in for a rough patch,” adds Leipziger. The World Bank Group announced during its Annual Meetings in October it stands ready to step up assistance to developing countries. Measures include increasing IBRD lending to as much as $100 billion over the next three years and doubling IFC’s trade finance program to $3 billion.
The World Bank Group is also working to speed up grants and long-term, interest-free loans to the world’s 78 poorest countries, 39 of which are in Africa. About $42 billion in funds are available through the International Development Association, the World Bank’s fund for these countries, over a three-year period.
World trade has indeed been an engine of the world economy, with developing countries posting nearly 8 percent growth and attracting a record $1 trillion in net private capital flows in 2007. Global trade is more than the mere exchange of goods and services. It includes exchanging knowledge, know-how, and ideas more generally, notes Leipziger. But in 2009, world trade could decline for the first time since 1982. The global economy is forecast to grow by only 1 percent, with developing country growth expected to fall to 4.5 percent from a previously projected 6.5 percent. The World Bank estimates each 1 percent drop in growth could trap another 20 million people in poverty.
Global recession looms as heads of state are set to meet at the International Conference on Financing for Development in Doha, Qatar, November 29 to December 2. The conference is a follow up to a 2002 meeting in Monterrey, Mexico, often seen as a turning point in development cooperation by the international community. The meeting will be preceded by a special UN summit on the financial crisis in Qatar on November 28, expected to be attended by leaders of G20 and non-G20 countries.
“At the moment what’s constraining world trade is not only falling global demand but lack of trade finance,” says Leipziger. “You can’t get enough financing to ship your goods. So this is something that needs to be solved, and the quicker the better.” “The main thing is to try and have this recession be as short as possible,” he says. With most developed countries expected to slip into recession, fears linger some will move to raise trade barriers. “The multilateral trading system is no doubt being tested,” says Leipziger. A case in point are the subsidies and other forms of domestic support to various industries that developed countries are contemplating.
Leipziger says keeping markets open is key. Governments should strive to use the crisis as an opportunity to invest in trade-related infrastructure, implement measures to facilitate trade, and maintain trade finance credit lines and guarantees, especially through their export credit agencies, he adds. The World Bank welcomes the commitment to trade that G20 participants made at the Washington Summit on November 15. In their communiqué they said: “we will refrain from raising new barriers to investment or to trade in goods and services, imposing new export restrictions, or implementing World Trade Organization (WTO) inconsistent measures to stimulate exports.”
Leipziger says the World Bank’s trade programs can also help countries improve their trade prospects. One program focuses on expanding the Bank’s trade facilitation and logistics and aims at getting exports to ports more efficiently, as well as helping developing countries reduce the costs of engaging in international trade and take better advantage of global trade opportunities, including meeting OECD import standards.
Another program helps create new trade opportunities and expand the “Aid for Trade” initiative by supporting country programs on trade and competitiveness, trade-related infrastructure, and other trade-related issues. “We need to ensure developing countries have access to credit and international markets. I think that’s where the maintenance of an open trading system is very important,” says Leipziger. “Even though OECD countries may be in recession, that doesn’t mean we should be resorting to protectionism, which will set developing countries back for many years. It’s really incumbent on all countries to keep international trade and finance flowing, because that can limit the damage of the global downturn; we all stand to benefit the most from that, especially developing countries.”
Crisis in paradise: Economic meltdown creates ghost resorts in the Caribbean
The ocean glows a milky turquoise. Tiny waves lap at the powder-beige sand, in no rush to reach the line of postcard-perfect palm trees.
Hundreds of luxury villas are positioned to take in the view, but there are no guests. There are no roofs either; neatly tied bundles of red tiles are stacked outside. The wind slams doors and rustles the yellowed newspaper taped to the windows.
The paralyzed work scene at the Cap Cana resort, a development including four luxury hotels, three golf courses and a mega-yacht marina, is a victim of the global financial crisis that has hit the Caribbean's tourism industry especially hard. Cap Cana fired 500 workers last month after Lehman Brothers declared bankruptcy and a $250 million loan fell through. Talks to re-negotiate a $100 million short-term loan collapsed last week, and more layoffs are expected. "Our project has been affected by the economic tsunami that has paralyzed the global financial markets," said Cap Cana President Ricardo Hazoury.
Construction is also paralyzed at the Ritz-Carlton Molasses Reef resort in secluded West Caicos, where 60 Chinese workers revolted last month to demand back wages. About 160 workers have been sent home to China, and it's unclear when construction will resume at the hotel, marina and condominium project, which is three-quarters complete.
This month, the sprawling Atlantis resort in the Bahamas laid off about 800 workers, citing low occupancy rates. Baha Mar Resorts Ltd. laid off about 40 employees at its Sheraton Resort in the Bahamas and 40 more at the Wyndham Nassau Resort. The Bahamas Hotel Catering and Allied Workers Union has called a demonstration Thursday to demand government aid. "I've been in the business 38 years. I have seen the impact of the Gulf War. I have seen the recession of the '80s. Certainly Sept. 11," said Robert Sands, senior vice president of external affairs at Baha Mar. "But nothing has been of a global nature, which makes the current financial situation we're in much more worrisome."
In Puerto Rico, the Caribe Hilton laid off more than 50 people this month because of rising costs and sluggish occupancy rates. The last time the hotel had to lay off workers was after the Sept. 11 attacks, General Manager Jose Campo said. "What worries me is that this will last longer," he said. "We are mounting an aggressive campaign, but the situation is what it is."
Even the normally busy holiday season is expected to be relatively quiet. "There is space available for the holiday season and beyond," said Alec Sanguinetti, CEO of the Caribbean Hotel & Tourism Association. "This is often a time when hotels are sold out and vacationers are looking for any place that has availability." Workers are spending their days off looking for jobs outside the tourism industry. Others have already been sent home.
Victor Felipe Feliz, 24, has been feeding his two children on store credit since he lost his construction job at Cap Cana last month. "I need to work so I can buy Pampers, so I can buy food," he said. "It has been a couple of months since I bought clothes. I can't afford anything." Cap Cana plans to fire another 1,000 workers in the coming months, according to a company official who spoke only on condition of anonymity because he wasn't authorized to release the information. But Cap Cana President Ricardo Hazoury said he expects the project to go forward as the company outsources certain services.
The 50-square-mile (130-square-kilometer) development is nestled in the Dominican Republic's easternmost point amid lush jungle. Its developers include Deutsche Bank, the Trump Organization and the Ritz Carlton Hotel Company. Cap Cana runs more like a city than a private development. It generates its own power and water and has hundreds of villas and condominiums — even a school. Some of the villas and hotels are inhabited, but most remain under construction. "We used to have a lot of workers — brick layers, plumbers, electricians," said Wilkin Cuevamato, who was laid off but later found work at another Cap Cana property. "The majority have left and gone home."
Tourists willing to make last-minute travel arrangements will find some real bargains as hotels react to the soft period, according to Scott Berman, a tourism adviser for Pricewaterhouse Coopers in Miami. "If you're flexible and have time on your hands, you're going to find some favorable deals this winter," he said. But cheaper rooms are often offset by expensive airfare, according to Renaldo Inesta, division manager for AAA in Puerto Rico. American Airlines, the main carrier to the island, has cut back flights by 44%, though other airlines are stepping in to reduce the overall drop to 14%.
Beyond the holiday season, the picture is bleak. Getting money to finance new projects will be difficult amid the credit squeeze. A new U.N. report predicts access to external financing for the region will be limited, and what is available will come with high interest rates. But some remain optimistic. In September, even as the financial crisis was gathering steam, Hilton Hotels Corp. announced plans to build 17 hotels in the Caribbean, adding to the 13 it already has.
"We have analyzed the region," said Gregory Rockett, who is overseeing the expansion. "We are very confident that in the next five years we can do these numbers." And Sanguinetti points out that for North Americans, the Caribbean remains a quick and attractive getaway. "We provide a relaxing escape from the tensions that people are facing at work during this economic crisis," he said. "We expect that pent-up demand will be released."
Double jeopardy for financial policymakers
In the current turmoil, accidents can pull us in vastly different directions. The unforeseeable bankruptcy of Lehman Brothers, the US investment bank, transformed a lingering financial crisis into a near-systemic meltdown. Depending on how other unpredictable events turn out in the next few weeks and months, we could end up with a deflationary depression, an inflationary boom or even one followed by the other. In such an environment, economic forecasts are useless – worse than useless, in fact, because they give us a sense of certainty where there is none.
One path-changing accident would be the bankruptcy of one of the large US carmakers. The probability of such an event has clearly risen in the past week. Naturally, this would be bad for the US car industry itself. But it might be even worse for the banks, especially those that got involved with credit default swaps – probably the most dangerous financial products ever invented. CDSs are unregulated shadow insurance products that investors buy to protect themselves against default of corporate and sovereign bonds. Protection against a default by General Motors was among the most sought-after contracts.
The housing market is another potential time-bomb. Until recently, most of the housing experts were content to predict a 25-30 per cent fall in US prices – peak to trough. Such a fall would bring prices back in line with the long-term trend. But this was before an expected mild downturn turned into a big recession, and credit froze up. Under such conditions, one would expect house prices to overshoot, say at least 10 or 20 percentage points beyond the trend line. So we may be talking about a peak-to-trough fall of 40-50 per cent on average in nominal terms – and more in real terms. There is no reason to see why the downturn should be any different in the UK, Ireland and Spain.
The path might take us elsewhere, however. Suppose the Detroit Three get their bridging loans. Suppose further that the CDS market does not collapse, and governments find effective measures to prevent an extreme overshooting of house prices. Then we might find ourselves in a completely different world. The recession in the western economies might end in the middle of next year. With interest rates close to zero, borrowing would pick up fast. Oil and commodity prices would rise as fast as they came down. I would expect the central banks to be too slow in raising their interest rates for fear of killing off the incipient recovery.
The result would be a sudden rise in inflation, perhaps the mother of all bond market crashes and, quite possibly, a dollar crisis. So there are risks both ways – asymmetric perhaps, but surely significant, both in terms of their impact and their probability. Statisticians distinguish two types of errors: type one and type two. Suppose we believe that another Great Depression is about to happen. A type-one error would be to reject our depression scenario when it is true, while a type-two error would be to accept it when it is false. The US Federal Reserve’s policy is about avoiding a type-one error – underestimating the threat of a depression – at all costs. I was quite surprised last week – though perhaps should not have been – when I learnt that the Fed had quietly adopted a policy of “quantitative easing”.
The Fed conducts open-market operations normally with the goal of keeping the actual Fed funds rate close to the target rate set by the Fed’s open-market committee. The Fed funds rate is the rate at which banks lend their balances to each other overnight. But, more recently, the actual Fed funds rate has fallen much below the target rate, which is 1 per cent. Under a strategy of quantitative easing, the Fed does not care about the rate. The goal is to increase the money supply, by swamping the Fed funds market with liquidity. The calculation is that this would give banks an incentive to buy higher yielding securities, which would reduce long-term interest rates, over which the central bank has no direct influence.
For a central bank, this is comparable to the deployment of the nuclear option – your last or last-but-one policy option. Ben Bernanke, the chairman of the Fed, once co-wrote a paper on the subject of what a central bank can do when interest rates hit the “zero bound”* – a zero rate. The answer is that there are a few options, quantitative easing among them. It is interesting, though, that he has already deployed his weapon of mass desperation while still some distance away from the zero bound.
The US policy establishment regards this crisis principally as carrying a “one-tailed”, or one-sided, risk of a deflationary depression, to be avoided at all costs. But there are also grave risks associated with making a type-two error. A subsequent rise in US inflation could trigger a mass flight out of dollar assets and a large rise in US market interest rates, followed by a huge recession. The main difference is that the policy options would be a lot more constrained under such a scenario. In fact, a type-two error could also give rise to a depression – only later. I still think it is best to treat the crisis as an event with a “two-tailed” risk.
Coal's return raises pollution threat
Britain is poised to expand its coal mining industry, despite fears that the move will lead to a rise in climate change emissions and harm communities and the environment. Freedom of information requests and council records show that in the past 18 months 14 companies have applied to dig nearly 60 million tonnes of coal from 58 new or enlarged opencast mines. At least six coal-fired power stations are planned. If all the applications are approved, the fastest expansion of UK coal mining in 40 years could see southern Scotland and Northumberland become two of the most heavily mined regions in Europe.
The demand for new mines is being driven by dramatic increases in the price of coal. This has quadrupled in two years and has risen by 45 per cent since the start of this year. Opencast, or surface, mines are much cheaper than deep mines, but those living nearby can suffer years of pollution.
The increase in mining will embarrass the Energy and Climate Change Secretary, Ed Miliband, who is arguing that Britain must reduce carbon emissions. Ministers must soon decide whether to approve a controversial new coal-fired power station at Kingsnorth in Kent, the first in 30 years. 'Attention has been focused on the decision at Kingsnorth, but over the past 18 months local authorities have approved more than 24 new opencast mines and 16 expansions of existing mines,' said Richard Hawkins, of the Public Interest Research Centre (Pirc), which conducted the study.
'There is a clear contradiction between the government's 80 per cent target for climate change emissions cuts and investment in new coal. With industry and government saying carbon capture and storage is at least 20 years away, this shows that the 160m tonnes of carbon dioxide released by burning this coal would not be captured,' he said.
Research shows that Scotland will bear the brunt of the expansion. Currently 11 mines produce about 5m tonnes of coal a year. A further 27 mines could extract a total of 22m tonnes of coal over just a few years. Thirteen of the 27 have already been approved and the rest are awaiting planning decisions.
Northumberland is likely to become the centre of coal mining in England with plans to extract more than 20m tonnes of coal from some of the largest opencast mines in Europe. Wales, which has one of the biggest surface mines in Europe at Ffos-y-Fran, could have five large new mines. The research also suggests that power companies would like to build six new coal-fired power stations. These would replace existing power stations if given the go-ahead but could lock Britain into coal for the next 50 years at a time when it is trying to lead the world on reducing climate change emissions.
According to the research, based on information provided by energy companies, Scottish and Southern, Scottish Power, Eon and RWE npower all have plans at different stages of development. Feasibility studies have been carried out on new plants at Cockenzie and Longannet in Scotland, as well as new stations at Tilbury in Essex, Blyth in Northumberland and Ferrybridge in Yorkshire. Only one application to build, at Kingsnorth in Kent, has so far been put forward.
In the past six months 12 groups, made up of climate change activists and residents, have been set up to object to the plans. There have been big protests in Wales, Derbyshire and Yorkshire and a coal train heading for Britain's biggest power station at Drax in North Yorkshire was hijacked by protesters in June.
Nearly half of all British coal is mined using opencast methods against just 12 per cent 10 years ago, but this is expected to increase significantly. In 2005, total UK production was 20m tonnes, with 9.6m tonnes coming from deep-mined production and opencast accounting for 10.4m tonnes. Nearly 70 per cent of all the coal burnt in UK power stations is imported from Russia, South Africa, Colombia and Australia.
But coal prices have risen far above official projections. 'Part [of the increase in applications] is certainly due to the increase in the world coal price, which follows oil and gas,' said a spokesman for the Coal Authority, the body which regulates the licensing of UK coal mines.
Monbiot: The planet is now so vandalised that only total energy renewal can save us
It may be too late. But without radical action, we will be the generation that saved the banks and let the biosphere collapse. The costs of a total energy replacement and conservation plan would be astronomical, the speed improbable. But the governments of the rich nations have already deployed a scheme like this for another purpose. A survey by the broadcasting network CNBC suggests that the US federal government has now spent $4.2 trillion in response to the financial crisis, more than the total spending on the second world war when adjusted for inflation. Do we want to be remembered as the generation that saved the banks and let the biosphere collapse?
This approach is challenged by the American thinker Sharon Astyk. In an interesting new essay, she points out that replacing the world's energy infrastructure involves "an enormous front-load of fossil fuels", which are required to manufacture wind turbines, electric cars, new grid connections, insulation and all the rest. This could push us past the climate tipping point. Instead, she proposes, we must ask people "to make short term, radical sacrifices", cutting our energy consumption by 50%, with little technological assistance, in five years.
There are two problems: the first is that all previous attempts show that relying on voluntary abstinence does not work. The second is that a 10% annual cut in energy consumption while the infrastructure remains mostly unchanged means a 10% annual cut in total consumption: a deeper depression than the modern world has ever experienced. No political system - even an absolute monarchy - could survive an economic collapse on this scale.
She is right about the risks of a technological green new deal, but these are risks we have to take. Astyk's proposals travel far into the realm of wishful thinking. Even the technological new deal I favour inhabits the distant margins of possibility.
Can we do it? Search me. Reviewing the new evidence, I have to admit that we might have left it too late. But there is another question I can answer more easily. Can we afford not to try? No, we can't.