Stoneleigh: Everyone has heard of pyramid, or Ponzi, schemes. In their simplest form they are short-lived deliberate frauds where a small number of existing members are paid from the buy-in of a larger number of newer members until the supply of newer members is exhausted, whereupon they collapse. Typically, the founders, and perhaps a few others who got in early and out before it was too late, end up making a lot of money at the expense of later entrants, who end up holding the empty bag. There are always many more losers than winners. What most do not realize, however, is that Ponzi dynamics are far more pervasive than people think. There are many human systems that ultimately rest on the buy-in of new entrants, and every one of them will ultimately meet the same fate, although it can take far longer for complex constructions than for simple pyramid frauds.
What allows a more complex pyramid to last for longer than a simple one is a supplementary source of funds to pay members, besides merely the buy-in of newer members. The more such sources there are, legitimate and otherwise, the more complex the pyramid can become and the longer it will last, as the apparent on-going success of early entrants will attract many more new ones. There's nothing like seeing one's friends and neighbours seemingly making a lot of easy money for a long time to eventually overcome the mental defenses of even the most skeptical.
Following the collapse of communism in Eastern Europe, there was a spate of such schemes - notably MMM in Russia, Caritas in Romania, Jugoskandic and Dafiment Bank in Serbia, TAT in Macedonia, and VEFA Holdings, Xhafferi, Populli, Gjallica and several others in Albania. They were the topic of my academic research at the time. All of these lasted for quite a long time, and some paid out spectacular returns for much of that time. For instance, the Albanian funds , or quasi-banks, began by paying out 3-5% per month over a 6 month term and were eventually paying out 10% per month (and briefly much more as an interest rate war ensued very late in the game).
They were able to do this temporarily because the income from the buy-in of new entrants was supplemented by revenue from drug smuggling, oil sanctions busting, money laundering, gun running, human trafficking and a thriving trade in car theft from across Europe. There was some revenue from legitimate business interests, but not much in a country that survived mainly on a combination of remittances and politically supported criminal activity. Ironically, Albania was the darling of the IMF at the time.
Over time, approximately 80% of the Albanian population was drawn into the pyramids, often selling their only real property in order to invest and then depending on the pyramids for all their income. When the inevitable happened, the vast majority of the population was completely dispossessed. Although many had realized that there was something too-good-to-be-true about their 'investments' they had succumbed to greed "in the belief that they were in the hands of properly structured criminality", as The Guardian newspaper put it in February 1997. The population believed, erroneously, that there was an implicit guarantee from the government, which was conspicuously and intimately entwined with the activities of the various funds.
In the developed world, there are many examples of pyramid dynamics where there is no intent to defraud at all - where even the founders really don't understand the underlying logic of their business model taken to its logical conclusion. Direct marketing, for instance, is essentially pyramid-based - depending on an ever-increasing network of sales people, each of whom receives a percentage of their income from those they can attract into the business. If these businesses can no longer grow by attracting new salespeople, then they are ultimately finished, but as they cannot grow perpetually (or eventually everyone in the country would end up making a living selling these products to each other), they are inherently self-limiting. They can last for many years thanks to legitimate business revenues, but not forever. Early entrants will always do very well, at the expense of later ones, and the last tiers will certainly lose their stake.
Large economic bubbles, typically formed in dominant economies during periods of manic optimism (see McKay's Extraordinary Public Delusions and the Madness of Crowds), have the same underlying dynamic. Without continual buy-in from new money - new investors or more money from existing investors - they cannot grow, and when they can no longer grow, they will collapse. Although grounded initially in legitimate business activity, they morph into structures where one has to question the motives and understanding of key individuals. In some cases there may be intent to defraud, but what is far more common is a characteristic recklessness as to the risks those in control are prepared to take with other people's money.
In their latter stages, such structures hollow out, feeding on their own internal substance as they lose the ability to attract new investment. In the terminal phase, there is the appearance of great wealth, but it is virtual, and therefore extremely ephemeral. The next step is implosion, as the virtual wealth disappears - where the claims to wealth generated through leverage that exceed the amount of underlying real wealth are extinguished en masse. Enron was a prime example, and on a much larger scale, so is the derivatives market. Bubbles, like all Ponzi structures, are inherently self-limiting and will always collapse in the end.
At the largest scale, empires are also grounded in pyramid dynamics, which is why they too have a limited lifespan. They grow by assuming control, either politically or economically, of new territories, positioning themselves to cream off surpluses from an ever-expanding geographical area in a form of involuntary buy-in. In the past political control through invasion or physical colonization was more common, but latterly globalization has enabled the development of a sophisticated system of economic control based on international debt slavery, supplemented with economic colonization for the purpose of resource extraction. Both resources and financial surpluses, in the form of perpetual interest payments, could be efficiently extracted from the periphery and accumulated at the centre, where they led to the development of an unprecedented level of socioeconomic complexity.
Such wealth conveyors in favour of the economic centre, at the expense of the hinterland, are the very heart of empire, but without continual expansion to feed rapidly developing central complexity, they eventually fail, leaving the centre unable to sustain its existing complexity level. As with economic bubbles, empires hollow out in the latter stages, consuming their own substance in a catabolic manner in order to compensate for the inability to strengthen wealth conveyors sufficiently quickly to keep pace with the expanding requirements of the centre.
As the hinterland is increasingly stripped of wealth and resources, and burdened with the increasing environmental impact of its own exploitation, an increasing fraction of it is left too impoverished to sustain a minimum level of internal order. In modern times we speak of failed states without realizing why many of these states are failing, or the impact that an increasing number of failed states will ultimately have on our own standard of living.
Wealth conveyors are breaking down, and no amount of financially squeezing the population in the central economies can compensate for the loss of that ability to accumulate wealth from virtually the whole world. The vast majority of the central population will be brutally squeezed as the elites try to hang on to their own privileged position, but this can only sustain a very small, and rapidly shrinking, fraction of the population, and at great cost.
We are living through the collapse of the final - and all-consuming - economic bubble at the end of the American empire.
New home sales fall to slowest pace since 1991
Sales of new homes fell in October to the lowest point in nearly 18 years while the median price of a new home dropped to the lowest level since 2004.
The Commerce Department reported Wednesday that new home sales decreased 5.3 percent last month to a seasonally adjusted annual sales pace of 433,000 homes, the lowest level since January 1991, another period when the country was undergoing a steep housing downturn. The median price of a new home sold in October fell to $218,000, down 7 percent from a year ago. It was the lowest median sales price since September 2004.
The drop in new home sales was bigger than analysts had expected and left sales 40.1 percent below where they were a year ago. The bad news on new home sales follows other reports this week that paint a bleak picture of the housing industry. On Tueday, a report on home prices and downbeat earnings results from homebuilder D.R. Horton showed further deterioration in the housing market. The Standard & Poor's/Case-Shiller U.S. National Home Price Index said home prices tumbled a record 16.6 percent during the third quarter from the same period a year ago. Prices are at levels not seen since the first quarter of 2004.
Fort Worth, Tex.-based D.R. Horton Inc. reported a nearly $800 million loss in its fiscal fourth quarter on slower home sales and more than $1 billion in charges. A report Monday showed sales of existing homes fell a bigger-than-expected 3.1 percent in October to an annual rate of 4.98 million units. The median or midpoint price for existing homes plunged to $183,000, down 11.3 percent from a year ago.
The disappointing performance for both new and existing homes showed that the country is still in the grips of a severe housing downturn. The problems in housing have sent shockwaves through the entire economy as mounting mortgage foreclosures have cost banks billions of dollars in loan losses, creating the worst financial crisis to hit the country in seven decades. President-elect Barack Obama has said Congress should begin working on a sizable stimulus program even before he is sworn in on Jan. 20, with the goal of creating 2.5 million jobs over the next two years to keep the economy from falling into a prolonged recession. The housing industry also is appealing for help from the new administration.
The report on new home sales showed sales were down 18 percent in the West and 6 percent in the South. Sales posted a 22.6 percent increase in the Northeast and were up 6 percent in the Midwest. The drop in sales pushed the inventory of unsold homes up to 11.1 months, meaning it would take that long to exhaust the stock of unsold homes at the October sales pace.
Builders, who have been slashing production in an effort to get control of inventories, are being faced with soaring mortgage defaults which are dumping more unsold homes on an already glutted market. The National Association of Home Builders reported last week that its survey of builder confidence fell to an all-time low of 9 in November, down from 14 last month. Index readings higher than 50 indicate positive sentiment about the market. But the trade group's index has drifted below 50 since May 2006 and below 20 since April.
The housing slump already has cost the country 3 million jobs in construction and related industries, and the home builders are urging Congress to help with increased support for the industry. Tighter lending standards, rising defaults and fear about the housing market's future have sidelined buyers, an absence felt acutely by homebuilders such as Pulte Homes Inc. and Centex Corp.
Consumer spending, durable goods orders plunge
Consumers cut spending during October at the steepest rate in more than seven years and orders for costly manufactured goods plummeted, according to Commerce Department reports on Wednesday that implied a steep recessionary downturn was at hand. Spending that fuels two-thirds of U.S. economic activity dropped 1.0 percent, its biggest fall since the attacks against the United States seven years ago in September 2001.
It was a fourth straight monthly fall in spending and underlined how a credit crunch, falling home prices and steady job losses were sapping consumers' will and ability to spend. Worse yet, a survey showed consumer confidence fell to a 28-year low in November as mounting job losses, falling incomes and tumbling household wealth battered sentiment, highlighting the troubles for the economy ahead.
Orders for costly durable goods like cars, machinery and computers dropped by 6.2 percent in October, more than twice as much as Wall Street economists had forecast, as demand weakened across nearly every major sector of manufacturing. "The durables is not a pleasant number. It's horrid across the board," said Boris Schlossberg, director of currency research at GFT Forex in New York.
The only piece of relatively good news was a report from the Labor Department that new claims for jobless benefits fell by 14,000 last week. But that still left claims at a seasonally adjusted 529,000, well above levels that economists typically associate with recessionary economic conditions. A four-week moving average of claims that irons out weekly fluctuations climbed to 518,000 last week from 507,000 the week before, its highest reading since January 1983. The slew of weak data pushed U.S. government bonds higher in price and the U.S. dollar was down against the yen. U.S. stocks fell early in the day.
The deluge of data included a report showing business activity in the U.S. Midwest contracted in November at a more severe rate than expected. The Institute for Supply Management-Chicago business barometer fell to 33.8 from 37.8 in October. Economists had forecast the index at 36.7. A reading below 50 indicates contraction. The Reuters/University of Michigan Surveys of Consumers said its final index reading of confidence for November fell to 55.3 from October's 57.6. That was its lowest since 1980.
The index came in well below economists' expectations of 57.7, according to the median of forecasts in a Reuters poll, and deteriorated sharply since the middle of the month, when lower gasoline prices had cheered many consumers.
U.S. Details $800 Billion Loan Plans
The Federal Reserve and the Treasury announced $800 billion in new lending programs on Tuesday, sending a message that they would print as much money as needed to revive the nation’s crippled banking system. The gargantuan efforts — one to finance loans for consumers, and a bigger one to push down home mortgage rates — were the latest but probably not the last of the federal government’s initiatives to absorb the shocks that began with losses on subprime mortgages and have spread to every corner of the economy.
In the last year, the government has assumed about $7.8 trillion in direct and indirect financial obligations. That is equal to about half the size of the nation’s entire economy and far eclipses the $700 billion that Congress authorized for the Treasury’s financial rescue plan. Those obligations include about $1.4 trillion that has already been committed to loans, capital infusions to banks and the rescues of firms like Bear Stearns and the American International Group, the troubled insurance conglomerate. But they also include additional trillions in government guarantees on mortgages, bank deposits, commercial loans and money market funds.
The mortgage markets were electrified by the Fed’s announcement that it would swoop in and buy up to $600 billion in debt tied to mortgages guaranteed by Fannie Mae and Freddie Mac. Interest rates on 30-year fixed-rate mortgages fell almost a full percentage point, to 5.5 percent, from 6.3 percent. But analysts said the program would do little to reduce the tidal wave of foreclosures. That is because most of the foreclosures are on subprime mortgages and other high-risk loans that were not bought or guaranteed by government-sponsored finance companies like Fannie Mae. Stock investors reacted coolly to the announcements. The major stock indexes initially fell. The Standard & Poor’s 500-stock index later edged up, closing at 857.39, up 0.66 percent. The Nasdaq closed down 0.5 percent, at 1,464.73.
The long-term risks are enormous but difficult to estimate. They begin with the danger of a new surge of inflation, at least after the economy comes out of its current downturn. Beyond that, taxpayers will have to pick up the losses from loans that default or guarantees that have to be made good. But the most troublesome unknowns are how the maze of protections for investors and consumers will change economic and political behavior in the future.
“The Federal Reserve has a lot of levers of influence with consequences for individual industries,” said Vincent R. Reinhart, a former Fed official and now a senior fellow at the American Enterprise Institute. “Now that it has used those levers, don’t you think Congress will want it to start using them again? The Fed could become the go-to place for bailouts.”
Administration and central bank officials contend that the risk of doing nothing is a full-blown depression in which unemployment climbs above 10 percent and the country needs years to recover. Many private economists agree. “They are doing whatever it takes,” said Laurence H. Meyer, a former Fed governor who is now vice chairman of Macroeconomic Advisers, an economic forecasting firm. “The problem is, the more you go in this direction, the harder it is to turn around and the harder your exit strategy is.”
Most economists agree that the United States is in the worst financial crisis since the Great Depression, and that it has already fallen into a severe recession that is likely to be one of the deepest in decades. “What they are doing is trying to limit the damage to something consistent with a severe postwar recession, but not something worse than that,” Mr. Meyer said. Indeed, the government reported on Tuesday that the economy contracted by 0.5 percent in the third quarter, slightly worse than previously estimated. But private forecasters predict that economic activity will fall by 4 to 5 percent in the fourth quarter and continue to contract for much of next year.
In the first of two new actions announced on Tuesday, the Treasury and the Fed said they would create a $200 billion program to lend money against securities backed by car loans, student loans, credit card debt and even small-business loans. The Treasury would contribute $20 billion to the so-called Term Asset-Backed Securities Loan Facility and assume responsibility for any losses up to $20 billion. The Federal Reserve would lend the new entity as much as $180 billion.
The new facility would then lend money at low rates to companies that post collateral based on securities backed by consumer debt or business loans. The new program would be allowed to accept only securities with Triple-A ratings, the highest possible, from at least two rating agencies. The Treasury secretary, Henry M. Paulson Jr., made it clear that the new lending facility was just a “starting point” and could be expanded to many other kinds of debt, like commercial mortgage-backed securities. “It’s going to take awhile to get this program up and going, and then it could be expanded and increased over time,” he said at a news conference.
Separately, the central bank announced that it would try to force down home mortgage rates by buying up $600 billion in debt tied to home loans guaranteed by Fannie Mae, Freddie Mac and other government-controlled financing companies. The actions on Tuesday represented two milestones in the government’s expansion into private markets.
It was the first time that the Fed and the Treasury have stepped in to finance consumer debt. The $200 billion program comes close to being a government bank.
But the new programs also represented a new level of commitment by the Federal Reserve. Instead of trying to strengthen the economy by reducing short-term rates, which is the usual policy tool, the Fed is now pumping vast amounts of money directly into specific markets for mortgages — and anything else it believes needs help. Over the last year, the Fed and the Treasury have bailed out major Wall Street firms, rescued the world’s biggest insurer, taken over Fannie Mae and Freddie Mac, and guaranteed hundreds of billions of dollars in bank transactions.
As big as the two new lending programs are, Mr. Meyer cautioned that they were only going to reduce the pain that lies ahead, not eliminate it. Unemployment, at 6.5 percent in October, is still likely to climb to 7.5 or even 8 percent next year, he predicted. But it may not shoot up to 9 or 10 percent, a level that economists often consider the unofficial dividing line between a recession and a depression.
The new actions are unlikely to be the last. Until the economy begins to turn around, Fed officials have made it clear they are prepared to print as much money as needed to jump-start lending, consumer spending, home buying and investment. “They are using every tool at their disposal, and they will move from credit market to credit market to reduce disruptions,” said Richard Berner, chief economist at Morgan Stanley.
The Federal Reserve has now moved to a radical new phase of its effort to shore up the economy. Until now, it has carefully distinguished between two goals — reducing the panic and turmoil in financial markets, and propping up the economy itself, which has been battered as the supply of credit has dried up. To tackle the first goal, the Fed expanded its lending programs to banks and Wall Street firms, and organized the rescue of failing firms like Bear Stearns.
To bolster the general economy, it relied on its traditional tool: reducing the overnight Federal funds rate, the interest rate that banks charge for lending their reserves to one another. Normally, a lower Federal funds rates leads to lower long-term rates, like those for mortgages. But the central bank has already lowered the rate to 1 percent, and it cannot reduce it below zero. Instead, policy makers are buying up other kinds of debt securities, which has the effect of driving down the rates in those parts of the market.
The move amounts to what economists refer to as “quantitative easing,” which means having the Fed pump staggering amounts of money into the economy by buying up a wide range of debt instruments. In a conference call with reporters, Fed officials insisted their goal was not to pursue a policy of quantitative easing, but simply to unfreeze the mortgage market. But for practical purposes, the actions lead to similar results.
Encouraged by a wicked wizard, Greenspan, Bernanke toils at his printing press, by Hugh Hendry
People blame this crisis on cheap money and greedy bankers. They certainly cannot be exempted. But I take a more fatalist point of view. There has to be a reason for humans to die off in their 70s and 80s. I believe it is so that the memory of a generation's mistakes is erased, allowing future ages to repeat the folly of greed and fear. Because of this, I spend a lot of time reflecting on social mood and behaviour. Popular fiction is a particular fascination; I believe it provides a mind map of the social conscience.
The Wizard of Oz is a personal favourite. I would contend that bullish markets produce feel-good films, like Disney animation; that bear markets produce depictions of horror and foreboding (think Hammer House of Horror in the 1970s and SAW, its modern equivalent); and that social mood is linked to stock market patterns. The original Frank Baum story was written as a political allegory of America's entry on to the gold standard in 1879. The strictures of sound money coincided with a vibrant post Civil War economy.
The result was deflation: prices fell by 1.7pc pa between 1875 and 1896. The farmer, as depicted by the scarecrow, was held captive by falling agricultural prices and mortgages owed to the big banks, the wicked witch of the east. The spell of tight monetary policy cast a pall over the poor tin woodsman: every time he swung his axe, he chopped off part of his body. It was a depiction of the economy's shuttered and rusting factories.
The easy-money crowd, Bernanke and Greenspan's great grandfathers perhaps, argued the responsibility for the economy's woes lay with an insufficient monetary response. The gold market had a scarcity that choked the US economy into serfdom. Instead, the populists' manifesto called for the readmission of more plentiful silver coinage into the system – a point captured by Dorothy's silver slippers (Hollywood changed them to ruby) as she skipped along the yellow brick road (the gold standard). Print more money and remove us from penury.
Consecutive presidential elections were contested on such a return to bimetallism in 1896 and 1900. Surprisingly, the easy-money crowd, proved unsuccessful; they were defeated by powerful bankers such as JP Morgan. However, the story ends with the good witch of the south (the populace) prophesying that Dorothy's silver slippers (easy-money policy) are so powerful they can fulfil her every wish. This utopia was made possible just 13 years later with the formation of the Federal Reserve. The tin man and the scarecrow would have a more forgiving lender of last resort after all and 71 years later the wizard, called Nixon, went one step further and abolished the need for gold and silver ounces (Oz) when the US reneged on its Bretton Woods commitment to sound money.
Of course, today we could be watching a comparable parable unfold. The past 30 years of economic history may have produced a daunting sequel. I would suggest tomorrow's fiction will prove much darker, perhaps in the image of Goethe's Faust. The story would feature an apprentice printer called Bernanke. Encouraged by a wicked wizard, Greenspan, he toils at his printing press night and day producing reams of paper money. At first his monetary accommodation seems to bring unbridled prosperity. Boom follows boom, as the business cycle is seemingly abolished, house prices grow to the sky and his political stock rises. In time, the scarecrow is bought-off by crop subsidy; the tin man vacations in Vegas, having refinanced his mortgage for the 13th time. And the sorcerer's apprentice is promoted to top wizard.
However, Greenspan, now in retirement, finally reveals his scheme has brought only "bogus riches". The printing presses have created a "zero-sum game" where dollars lose their purchasing power against God's brew of precious metals. The populace begins to save. Spending is reined in. Even the corporate sector suffers. With consumers no longer spending, there are no profits. Shares slump and the fiat kingdom collapses in anarchy. And that is pretty much where we are today.
I withdrew my hard-earned money from a bank this summer. But it may surprise you to learn that I bought government bonds of long duration. Surely I should have bought gold? Except that I believe the way to make money is to seek opportunities through paradox. And therein lies our brinkmanship: everyone has skipped our story and read the conclusion. They fear financial anarchy. Gold coins are sold out. Everyone is in. And yet the price of gold has fallen this year.
So, for now, I would stick with the bonds. The 18-year British gilt yields 4.8pc but, with the Bank of England likely to follow the Fed and slash rates to 1pc, I believe we could see gilt yields below 3pc. And I promise you that if bond yields broke 3pc there would be a stampede to buy. At this stage gold might trade close to $500, and those who missed its rally from 2002 would have the solace of schadenfreude when in reality they should be buying the stuff and selling their bonds. What delicious irony: deflationists and inflationists could both claim to be right. But how many will have profited?
BCE Takeover May Collapse on Insolvency Concerns
BCE Inc.’s takeover by the Ontario Teachers’ Pension Plan may collapse after auditor KPMG said the C$52 billion ($42 billion) deal, the second-biggest leveraged buyout, would leave the Canadian phone company insolvent. The stock fell as much as 40 percent after BCE said the acquisition won’t close Dec. 11 as scheduled if KPMG doesn’t change its opinion. If completed, the purchase would trail only KKR & Co.’s $43.2 billion takeover of TXU Corp. last year.
At least $55 billion of buyouts have fallen apart since last year after the collapse of the U.S. subprime-mortgage market drove up borrowing costs. They include deals for SLM Corp., the student lender known as Sallie Mae, and Penn National Gaming Inc. “The chances of any deal getting done are very low now,” said Sachin Shah, a merger arbitrage analyst with ICAP Corporates LLC in Jersey City, New Jersey. “Having BCE’s auditor call the deal insolvent is what’s surprising here. The market had been expecting that the banks would balk.”
BCE dropped C$13.35 to C$25 in Toronto Stock Exchange trading. Earlier the stock fell as low as C$22.90, or 46 percent less than the C$42.75 offered by Ontario Teachers and its partners. BCE’s predecessors traded as early as 1905, making it one of the country’s oldest public companies. The phone company’s sales have stagnated for four straight quarters, hurt by land-line losses and increasing competition for wireless subscribers.
Last year, Ontario Teachers agreed to buy BCE along with Providence Equity Partners Inc. and Madison Dearborn Partners LLC. Canada’s highest court approved the buyout in June, dispatching a legal challenge by bondholders. Teachers said today that it “will continue to fulfill its obligations under the terms of the agreement” to buy BCE. Citigroup Inc., Deutsche Bank AG, Toronto-Dominion Bank and Royal Bank of Scotland Group Plc are on the hook for about $34 billion for BCE, according to regulatory filings. The banks have sold debt that backed buyouts at discounts to face value to get the debt off their books. In the case of BCE, it would cost billions of dollars.
The average high-yield, high-risk loan is tading at about 66.6 cents on the dollar, just shy of the record, according to Standard & Poor’s LCD. Prices have plummeted almost 9 cents since Nov. 6 and 28. 3 cents this year as investors in the debt have been forced to liquidate funds. Toronto Dominion said it would probably have to keep the loans. “It’s going to be hard,’” said Toronto-Dominion Chief Executive Officer Edmund Clark said this month. “If you take a look at the market, we’re going to hold this on the balance sheet.” Danielle Romero-Apsilos, a spokeswoman at Citigroup, and Deutsche Bank spokesman John Gallagher declined to comment. Patrick Meneley, a banker at Toronto-Dominion Bank’s TD Securities arm, didn’t immediately return a phone call seeking comment.
EU Ready to Present Stimulus Package
On Wednesday the European Commission will present a giant stimulus package to meet the looming economic downturn -- with an estimated €130 billion in initiatives. But Brussels has neither the money nor the ability to forge an economic program.
The situation is getting serious. Europe's industries are running out of contracts. Economists predict that next year will bring reduced working hours and layoffs and that times will get bleak. The states -- or, more precisely, their taxpayers -- have just been forced to rescue the global banking system because its leaders proved to be little more than incompetent gamblers. Now more tax revenues are supposed to avert -- or cushion -- a threatening crisis in the global economy. Taking their places at the head of this phalanx in the fight of "politics against recession" are Barroso and his commissioners. They plan to bring forward an enormous economic program on Wednesday full of prescription for battling the crisis.
"Temporary cuts in value-added (or sales) tax" is one of the proposals that could be "quickly implemented to give a strong fiscal impulse to promote consumption," reads one of the proposals. But that's still not enough. The Commission will also call on EU member states -- especially those that are not deep in debt -- to use national spending packages to "quickly stimulate demand and to lift consumer confidence." According to the plan, the European Central Bank (ECB) should lower interest rates even further and the European Investment Bank (EIB) should offer cheap credit for measures meant to conserve energy and for the production of climate-friendly automobiles. Barroso says the package is based on a "groundwork of coordinated measures by member states, which are tailored to each specific situation." The head of the EU's largest economy, Chancellor Angela Merkel, liked the sound of that and proceeded to do just what Germany's "specific situation" required. Her government has approved injections of capital which over the next two years will total €32 billion. She refuses to do more, and she's said nothing about a quick reduction in taxes. French President Nicolas Sarkozy could not talk her out of this strategy on Monday in Paris. The British example doesn't interest her, either. Prime Minister Gordon Brown's government wants to lower its value-added tax (or VAT) for 13 months, from 17.5 to 15 percent, starting in December.
All European governments are currently facing the same task of building crisis packages. But no one has come up with a convincing, all-encompassing strategy, and true experience among those in charge is lacking. The times when much of the world followed policies developed by British economist John Maynard Keynes have faded into the past. His recipe, more or less, was to save during boom times and spend massively when the economy sputtered. But his antidote became unfashionable -- not least because governments rarely saved.
This crisis has changed everything -- and has forced Europeans to look for lessons from the past. It has led to some rather helpless-sounding proposals. One example is offered by the debate over reducing VAT. It's tempting to wonder whether a flat-screen television will really look more attractive if it costs €575 instead of €587.50. That would be the result of the Britain's VAT reduction. The government in London believes this plan is a good one -- and Brussels agrees. But small businesses disagree, arguing that such a small difference won't spur consumption. On the contrary, many are now complaining of a "logistical nightmare" now that they have to re-tag all of their products.
Still, it seems difficult to imagine that Berlin won't make a similar move next year. Chancellor Merkel may be against it, but many in Germany's conservative camp both in Berlin and in the European Parliament are in favor. And Angela Merkel faces general elections in Germany next year. She has already said that her government will examine the situation once again in January to see if further steps will need to be taken to prop up the German economy. The answer is likely to be "yes."
Bankruptcy update, Britain plus California
The CDS spreads on British debt jumped even higher on Tuesday, touching 100 at one stage. This is a little frightening. I suspect it reflects fear that the liabilities of the British-based banks -- which include HSBC and Standard Chartered, with all their global exposure, as well as RBS, Barclays, Lloyds TSB, HBOS, and Northern Rock -- are disturbingly large for the size of the UK economy. Britain has no real debt in foreign currencies. Like other AAA states, it borrows in its own currency. This is a lifesaver.
However, and here is the awful catch, some of these private banks have vast dollar positions, so as more of them fall into the hands of the British state (partially or fully) the dollar debt implicitly moves across onto the sovereign balance sheet. This is not a subject that I have seen discussed anywhere, but it is worth pondering. What killed Iceland was the dollar/euro debts of its three big banks, not its own sovereign debt in Krona. It is the dollar liabilities of Russia's banks and companies that is now causing a run on the rouble. Here lies the real danger of taking over all these banks so nonchalantly.
I suspect that some hedge funds have already spotted this Achilles Heel and are now testing the trade. (Although a US hedge fund told me last weekend he was targeting the default risk in five other countries in Europe -- and the EIB -- but not British debt because he thought that the UK's role as a military power and a permanent UN Security Council member provided an extra shield, ie the global order has too much political investment in Britain to let it happen. I have no idea whether this is a good judgement, but I pass it on).
By the way, my colleague Yvette Essen showed me the CDS data on some of the US states. These are quite revealing too: Michigan -192; California -165; Nevada - 164; New Jersey - 150; Ohio -104. So, California is now priced as a greater bankruptcy risk than Slovakia, 150.
Re-lend it or lose it
I am in Slovenia today, talking to bankers, entrepreneurs, managers, politicians, government officials and academics. The story is the same here as in every country I have visited since mid-September 2008: the banks aren’t lending. They don’t lend to each other. They don’t lend to non-financial businesses and they don’t lend to households.
In Slovenia I have been told that the banks are both solvent and liquid. I have no way to verify the solvency claim. Based on my observations of the universal ’bankers’ Dance of the Seven Veils’ - where a deeper financial hole is revealed every time a veil is dropped - my benchmark position is that there is no such thing as a ’stand-alone’ solvent cross-border bank in the north Atlantic area any longer. All those that keep their head above water do so because of the explicit or implicit financial support of the state, which now has effectively underwritten their balance sheet.
But given the capital injections, guarantees and other forms of financial support extended by the state, a lot of banks are liquid and capable of lending. They refuse to do so. Where just a year and a half ago, hubris, recklessness, overconfidence and rampant optimism ruled, we now have fear bordering on panic, total lack of confidence, timidity and pessimism verging on institutional clinical depression. The loan officers are brow-beaten and rendered impotent by internal risk controllers. The bean counters are in charge. ‘What you don’t lend, you can’t lose’ is the new micro-prudential ethic. The macroeconomic consequences of this lending paralysis are potentially disastrous. It could turn a global recession into a global depression, with many years of stagnation and cumulative declines of GDP of 10 percent or more.
So, what is to be done? These are extraordinary times that could become desperate times. I propose the following form of forced lending by banks to non-financial businesses. Every loan that matures during the coming year gets extended/renewed for another year on the same terms as the maturing loan. This applies to both secured and unsecured loans. Likewise every credit line or overdraft facility that expires during the coming year gets extended/renewed for another year. Expiring loans, credit lines or overdraft facilities that had an original maturity of less than a year or more than a year will have the same interest rate and other conditions for the one-year extension/renewal as the original arrangement.
This proposal is an application to bank lending to non-financial corporates of a proposal made by Anne Sibert and myself for adding automatic debt roll-over options to lending to sovereign borrowers. The main difference is that the addition of the rollover option would be for one year only, it would be retroactive and it would be at no additional charge to the borrower. It would clearly be a violation of normal commercial practice and an infringement of voluntary exchange. So be it.
Banks that refuse to go along with this request would lose their banking licenses. Alternatively, they would be fined the full amount of the maturing loans (expiring credit lines, overdraft facilities) that they refuse to extend/renew. Measures in the spirit of this proposal, even if different in detail, will, in my view, be required to bridge the gap between micro-rational behaviour (don’t lend) and macro-rational behaviour (don’t starve the non-financial business sector of credit).
Banks in the north Atlantic region have been effectively socialised by the protective shield of capital injections, liquidity facilities, debt guarantees and other forms of financial support. So far, there have been only benefits for the banks, their management, their creditors, debt holders and shareholders from this socialisation. It is time to give something back. A one-year interval of forced lending to non-financial corporations is a small price to pay for the banks in return for the massive tax payer largesse they have been shown. From a macro-prudential perspective, it would certainly beat a continuation of the current lending paralysis. Banks fulfill no socially useful function if all they do is survive. Lending is their raison d’être. If banks don’t lend to the real economy, there is no reason for them to be in business at all.
The Next Bubble: Treasuries
In the last ten years we've had three bubbles: the stock market bubble; the housing bubble and the commodities and oil bubble. The next bubble is on its way, and it's the Treasuries bubble. As Bloomberg noted, the bill for the financial crisis is now up to 7.7 trillion. Most of that hasn't actually been paid for yet, and paying for it means issuing treasuries to expand the Fed's balance sheet to meet the size of its obligations, as well as money for Treasury, the FDIC and so on.
It won't be the full 7.7 trillion, but it's in excess of 5 trillion still to be issued. That's one hell of a lot of treasuries. The influx of money into the US to buy treasuries has been the cause of the dollar soaring. Money will have to continue to flood into the United States to fund this, and will likewise need to gush over to Europe, Japan, Korea and other countries who are throwing money at the financial crisis.
This is going to be a very Darwinian period, and it's going to cause a lot of countries on the periphery, including most of Africa, South America and good chunks of Asia, to shake apart. All that money coming into the 1st world will mean no money for them. Combine that with a complete crash in commodities prices and they will be starved for hard currency. Since most of these nations are not able to feed themselves, this will mean famines, starvation, food riots and fallen governments. Of immediate concern to the US, barring massive US help, I would expect that Mexico will slip into indisputable anarchy in large areas of the country within a year or so.
Now when you're talking trillions of dollars you're talking real money. In a normal financial crisis after money repatriates and causes a spike, the value of the currency usually depreciates. But the US isn't a normal country and the dollar is still the world's reserve currency. Moreover the US economy is in play. Dollars may yet be able to be used to buy up real assets for multi-generational low prices. On the other hand, America keeps making it clear that the real gems aren't on the table for foreigners to scoop up (say the Chinese buying GM or Arabs picking up a major bank.)
The fear, then, is that at some point during this giant buying spree, the rest of the world decides to stop buying treasuries. The Fed is aware of this risk, and one of the things they've done is start paying interest on treasuries. Oh, they don't call it that, but when you pay interest on reserves and when treasuries count as reserves, that's what it amounts to. So the real return on treasuries, if you're a bank, is rather higher than ordinary people get. And most foreign banks have US subsidiaries where they can park the treasuries to get the return. (This isn't the only reason they did this, there are other advantages to the Fed, more on that a later date.)
Assuming the rest of the world doesn't blink, the end result is a huge treasuries bubble consisting of primarily short term treasuries and large reserves for banks earning interest rather higher than they would otherwise. Most of the money is being used for loans to banks, at lower interest rates than they will be earning on treasuries held in reserves, leading to a further outflow of money to the banks. This is, as they say, a feature, not a bug, since banks still need more money.
In principle, because treasuries count as capital and reserves, this then becomes money the banks can lend. Whether they do so will depend on whether they feel the need to horde cash against further possible losses; whether they think they need to keep cash in order to buy up competitors and what the inflation rate is at. If it's deflationary, then making a couple percent will actually be acceptable, and in a high risk environment, they may just decide to sit on the treasuries, which is hardly what the government would like them to do. And meanwhile countries from Pakistan to Morocco to Venezuela will be shaking apart.
Wage Gap Widening Quickly in Germany
According to a new study released by the Geneva-based International Labour Office (ILO), wage inequality has risen faster in Germany than in any other Western country. The gap between Germany's highest and lowest earners has grown considerably, according to new data published Tuesday evening by the International Labour Office (ILO). Among European countries, only Poland has shown a sharper divergence in wages.
The study also showed increasing wage inequality in the USA, Canada, and Australia since the mid-nineties. The biggest increase was seen in Argentina, with China and Thailand not too far behind. France, Austria, Brazil, and Indonesia, on the other hand, have all seen their wage gaps shrink -- though the last two countries still have some of the most unequal wage distributions in the world. The wage gap in Indonesia, for instance, is still four times as high as in Germany. As average wages in Germany have failed to keep pace with economic growth, inequality has risen.
Between 2001 and 2007, real wages only inched up an average of .51 percent a year in Germany, which posted one of the weakest showings. In China and Russia, by contrast, real wages posted an average annual increase of 13 percent and 14 percent respectively.
The future looks gloomier still for German wage-earners. The ILO expects global wages to rise 1.7 percent in 2008 and 1.1 percent in 2009. In the industrialized world, however, the ILO forecast is for a 0.8 percent increase this year and a contraction of 0.5 percent next year. The report suggests that wage cuts in the industrialized world will be "painful" and lead to increasing "social tension."
The flip-side to Germany's paltry wage growth is that the cost of labor here has sunk relative to other countries. According to a study from the Macroeconomic Policy Institute (IMK), an affiliate of the union-friendly Hans Böckler foundation, Germany currently ranks 8th in the EU for labor costs. That's still slightly above average, but employing Germans remains a cheaper proposition than employing workers in Scandinavia, France, or the Benelux countries. Labor costs in Germany's private sector average €28 an hour after taxes and other costs are added. The average across Europe's common currency zone is €26 an hour.
With such a skilled and relatively under-paid workforce, one might imagine that Germany would be in a strong competitive position. Under normal circumstances, low wages would be a boon for Germany's export-driven economy. Given the economic earthquake brought on by the financial crisis, however, Germany's low wages might become a liability. According to IMK head Adolf Horn, wage contraction in Germany will only "deepen the crisis," since consumers can only spend as much as they earn. With consumer demand plummeting across the world, countries with high wages will have an easier time weathering the storm.
Debt Struggles and Elderly Living
The credit crisis is battering the two largest publicly traded operators of housing for the elderly. One of them, Sunrise Senior Living, is trying to stave off bankruptcy. The other, Brookdale Senior Living, is considered likely to resolve its short-term problems, but it faces a mountain of debt in the next few years. Both companies, behemoths in a largely fragmented industry, say they are taking steps to reduce costs but have pledged to refrain from cuts that could impinge on the care they offer their residents.
Brookdale manages 51,847 units of retirement and assisted-living housing, and Sunrise has 50,235 units. Once the bellwether of the assisted-living industry, Sunrise Senior Living, based in McLean, Va., has violated certain covenants imposed by its lenders on leverage ratios and has a deadline of Jan. 31 to restructure its line of credit. One analyst, Jerry L. Doctrow, a managing director at Stifel Nicolaus & Company, said Sunrise might need to raise as much as $300 million next year.
Sunrise’s new chief executive, Mark S. Ordan, a former gourmet-grocery executive who specializes in trying to rescue troubled companies, said he did not expect to wait until Jan. 31 to work things out with the lenders. “We should have an arrangement with the banks long before that,” Mr. Ordan said.
Mr. Ordan’s predecessor, Paul J. Klaassen, who founded Sunrise in 1981 with his wife, Teresa, stepped down this month. The Klaassens, who are still heavily involved in Sunrise, are regarded as pioneers in assisted living, which provides frail elderly people with an alternative to the hospital-like setting of a nursing home. But the couple’s reputation was tarnished in recent years as Sunrise became mired in accounting problems and other governance matters that drew the attention of the Securities and Exchange Commission and forced the company to restate years’ worth of earnings.
The company also stumbled when it expanded into Germany and branched into new areas, including developing age-restricted condominiums and acquiring a hospice company that was later accused of fraud in billing Medicare. “They have made a number of ill-advised investments,” Mr. Doctrow said. Sunrise recently suffered a blow when a real estate investment trust, Health Care REIT, backed out of a $643.5 million deal to acquire a 90 percent stake in 29 properties in which Sunrise has a minority stake, citing the stalemate in the capital markets. Sunrise was to realize at least $41 million from the deal. On Nov. 28, 2007, Sunrise’s shares closed at $32.16. But since Nov. 12, it has been trading below $1, closing at 53 cents on Tuesday.
Founded in 1986, Brookdale grew rapidly at the height of the real estate cycle by acquiring rival companies, doubling the size of its portfolio. To finance these purchases, Brookdale, now based in Nashville, took on short-term mortgages secured by its existing assets, and has about $1.6 billion in debt due by the end of 2012, according to Green Street Advisors, a research company in Newport Beach, Calif. Brookdale, the developer of the Hallmark at Battery Park City, a 14-story retirement and assisted-living home in Lower Manhattan, is expected to cut its dividend to meet near-term obligations. The company is also reducing corporate overhead costs, trying to sell some of its unencumbered real estate and increasing the availability of services like therapy and home health care, for which the company can charge fees not included in its basic rate. Bill Sheriff, Brookdale’s chief executive, said that in recent weeks, residents had urged him to forgo renovations to keep the company from raising monthly fees, which can run as high as $10,000. “Do everything you can to control costs,” he quoted them as saying. Brookdale’s shares, which traded for $35.16 on Dec. 10, closed at $3.76 on Tuesday.
Though the two companies are close in size and cater to the same upscale segment of the market, they have different business models. Brookdale owns or leases most of its homes, while Sunrise is primarily a management company that develops centers and then sells them to other companies while retaining a minority stake. The average monthly fee, including housing, meals and some services, at Sunrise-operated centers is $5,000. Nearly three-quarters of Sunrise’s units are dedicated to assisted living, aimed at people who need help with daily activities. A majority of Brookdale’s units are either stand-alone retirement homes — where communal meals are available but the population is less frail — or so-called continuing-care retirement communities, where residents initially live independently but contract in advance for assisted living and nursing care on the premises. The occupancy rate remains strong at both companies — 92 percent at Sunrise and 89.7 percent at Brookdale, according to the companies’ third-quarter earnings reports. Both companies said expenses had increased.
In the industry in general, occupancy — especially for retirement homes — is weakening in areas most affected by the housing slowdown, said Robert G. Kramer, president of the National Investment Center for the Seniors Housing and Care Industries, a research organization in Annapolis, Md. People planning to move into a retirement community can postpone their decision if their house does not sell. Less discretion is involved in the decision to move into an assisted-living residence, Mr. Kramer said. “There’s usually an event that triggers it,” he said.
It is not unheard of, of course, for a senior-housing company’s financial problems to spill into operations. Sunwest Management, a problem-plagued private company based in Salem, Ore., with 18,000 residents nationwide, has been fined repeatedly by regulators in its home state, who were responding to complaints about food, bills and safety, according to a recent report in The Oregonian, a daily newspaper in Portland. But despite the anxiety about Sunrise, analysts say there are no indications so far that its operations have deteriorated. “We keep asking the same question: is management becoming distracted by all these corporate-level challenges and possibly taking its eye off the operating ball?” said Rosemary Pugh, an analyst at Green Street Advisors. “There are some real concerns, but in the midst of this cash crunch, they are performing remarkably well.” Mr. Ordan said it would be foolhardy to reduce the level of care to save money. “Any stakeholder knows that what drives the strength of the company is that care,” he said.
At Brookdale, a chief concern is the majority stake held by Fortress Investment Group, a struggling hedge fund that owns nearly 60 percent of the company. Some analysts have said that Fortress’s interests may not necessarily be aligned with Brookdale’s. But Fortress has not pressured Brookdale to lower its standards, Mr. Sheriff said. “They have been incredibly quick to say, ‘We just don’t go there,’ ” he said. Specialists in housing for the elderly say the long-term prospects for the sector are very good because new supply is being kept in check. “As a rule, the senior-housing industry is not developing a lot of new product,” said David S. Schless, the president of the American Seniors Housing Association, a trade group. The National Investment Center found fewer than 23,000 units under construction in the 100 biggest metropolitan areas.
That is a far cry from the late 1990s, when the frenzied pace of new construction far exceeded demand, in part because developers were slow to realize that most people would not move into assisted living homes until their 80s.The slowdown means that there is likely to be a shortage of such housing eventually, said Kathryn A. Sweeney, a managing director for United States senior housing for GPT Group, an Australian real estate company. “If you plan to be a resident, you need to be saving your pennies now,” she said.
To Buy Children’s Gifts, Mothers Do Without
Come Christmas, McKenna Hunt, a gregarious little girl from Safety Harbor, Fla., will receive the play kitchen and the Elmo doll she wants. But her mother, Kristen Hunt, will go without the designer jeans she covets this season. For Ms. Hunt and for millions of mothers across the nation, this holiday season is turning into a time of sacrifice. Weathering the first severe economic downturn of their adult lives, these women are discovering that a practice they once indulged without thinking about it, shopping a bit for themselves at the holidays, has to give way to their children’s wish lists. “I want her to be able to look back,” Ms. Hunt declared, “and say, ‘Even though they were tough times, my mom was still able to give me stuff.’ ”
In this economy, nearly everyone is forgoing indulgences, and many fathers will no doubt sacrifice this year to put toys under the tree. But figures suggest the burden is falling most heavily on women, particularly mothers. In September and October, sales of women’s apparel fell precipitously compared with the same months the year before. They were down 18.2 percent in October, for instance, compared with a decrease of 8.3 percent for men’s apparel, according to SpendingPulse, a report by MasterCard Advisors. And a survey of shoppers’ intentions by the NPD Group, a consultant firm, suggests that such cutbacks may continue through the holiday season. Some 61 percent of mothers said they would shop less for themselves this year, compared with 56 percent of all women and 45 percent of men.
The survey suggested that mothers, more than any other group, would also spend less money over all and postpone big-ticket purchases, like the dishwasher that Ms. Hunt wants to buy. It may be noble sacrifice for women to spend less on themselves to benefit their families. But it is bad news for the troubled retail industry, which relies heavily on sales of women’s apparel. “As we go into the holiday, it’s not going to be ‘One for my sister and one for me,’ ” said Marie Driscoll, an analyst for Standard & Poor’s Equity Research Services. “You might not even get one for your sister so you can buy great gifts for her kids.”
Reyne Rice, who studies toy trends for the Toy Industry Association, said mothers do at least 80 percent of the holiday shopping in a family, and in past recessions they have been the first to do without. They tend not to get a new coat for themselves, Ms. Rice said, so they can provide for their children.
Analysts say the pullback by women in this downturn is among the most drastic they have seen. “You just keep hearing, ‘We’ve stopped shopping altogether,’ ” said John D. Morris, a retail analyst with Wachovia, adding that the typical woman is “finding fashion in the back of her closet.”
The downturn, analysts said, is being exacerbated by unexciting fashions in stores. And the lack of pressure to conform to one particular style these days means women do not have to update their work wardrobes. As they scale back their own indulgences, mothers are looking for additional ways to cut the cost of Christmas. Some are using online tools to organize meetings with other mothers to swap clothing, toys, video games and books. Others are buying DVDs and video games in bulk from warehouse stores like BJ’s Wholesale Club, then taking the sets apart to create multiple gifts.
Matriarchs of big families are bringing back the old practice of pulling names out of a hat to decide who will buy a gift for whom. Some mothers have made pacts, with their spouse or other family members, not to buy gifts for anyone but the children. Despite all these efforts, many mothers will nonetheless end up cutting back, at least a bit, on spending for their children. Historically, the toy industry has been more immune to economic downturns than other industries, but this year, analysts expect it to feel the pinch. That could translate into fewer presents for children over all, even though many parents will go to great lengths to buy the one or two gifts their child wants most. “While times are difficult, the last thing parents are going to cut from their budget is the Christmas present for their child,” said Gerald L. Storch, chairman and chief executive of Toys “R” Us. “We are not seeing price resistance for the hot toys.”
Crisis could create 150,000 new poor in Israel
Some 100,000-150,000 more Israelis will soon need government financial assistance as a result of the economic crisis, Nahum Itzkovitz, director-general of the Welfare and Social Services Ministry, said Tuesday. He spoke at the Sderot Conference on Social Issues held at the Sapir Academic College.
During his address, Itzkovitz demanded that funds be added to the ministry's budget so it could handle the expected increase in demand for unemployment benefits. "There will be significant growth in the number of new poor people and the ministry won't be able to assist all of them," Itzkovitz said. He even went as far as saying that if the social services did not receive additional funding, they would be unable to prevent cases such as the recent murder of Rose Pizem, the four-year-old girl from Netanya who was allegedly drowned by her grandfather in Tel Aviv's Yarkon River earlier this year "Even if we were to receive a report about Rose, it is more than likely that we would not manage to take care of the case, because of a massive waiting list," he said.
Meanwhile, Tel Aviv stocks jumped more than 5 percent on Tuesday after the Treasury unveiled and NIS 11 billion financial plan to bolster the capital market and east the credit shortage in an effort to help distressed companies survive and avert layoffs. The four-point plan will provide capital and guarantees, as well as tax exemptions for overseas investors to encourage investment in the local market and boost liquidity. NIS 6b. will be allocated as guarantees to the banks for the raising of capital.
Prof. Dov Chernichovsky from the Department of Health Systems Management at Ben-Gurion University of the Negev said those most likely to suffer from the economic crisis were senior citizens, especially those who lived on their provident funds or overseas pensions, people in service industries and nonprofessional employees in the export sector. The number of jobseekers rose by 1.1 percent during October and stood at 193,200, up from 191,100 in September, the National Employment Service said on Monday. Zvi Eckstein, the deputy governor of the Bank of Israel, warned that the current wave of layoffs was liable to reach thousands of employees.
This week, the ministry and National Insurance Institute presented a plan to ease eligibility requirements for unemployment benefits. The plan would require a shorter period of employment to be eligible for benefits, and further eases requirements for residents of the periphery. Health Minister Ya'acov Ben-Yizri, who attended the conference as well, added a warning of his own, saying that if the government doesn't channel additional resources to the health system there will be "a catastrophe. We have reached a situation in which instead of 2.9 beds per 1,000 people in the hospitals, we have only 1.9 beds." The Finance Ministry's budget supervisor, Ram Belnikov, told the panel participants that Israel faced a "not simple year of economic problems and uncertainty."
The budget deficit in 2009 is expected to be higher than the Finance Ministry had anticipated. Instead of NIS 7 billion, it might surpass NIS 20b., Belnikov said. Representatives of social advocacy organizations demanded they receive financial assistance from the state, just as the government plans to assist the private sector.
In an urgent letter to Prime Minister Ehud Olmert, Rachel Liel, director-general of Shatil-The New Israel Fund's Empowerment and Training Center for Social Change, and Ran Melamed, deputy director-general of Yedid-The Association for Community Empowerment, demanded increased governmental support for nongovernmental organizations that employ thousands of people. The letter was signed by dozen of prominent NGOs. "Many organizations face financial collapse... which indicates the Israeli market is heading toward a severe employment crisis, and the weak sectors will be the first to suffer it," the letter read.
Chernichovsky ended the Sderot Conference panel on a positive note, saying Israel was strong enough to survive the recession and to prevent a social crisis. "This is true only if a long-term work plan is prepared in advance," he said.
Britons know just nine neighbours by name
The shocking report paints a bleak picture of community life, adding that people know just 14 of their neighbours by sight. More than 4,000 home owners were questioned in the survey, which found people feel less safe and think their local amenities have deteriorated in the past five years. For most, an ideal neighbourhood means being able to live a quiet life free from the threat of crime and anti-social behaviour, according to the research carried out by home insurer LV=.
But it found that 32 per cent of people in the UK said they feel they have seen an increase in street crime in their neighbourhood, with only 8 per cent of people saying they have seen a drop over the last five years. And 28 per cent said they feel unsafe walking in their neighbourhood at night, it found. The problem is most pronounced in London, where 42 per cent of people say they feel there has been an increase in street crime and 12 per cent feel that crime has increased 'a lot' in their area – twice as much as in other regions.
Nick Kelly of neighbourhoodwatch.net, blamed the decline in neighbourhoods on families being much more mobile that they used to be, when they stayed in one house for a lifetime. He said: "Most people would not know if someone in their garden was an intruder or a neighbour. It is one of the good things that could come out of the credit crisis if people cannot afford to move and have to put down roots instead. People would get to know one another and all our findings show that this helps to improve safety levels."
The most popular thing that people want to change about their neighbourhood is the level of council tax they pay, with 40 per cent saying this is the biggest issue for them. John O'Roarke, of LV= Home Insurance, said: "The report shows that a large number of people throughout the country are not happy with the area they live in. "It's all too easy to say that if people are that unhappy with their neighbourhood, then they should move to somewhere else but with the current housing market decline and credit crunch, it's a difficult period for those who are aiming to sell their homes or move on."
Finances in limbo for Yellowstone Club
A Yellowstone Club bankruptcy hearing recessed Tuesday with no firm plan in place to prevent a shutdown of the exclusive Montana resort for the rich and famous. The club, which caters to the extraordinarily rich and counts Microsoft tycoon Bill Gates and Los Angeles Dodgers owner Frank McCourt among its members, is trying to get a loan so that it can keep its doors open for the ski season, its busiest time of year.
But its current lender, Credit Suisse, wants extra protections before it hands over more money. Club members, who want to see their ritzy private resort near Yellowstone National Park stay fully operational, say Credit Suisse is asking too much. Another firm, CrossHarbor Capital of Boston, Mass., is pitching a $20 million loan to get the resort through the winter. That plan is preferred by The Yellowstone Club and its members.
CrossHarbor Capital said it has invested at least $100 million in the club, including ownership in some of the once-prized real estate parcels. The firm has a long history with club founder Tim Blixseth and his former wife, Edra, who now controls it as part of a recent divorce settlement. CrossHarbor also spent a year trying to buy the club, and says everyone who has a stake in it will suffer if it has to shut its doors for the ski season. Property values would plummet amid a flurry of negative news, the firm argued.
"We believe the club needs to operate," testified Samuel T. Byrne of CrossHarbor. "We need to see the place stabilized. We have a lot of money invested up there." U.S. Bankruptcy Judge Ralph Kirscher said he would issue an order soon - and appeared to take a dim view of the Credit Suisse plan that required the club to raise $7 million by selling golf course building lots. The judge said he believed it unlikely the club could do so within 60 days. Kirscher gave both sides the better part of Tuesday to try to reach a deal, and held a closed-door session with more than a dozen attorneys involved in the case. But the talks ended in late afternoon, leaving the judge to issue an order. Kirscher gave no indication when that might be.
Credit Suisse offered to extend its current lending agreement until Dec. 5. But it is opposing the CrossHarbor offer because it would take precedence over the money owed to Credit Suisse. Credit Suisse argued that CrossHarbor is too wrapped up in financial lives of the Blixseths and the club to be given the senior position in the deal. The Yellowstone Club sought protection in bankruptcy court on Nov. 10. A $4.5 million loan recently arranged through Credit Suisse was enough to sustain the club for only three weeks.
Kirscher said the current economic turmoil is making it more difficult for the Yellowstone Club to make financial arrangements. But even the judge seemed surprised that a club that caters to the wealthy could be running out of money, saying it seemed to him one of them could just "write a check" to make the whole case disappear. Less than two years ago the club's owners were pursuing ambitious plans that they said included the world's most expensive home, a $155 million, 53,000-square-foot behemoth complete with heated driveway. That project was never built. Now the Yellowstone Club is one of at least four high-end resorts that have sought bankruptcy protection in recent months.
The Yellowstone Club had taken out huge loans to develop the ski hill, golf course and multimillion-dollar mountainside condominiums on 13,600 acres of private land. But when the money dried up in the credit crisis, members and hundreds of creditors owed about $400 million were left clamoring to get their money back.The owner, Blixseth, also still owes $13 million in a two-year-old lawsuit filed by former club members, including cycling star Greg LeMond, who argued they were shortchanged.
Members have alleged that their funds, which were supposed to pay for ongoing operations of the club, were diverted to fund a jet-setting lifestyle for the Blixseths. To join the club, each member put down a $250,000 deposit and bought a piece of property. Earlier this year, the asking prices for Yellowstone Club building lots were up to $10 million apiece. And the members may have to pay more.
CrossHarbor said it would seek to double the winter fees paid by members from $9,000 to $18,000 to help keep the doors open for the ski season, which the members appear to favor as a way to get through the crisis. An expert testified that the club owes hundreds of millions, a total more than it likely has in assets - including a warehouse full of antiques and thousands of acres of property. Those owed money then hope the extra time can be sued to find a new buyer - and avoid a fire sale that could shutter the club and leave hundreds of employees looking for work. "The club has already suffered tremendously under this public airing of dirty laundry," Byrne told the judge.
Anonymous Banker Weighs In On The Coming Credit Card Debacle
Today, we are bailing out the banks because of their greedy and deceptive lending practices in the mortgage industry. But this is just the tip of the iceberg. More is coming, I’m sorry to say. Layoffs are being announced nationwide in the tens of thousands. As people begin to lose their jobs, they will not be able to pay their credit card bills either. And the banks will be back for more handouts.
I received a catalog today from Casual Living and in big bold print on the front page, it said “BUY NOW, PAY NOTHING”. Then in significantly smaller print underneath, it said, (until April). That mantra has been sung throughout the credit markets over the last 10 years. The banks waive a carrot in front of the consumer and reel them in and encourage them to go deeper and deeper into debt. They do this by prescreening customers through credit reporting agencies, mailing offers to apply, and to transfer balances at teaser rates or zero percent financing. They base it on credit score and not on capacity to repay. A good credit score does not equate to the ability to repay debt.
Over my career, I have seen thousands of consumers that have credit card lines in excess of their annual salaries. Some are sinking under their burden. Some have been fiscally responsible and have minimal amounts outstanding. My 21-year-old daughter, who’s in college, gets pre-approved offers all the time. She has no ability to repay debt, yet the offers flow in just the same. We all know how these lines are accumulated. The banks, in their infinite stupidity, keep upping credit lines because the customer pays the minimum payments on time. My daughter’s credit line started at $1,000 and has been increased over the last two years to $4,400. She has no increased earnings to support this. But the banks do it without asking. And without being asked. The banks reel in the consumer, charge interest rates higher than those charged by the mob, increase lines without the consumer asking and without their consent, and lure them into overextending. And we can count on the banks to act surprised when they aren’t paid back. Shame on them.
As a banker, let me describe what we do wrong when we accept and review an application for a credit card. First, we don’t verify income. The first ‘C’ of credit: Capacity to repay, is completely ignored by the banks, just as it was in when they approved subprime mortgages. Then we ask for “household income” — as if other parties in the household could be held responsible for that debt. They cannot. And since we don’t ask for any proof of income, the customer can throw out any number they think will work for them. Then we ask if they rent or own and how much they pay. If their name is not on the mortgage, they can state zero. If they pay $1,000 in rent, they can say $500. (Years ago we asked for a copy of the lease to verify this number.) And finally, we don’t ask how much of a credit line the consumer is looking for. The banker can’t even put that amount into the system. There isn’t any place on the application for that information. We simply put unverified information into a mindless computer and the computer gets the person’s credit score and grants them the biggest line that score and income (ha!) qualifies for.
I recently had a client apply for a credit card. She is a homemaker, with no personal income. The house she lives in is in her husband’s name. She would have asked for a $3,000 credit line, just to pay miscellaneous expenses and to establish some credit on her own. So the computer is told that her household income is $150,000; her mortgage/rent payment is zero. The fact is that her husband’s mortgage payment is $7,000 a month (which he got with a no income verification loan). She had a good credit score, but limited credit since she has only lived in this country for the last three years. The system gave her an approval for a $26,000 line of credit!
This has got to stop. People are going to be learning hard lessons over the next years. It would help, though, if the banks could change their behavior now, before things get any worse. Tomorrow is already too late.
In 2003, Congress passed the Fair and Accurate Credit Transactions Act of 2003. This law was implemented through regulations issued by the Federal Trade Commission in consultation with the federal banking and credit union agencies. It requires all credit card and insurance solicitations to include a disclosure for “prescreened offers.” We are all familiar with them. They are the dozens of credit card offers that are sent, unsolicited, to consumers, usually by mail. The law allows the consumer to opt out of receiving prescreened offers by calling an 800-number.
I think Congress did this backwards. Perhaps it could amend the law. The regulation should have required the consumer to opt in, if they so desire, instead of opting out. That would mean that no one would get an unsolicited credit card offer. If a consumer needs a credit card he or she could be given an option to call an 800-number to opt in. Or the consumer could go to their local bank and apply for a credit card in person. Or the consumer could go online and apply for a credit card. The consumer can also view all the best credit cards, nationally, at bankrate.com. Bankrate.com is an invaluable tool for consumers.
Some other benefits: (1) It would halt the message being sent that credit is free and perhaps limit irresponsible accumulation of credit lines. (2) It would force the banks to become more competitive in their rates. The consumer is going to need a break and they will need it soon. And credit card rates, which are quite often above 22 percent, is piracy. (3) Eliminating mass mailings would save a lot of trees.
I’ve been reviewing many of the banks annual reports over the last month and there is no question that the default rates are on the rise. If Congress doesn’t act today, the bankers will have their hats in their hand before we know it, and doing another a tap dance before the Senate Banking Committee, and asking to be bailed out once again with our tax dollars. Sad, but true
Daimler Says Cerberus’s Demands Imperil Chrysler Sale
Daimler AG, the world’s second- largest maker of luxury cars, said the sale of its remaining stake in Chrysler LLC has been made more difficult by the “exaggerated demands” of Cerberus Capital Management LP. Cerberus’s demands concerning Daimler’s 19.9 percent holding in Chrysler exceed the value of the $7.2 billion the private-equity firm invested for its 80.1 percent stake, the Stuttgart, Germany-based company said in a statement today.
Daimler wants to sever ties with Chrysler as the third- largest U.S. automaker continues to weigh on its earnings, erasing 373 million euros ($483 million) from second-quarter profit. Daimler bought Chrysler in 1998 for $36 billion and sold a majority holding to New York-based Cerberus in August 2007 as losses mounted. The remaining stake was assigned a book value of zero in a third-quarter earnings report on Oct. 23.
“Cerberus probably has its back to the wall financially to make such huge demands,” said Juergen Pieper, an analyst at Bankhaus Metzler in Frankfurt who interprets today’s statement as indicating Cerberus wants Daimler to pay it more than 7.2 billion euros to take over the stake. “There’s a risk here for Daimler, but in these kinds of cases the two sides usually end up reaching a settlement.” He recommends selling Daimler shares. The stock has declined 63 percent this year, valuing the automaker at 23.8 billion euros.
“The claims made now go beyond the framework of the contractually agreed possible obligations,” Daimler said in today’s statement. “The new claims also include an allegation of conduct outside the ordinary cause of business by Daimler during the time between signing and closing of the transaction, as well as the allegation of incomplete information about the business. Daimler rejects these absurd allegations.”
Chrysler spokeswoman Lori McTavish wouldn’t immediately comment on the report. Cerberus spokesman Tim Price didn’t immediately return a message left on his mobile telephone. Daimler spokesman Thomas Froehlich said by phone that “the talks are not terminated and they have not failed,” while declining to elaborate on Cerberus’s demands. The completion of Daimler’s separation from Chrysler would make a contemplated merger or sale of the Auburn Hills, Michigan-based company less complicated. Cerberus had been in discussions with General Motors Corp. about a potential merger until the Detroit-based automaker set aside talks to focus on its liquidity crisis.
Toyota Suffers First Credit Rating Cut in 10 Years Amid Slump
Toyota Motor Corp.'s debt rating was cut by Fitch Ratings, the automaker's first downgrade in 10 years, as the slump in U.S. car sales drags down earnings at the company with the industry's best credit. Fitch cut Toyota's senior unsecured debt rating two levels to AA from AAA with a negative outlook on the company, it said in a report today. The shares dropped 4.6 percent, the most in two weeks, to close at 2,985 yen on the Tokyo Stock Exchange.
A lower debt rating raises borrowing costs for Toyota, potentially hindering its ability to offer interest-free loans to boost sales in the U.S. Toyota, set to topple General Motors Corp.'s 77-year reign as the world's largest automaker this year, may also have its worst share performance since at least 1975. "Toyota is suffering severely from the ongoing turmoil in the global automotive sector,'' said Tatsuya Mizuno, director at Fitch Ratings, in the report. "The negative developments in the industry are so substantial and fundamental that even the strongest player -- Toyota -- can no longer support a `AAA' rating.''
The rating cut is the company's first since Moody's Investors Service reduced its long-term debt rating from Aaa to Aa1 in 1998. Moody's raised the company back up to Aaa in 2003. Standard & Poor's has rated the carmaker AAA since 1985. "We are closely monitoring Toyota and especially the U.S. market,'' Moody's analyst Junichi Yamaki said. He declined to say whether the rating may be revised. S & P analyst Osamu Kobayashi couldn't be reached at his office.
Toyota has 289 billion yen in debt coming due this year, and owes 2.52 trillion yen next year, according to Bloomberg data. Credit-default swaps on Toyota were quoted 15 basis points higher at 215, 20 times the price of 10.5 a year ago, according to data from Deutsche Bank AG and CMA Datavision. Toyota had 1.85 trillion yen ($19.5 billion) in cash and near cash as of Sept. 30 and earned 169.5 billion yen ($1.79 billion) in operating profit in the three months ended Sept. 30. That compares with a $4.2 billion operating loss for GM, which said it may run out of cash by the end of the year.
"Toyota's financial foundation is solid, and I don't think there has been such a drastic change to warrant a two-level downgrade,'' said Yasuhiro Matsumoto, senior credit analyst at Shinsei Securities Co. in Tokyo. ``I don't see an impact on the company's new bond issues.'' Toyota's stock has dropped 51 percent this year, set for the worst annual performance since at least 1975. The company is still valued at 18 times GM and Ford Motor Co. combined. Toyota spokesman Hideaki Homma declined to comment on the rating change.
Toyota had an operating loss of 34.6 billion yen in North America in the fiscal first half, after adjusting for a one-time gain in the valuation of interest rate swaps. The company's U.S. sales through October fell 12 percent, heading toward the company's steepest annual drop since at least 1980, as the industry total slid 15 percent. "Nobody is immune both from the credit crisis and the crisis in the industry,'' said Rebecca Lindland, an analyst with IHS Global Insight Inc. in Lexington, Massachusetts. "The industry is in a lot of trouble.''
The rating cut leaves only five companies left with an AAA rating from Fitch: Exxon Mobil Corp. and Johnson & Johnson in the U.S. and Regie Autonome des Transports Parisiens, Reseau Ferre de France and Societe Nationale des Chemins de Fer Francais in France. Declining demand has prompted Japan's largest carmaker to slash its domestic temporary workforce by 50 percent to 3,000 by the end of March. The weak market has spurred U.S. automakers to seek government aid, and General Motors has said it may run short of operating cash by year's end. "The turmoil in the U.S. and other markets may be protracted, potentially lasting for the next two to three years,'' Mizuno said.
Toyota slashed its profit forecast 56 percent earlier this month as the yen gained against the dollar and euro and the credit crunch pushed industrywide October U.S. sales to the lowest level since 1983. The yen has gained 18 percent rise against the dollar and 32 percent against the euro this year. Toyota based its forecasts on 103 yen to the dollar and 146 yen to the euro, compared with its previous estimate of 105 yen and 161 yen, respectively. Every 1 yen gain against the dollar and euro trims Toyota's annual operating profit by 40 billion yen and 6 billion yen.
Congress has set a Dec. 2 deadline for GM, Ford Motor Co. and Chrysler LLC to present plans that prove they will be able to survive and pay back any federal loans. Congress may vote on an aid package on Dec. 8. GM said Nov. 7 that 2009 U.S. industrywide sales will be 11.7 million, down from a forecast of 14 million. Hyundai Motor Co., South Korea's largest carmaker, said yesterday that the U.S. market could fall to 10 million vehicles next year, the lowest since 1981.
Quebec pension fund caught in loonie downdraft
The Caisse de dépôt et placement du Québec on Tuesday revealed the unprecedented steps it took to exit derivative and currency hedging positions during the recent market downturn, a damage control exercise that is playing out at most major Canadian pension funds. As speculation continues to swirl over possible losses at the country's largest pension fund, Caisse executives explained that last month, with the loonie in freefall, the fund “adjusted its currency-hedging operations in the context of the Canadian dollar's instability and closed out certain futures contracts that could have created the need for additional capital in a down market.” The $155-billion money manager is sticking with its policy of only revealing performance at year-end.
The Caisse also sold “liquid securities” last month, a move meant to preserve capital. Sources close to the Caisse have said the fund dumped up to $10-billion of stock, but Caisse executives say the sales were “much smaller,” without giving details. The Caisse's wheeling and dealing is typical of what large funds are doing to cope with a violent shift in markets at a time when investments are tied up in multiple currencies and long-term holdings such as real estate and private equity. The Montreal-based fund said Tuesday that “like all the world's large institutional investors, [the Caisse] has to adjust its strategies in response to a financial crisis whose course over the short term is unforeseeable.”
While the Caisse is putting the best face on strategies used to invest the retirement savings of Quebec residents, opposition politicians in the midst of an election campaign continue to question the fund's leadership and results. There has been widespread speculation in Quebec business circles that newly named Caisse chief executive officer Richard Guay will not return to the fund after a medical leave that is scheduled to end on Dec. 10 – two days after voters go to the polls. Mr. Guay took the top job in September; prior to that, he was the fund's chief investment officer.
A Caisse director who spoke on condition he not be identified said the board dismissed suggestions it has lost confidence in Mr. Guay's abilities to lead the Montreal-based fund through the global financial meltdown. The director said: “He has the full support of the board.” The Caisse also continues to grapple with problems created by the 15-month-old freeze in Canada's $32-billion third-party asset-backed commercial paper (ABCP) market. An ABCP restructuring backed by the Caisse was to be completed by month-end but was delayed yesterday, with no new deadline set.
To date, the Caisse has written down the value of its $13-billion ABCP portfolio by $1.9-billion or 15 per cent. In contrast, Desjardins Group, another large Quebec financial institution, has written down its holdings by 30 per cent. An executive at one of seven Quebec plans that have their money invested by the Caisse said: “There was a clear lack of oversight there. They failed to consider the liquidity risks [of having so much tied up in ABCP].” He added that this whole saga – the ABCP freeze and the Caisse's scramble during the market meltdown – will create resentment among the different portfolio teams within the fund, since the failures of a few are pulling down results for the entire organization. “The Caisse is a confederation of fairly autonomous [portfolio management] units. There is competition between them.”
Volcker to head board of economic experts
President-elect Barack Obama announced Wednesday that he is creating a new economic recovery board to provide a "fresh perspective" for his administration. The board will be headed by Paul Volcker, who served as the chairman of the Federal Reserve from 1979 through 1987, serving under Presidents Carter and Reagan.
Following his tenure there, Volcker worked in the private sector as an investment banker until 1996. Volcker also headed the investigation into the United Nations' oil-for-food program for Iraq. "The reality is that sometimes policymaking in Washington can become a little bit too ingrown," Obama said at a news conference in Chicago, Illinois.
"The walls of the echo chamber can sometimes keep out fresh voices and new ways of thinking. ... This board will provide that perspective to me and my administration, with an infusion of ideas from across the country and from all sectors of our economy," he said. The board will advise Obama on how to revive the ailing economy, offering independent, nonpartisan information, analysis and advice to the president as he formulates and implements his plans for economic recovery, Obama's transition office said. It will be established initially for a two-year term, after which Obama will determine whether to continue its existence, based on whether it's needed.
Obama said he would announce the rest of the board members in the coming weeks. In news conferences earlier this week, Obama announced his choices for key members of his economic team, including New York Federal Reserve President Tim Geithner as treasury secretary and former Treasury Secretary Larry Summers as chief of the National Economic Council.
Those named to Obama's economic team have started work on crafting an economic recovery plan. The group also must figure out how best to allocate the rest of the $700 billion bailout that Congress passed in October. Obama has said he hopes the new Congress will begin work on an aggressive economic recovery plan when it convenes in January so his administration can immediately get to work. The president-elect said Tuesday that it is important that his administration not "stumble" into office but "hit the ground running."
An economic stimulus package is central to Obama's plan. He has declined to speculate on how big the stimulus would need to be, saying only that it has to be "large enough to jump-start the economy." Responding to criticism that he was filling out his team by recycling the Clinton administration, Obama said Wednesday that he is looking to combine "experience with fresh thinking."
Obama said advice from his economic advisory board would be an example of a "cross section of opinion. We want ideas from everybody, but what I don't want to do is to somehow suggest that, because you served in the last Democratic administration, that you are somehow barred from serving again -- because we need people who are going to be able to hit the ground running," he said.
Several officials close to the transition tell CNN that a member of President Bush's administration, Defense Secretary Robert Gates, is expected to stay on the job for at least the first year of the new administration. One source called it "all but a done deal" that the announcement could come as early as next week. To some, the choice demonstrates bipartisanship and conveys that Obama has the self-confidence in his leadership abilities to keep one of the more widely respected members of the Bush administration. iReport.com: What do you think of Obama's cabinet picks?
"We've got confidence, continuity, and I still think the mission to get out of there as soon as possible will be accomplished. So I think it's a great choice," Democratic Rep. Charles Rangel told CNN's "Larry King Live." Others say keeping Gates could delay the change that Obama promised during his campaign by prompting potential policy conflicts over missile defense funding and a speedy Iraq pullout. "If we don't have good civilian personnel alongside our good military personnel, we're not going to reform. It can't happen. You need the right people to make it work," former Pentagon comptroller Dov Zakheim said.
Sources close to the transition have said Obama is interested in some continuity at the Pentagon because he is entering office while dealing with two wars, in Iraq and Afghanistan, as well as the international financial crisis. The president-elect has made no secret of his interest in having divergent views within his Cabinet, and Gates has served in various national security roles under Republican presidents, including as CIA director during former President George H.W. Bush's administration.
Gates would be joining a high-profile national security team that is also expected to include a retired four-star general. Several sources say retired Marine Gen. Jim Jones is on track to become national security adviser within the White House. Also Tuesday, the head of Obama's intelligence transition team said he is withdrawing his name from consideration for director of the CIA. In a letter to Obama obtained by CNN, John Brennan cited strong criticism from people who associated his work at the CIA with controversial Bush administration policies on interrogation techniques and the war in Iraq. Brennan defended himself against such accusations, saying, "The fact that I was not involved in the decision-making process for any of these controversial policies and actions has been ignored" by his critics.
A number of names have been floating around Washington as possible choices for CIA director. They include Rep. Jane Harman, D-California, who chaired the House Intelligence Committee; retiring Sen. Chuck Hagel, R-Nebraska, a member of the Senate Intelligence Committee; and Timothy Roemer, the former Democratic congressman from Indiana who served on both the congressional and the presidential September 11 commissions.
Fears mount that UK will default on bonds
The cost of insuring against the British Government defaulting on its gilts in the next five years surged to 100 basis points above libor at one stage yesterday, before closing at 88.2 basis points. In comparison, insuring against leading banks failing to pay back their debt now stands at 58.8 basis points for BNP, 65.2 for Commerzbank and 68.6 for Credit Agricole. In the UK, Lloyds TSB is priced at 95 basis points and 99.2 for HSBC.
Traders said to insure against the Government defaulting – via a derivative known as "credit default swap" (CDS) – a year ago would have been just two basis points above libor. The soaring cost comes as the Treasury unveiled record amounts of spending in the pre-Budget report, with plans to issue an unprecedented £146.4bn of gilts in this fiscal year.
The Government has never defaulted on any of its loans, but fears are mounting that with record levels of debt it may struggle in the future. Jeremy Batstone-Carr, head of research at stockbrokers Charles Stanley, said there are concerns that the Government is taking a big risk in increasing spending to manage the recession. Chancellor Alistair Darling unveiled plans on Monday to borrow £118bn next year – the equivalent of £1,934 per person or 8pc of gross domestic product.
"There is no doubt this is a huge gamble," Mr Batstone-Carr explained. "The possibility that the Government might default on its debts may seem unthinkable, but in these markets, you have to think about it. Everyone is crossing their fingers very hard and hoping that maybe this fourth quarter of 2008 may represent the bottom. There is no certainty that economic activity will pick up – even when it does, there is no guarantee it will pick up strongly."
A spokesman for the Debt Management Office (DMO) said £77bn has been raised through gilt sales so far this financial year and these government assets "generally remain the preferred risk-free asset for major international investors and are in strong demand internationally and in the UK". Commenting on the CDS spreads being less favourable than those offered on some banks, he said: "We think investors in UK Government securities will be assured by the fact that the UK Government has never defaulted on a payment since the origins of the national debt in 1694." Mr Batstone-Carr said institutions switching out of riskier shares and into bonds should lead the demand for the Government's new bonds.
Meanwhile pension funds have hit out at the DMO's announcement that of of the additional £36.4bn gilts to be issued to balance the government's books, only £5.3bn will be long-dated issues. Pension funds require long dated gilts to match their liabilities. The National Association of Pension Funds, which speaks for 1,200 pension schemes with assets of around £800bn, described it as a "missed opportunity to help pension funds and pension savers".
Chris Hitchen, NAPF chairman, criticised the Government for ignoring its pleas to issue more long-dated assets ,which mature in 15 years or more. He said: "In the current economic environment, the Government must take all steps necessary to help pension scheme sponsors and pension savers. This includes ensuring the right assets are available to back schemes."
China Slashes Lending Rate to Support Slowing Economy
China lowered its key lending rate by the most in 11 years, extending efforts to prevent an economic slump less than three weeks after unveiling a 4 trillion yuan ($586 billion) stimulus plan. The key one-year lending rate will drop 108 basis points to 5.58 percent, the People’s Bank of China said on its Web site today. The deposit rate will fall by the same amount to 2.52 percent. The changes are effective tomorrow.
China‘s economy, the biggest contributor to global growth, will expand at the slowest pace in almost two decades next year, the World Bank forecast yesterday. Manufacturing shrank by the most on record in October as recessions in the U.S., Japan and Europe cut demand for exports and property prices fell at home. “It underlines the harshness of the economic slowdown,” said Gabriel Gondard, Shanghai-based deputy chief investment officer at Fortune SGAM Fund Management Co., which oversees about $7 billion. “The past six weeks has seen a rapid deterioration in the economic picture.”
The bank lowered the reserve requirement for the biggest banks to 16 percent from 17 percent, effective Dec. 5. The requirement for smaller banks will fall to 14 percent from 16 percent. The central bank also reduced the interest rate that it pays on reserves deposited by commercial banks to encourage lending. Two hours after the rate cut, China’s cabinet said it was studying extra measures to help struggling companies in the steel, auto, petrochemical and textile industries; to increase key commodity reserves; and to expand insurance for the jobless.
The government will also push ahead with fuel-price and tax reforms to help boost consumption, the cabinet said. A fuel-price cut would be the first in almost two years. The government regulates energy prices to contain inflation, which fell to a 17- month low in October. China’s stock market was closed when the announcement was made. Earlier the CSI 300 Index rose 0.5 percent, ending a four- day, 6.1 percent decline. The yuan closed at 6.8287 against the dollar from 6.8280 before the announcement.
The cuts are aimed “at ensuring sufficient liquidity in the banking system and to promote steady loan growth so that monetary policy can play an active role in supporting economic growth,” the bank said in a statement. “There is still ample room to cut rates in the future,” said Peng Wensheng, head of China research at Barclays Capital in Hong Kong, who predicted a 54 basis point reduction in December.
China can help cushion the global recession by stoking its own expansion, President Hu Jintao told Group of 20 nation leaders in Washington on Nov. 15 said. “China, as it promised, is taking a more responsible and leading role,” said Xing Ziqiang, an economist at China International Capital Corp. in Beijing. China, the world’s most populous nation, is targeting growth of 8 percent a year to provide jobs for workers moving to the cities from the countryside. A decline in economic growth to even that level would be tantamount to a recession, said Tao Dong, chief Asia economist with Credit Suisse AG in Hong Kong.
The outlook for jobs next year is “grim”, Yin Weimin, head of the Ministry of Human Resources and Social Security said last week. Two-thirds of small toy exporters closed down in the first nine months of this year, the customs bureau said this week. About 1,000 police and security guards attempted to break up a demonstration as sacked toy company workers overturned a police car, smashed four police motorbikes and broke equipment in the southern Guangdong province yesterday, Xinhua News Agency reported.
The World Bank cut its forecast for China’s economic growth next year to 7.5 percent from 9.2 percent previously. The Organization for Economic Cooperation and Development also lowered its forecast. China’s economy grew 9 percent, the weakest pace in five years, in the third quarter, slowing from 11.9 percent last year. The slowdown is deepening, after export orders fell last month to the lowest level since 2005 and property price slid. “The last print on their GDP was 9, but given the near panic you’re seeing on the policy front, they are either fearful it will go well below that or it may be growing much slower than that right now,” Stephen Roach, chairman of Morgan Stanley Asia Ltd., said this week.
On Nov. 9, the government announced spending on housing and infrastructure through 2010, pledging “fast and heavy-handed investment” and a “moderately loose” monetary policy. The plan spans housing, rural development, railroads, power grids and rebuilding after May’s earthquake in Sichuan province. Export and investment growth cooled in October, and industrial production had the smallest gain in seven years. China contributed the most to global growth in 2007, the International Monetary Fund said in a report in April. It used purchasing power parity calculations, which account for differences in the exchange rates of national currencies.
Strained Aussie welfare agencies plead for social capital cash
Major welfare providers are in Canberra today and hope to meet with Deputy Prime Minister Julia Gillard over what is being called a social services funding "perfect storm". Catholic Social Services Australia executive director Frank Quinlan told Radio National's Fran Kelly their services are already stretched to the limits and that in the past 12 months around 80,000 Australians in need have been turned away from welfare organisations.
"We're also facing very severe capacity constraints because many agencies provide additional services, or supplement Government services, through returns on investments or through donations that are received through other sources, and we're already hearing reports that those sources are drying up," he said. And it shows no signs of getting better. A report released overnight by the Organisation for Economic Cooperation and Development (OECD) predicts unemployment in Australia will rise to 6 per cent by 2010.
Mr Quinlan says that according to data sourced from Access Economics, at least 150,000 more people and their families will be turning to social services for help. He has described the situation as a "perfect storm" and says that aside from corporate and self-funded retiree donations taking a hit, so too are the investment returns welfare agencies heavily rely on.
"Large agencies such as the Salvation Army, Uniting Care and Anglicare...have very substantial investments and from the return on those investments they've traditionally been able to fund services in gaps that are not provided by Government services," he said. "Just like any other investors, as those investment returns dry up, so to does the capacity for those organisations to supplement Government funding."
Mr Quinlan says that while funding for social service providers is dropping rapidly, demand for them is increasing at the same rate - and those reaching out for help are not just low-income Australians. He says along with the general rising cost of living, middle-income families are now paying up to 50 per cent of their income in mortgage payments and need help keeping their heads above water.
According to their data this is only going to get worse and agencies are already buckling under the pressure. "Some of our services are saying that they are already concerned their budget for emergency relief for the financial year, which should be seeing them through to June, has almost been used up already," he said. "The other concern about the emergency relief is that for many of our agencies it's the canary in the coal mine, as it were.
"It's an indicator that people have struggled and struggled and struggled, and are finally making that first step to come to a social services organisation. Often that means that there are a whole raft of other challenges they are facing and things might have gone wrong in relation to their accommodation, or their housing arrangements, or credit problems that they might have developed - often stemming out of unemployment. So even though emergency services are a first starting point for many people, it's a sign that a whole raft of problems are being experienced by people and their families."
Although Mr Quinlan says social services welcome the Government's $10.4 billion economic stimulus package, $3.9 billion of which directly targets around two million low-income families, he says more than an economic quick fix is needed. "In addition to being the right thing to do, the sorts of services that social services offer are in fact a long-term investment in the productive capacity of the economy," he said.
"We all know that if we can fix a pothole while it's a pothole, we don't have to replace the whole road, and the same theory applies when people are experiencing social difficulties. If we can nip problems in the bud, a problem that is a small problem today can be fixed and not become a substantial problem enveloping whole families in serious disadvantage over long periods of time. So there's a very strong argument to say the sorts of services social services are offering are in fact a long-term investment that reaps substantial rewards for the economy. We think that as rescue packages are canvassed, the opportunities to invest substantially in the capacity of social service organisations and community groups to build social capital is a very worthwhile investment."
Canada's economy entering deep recession - OECD
The Bank of Canada has more room to slash interest rates, the OECD said in a report on Tuesday, forecasting Canada's economy will shrink for three straight quarters as the global crisis bites into domestic spending. The economy is now in a recession, said the Organisation for Economic Co-operation and Development, which predicted gross domestic product would shrink 1.6 percent in the fourth quarter, 1.4 percent in the first quarter of 2009 and 0.3 percent in the second quarter, before returning to growth. The economy will contract 0.5 percent in 2009, it estimated.
"Excess capacity and lower commodity prices are alleviating inflation pressures, allowing the Bank of Canada to boost its expansionary stance," it said. The central bank has cut its key overnight lending rate by 225 basis points since December 2007 and has suggested it will ease rates again on Dec. 9. Domestic demand, until recently the motor of growth in Canada as exports sagged due to the global slowdown, slowed to 2.8 percent growth in the first half of this year. That is almost half the rate of the past few years.
"Indicators point to further weakening in the last half of 2008 as a recession takes hold," it said. As a result, there will be a net loss of jobs in 2009 and the unemployment rate will rise to 7 percent, the highest since February 2005. The OECD sees the jobless rate peaking at 7.5 percent in 2010. The federal and provincial governments combined will likely post a deficit in 2009 and 2010, it said, but it called the shortfall "a largely cyclical outcome that is not alarming and leaves room to absorb eventualities, but underlines the need to keep a lid on discretionary expenditure increases." The OECD predicts a deficit in the current account, amounting to 1.7 percent of GDP in 2009 and 1.4 percent in 2010.
Tits on a bull
In a decentralised market economy, financial intermediation between economic agents with financial surpluses and those with financial deficits (or, more accurately, between economic agents who would like to run financial surpluses and those who would like to run financial deficits) is an essential economic activity. If this task if not performed effectively, it will still be the case that, ex-post, the sum of all realised financial surpluses equals zero, that is, realised saving equals realised investment - accounting identities are very insistent - but both are likely to be far from their optimal levels. In addition to channelling resources from financial surplus units to financial deficits units, the financial system performs, through risk trading, a significant part of the total risk sharing that takes place in a society. It also performs the portfolio management of much of the stock of financial wealth in existence.
The depth of the current crisis is such that the last two tasks of the financial system (risk trading and portfolio management) are being performed abysmally, and the first, the intermediation of financial surpluses and deficits, has effectively ceased to be fulfilled by our financial markets and banks. Financial intermediation has all but ground to a halt.
Many systemically important financial markets are closed to new issuance. Even secondary markets (for trading and pricing existing asset stocks) are badly impaired. Banks have all but stopped lending to households and to non-financial enterprises. Where banks are notionally still present as lenders, the financial terms and non-financial conditions (collateral and other covenants) are often prohibitively onerous.
We have no longer just a crisis in the financial system. We have gone even beyond the stage where there is a crisis of the financial system. The western (north-Atlantic) financial system we knew has collapsed. If I may paraphrase that great ensemble of Nobel-prize winning financial wizards, Monty Python’s Flying Circus:
“This financial system is no more! It has ceased to be! ‘It’s expired and gone to meet its maker! ‘It’s a stiff! Bereft of life, it rests in peace! If you hadn’t nailed ‘it to the tax payer’s perch it’d be pushing up the daisies! ‘Its metabolic processes are now ‘istory! ‘It’s off the twig! It’s kicked the bucket, it’s shuffled off its mortal coil, run down the curtain and joined the bleedin’ choir indivisible!! THIS IS AN EX-FINANCIAL SYSTEM!!”
Getting financial markets for illiquid assets going again will require public intervention, through the state acting as market maker of last resort, accepting illiquid assets as collateral for loans or buying them outright. It makes no fundamental difference whether this happens along the lines originally proposed for the TARP, or by the government insuring the value of illiquid assets, as the US Treasury has now agreed to do for Citi Bank. In both cases the government and the current owner of the illiquid asset have to agree on a price or a valuation.
The main practical ‘advantage’ of the insurance proposal over attempts at price discovery through auctions and similar mechanisms, is that the insurance plan hides the problem of valuing the illiquid assets behind non-transparent bilateral negotiations about the insurance premium paid and the level of the price guaranteed in the insurance contract. Opaqueness and lack of transparency are obviously at a premium when tax payer resources are being funnelled into the black holes that are our leading banks and other financial instutition.
Getting banks to lend again is even more essential than getting primary and secondary markets for illiquid structured financial products going again. It may be even more important than getting the regular commercial paper market going again, important though that is. Small and medium enterprises rely overwhelmingly on banks for external finance. Without access to bank loans, credit lines and overdraft facilities, countless SMEs that would be perfectly viable with a functional financial and banking system are threatened with bankruptcy. Without working capital, businesses go out of business. Banks are essential. But they are not lending. Why? A number of possible explanations suggest themselves.
(1) Normal commercial prudence has finally resumed its rightful place, after many years of excess Sound commercial judgements, made on a case-by-case-basis, produce the right supply of credit for each particular risky venture requesting financing. These individual lending decisions aggregate into an entirely appropriate volume of economy-wide lending that happens to be very low. Don’t blame the banks. Blame the entrepreneurs for not coming up with more creditworthy projects.
(2) In a world with multiple and quite different self-fulfilling equilibria, we somehow have ended up in the lousy equilibrium. Here each bank, believing the state of the aggregate economy to be lousy, decides not to extend credit to a would-be borrower that would be viewed as an acceptable risk, but for the dim view the bank takes of the aggregate economy. When all banks act this way, they will, by severally and jointly witholding credit, produce the lousy aggregate economic environment that they assumed/feared when they individually turned off their credit spigots. We just have to find some way of changing the focal point that coordinates individual banks’ actions to the good equilibrium. In the favourable equilibrium each bank, believing the state of the aggregate economy to be good, decides to extend credit to a quite reasonable would-be borrower the bank would not have lent to had it believed the state of the overall economy to be lousy.
(3) After years of excess and anything goes, the bean counters and risk controllers now rule supreme in the banking world. There is little upside to lending and taking a risk, but a lot of downside. Rolling over an old loan or extending a new one won’t help your bonus and it may cost you your job.
(4) Blind fear and panic rule the roost in the banking sector. Bankers are shell-shocked and paralyzed. More Prozac please.
(5) Banks hoard cash and liquidity to retain or regain their independence. The predator they fear is not Warren Buffett, foreign sovereign wealth funds or Qatari princes, but the state. Banks where the state has acquired a preferential equity stake or another equity interest are often subject to dividend limits and restrictions on executive remuneration. Paying down these government capital injections to regain full discretion over dividend payments and executive remuneration is a key pre-occupation. Banks seek out new private investors, trampling the pre-emption rights of existing shareholders and at higher financial cost to the bank than would have been attached to a capital injection by the government. All this just to retain their independence. Whose interest is being served you may ask? Not the existing shareholders. Not the other stake holders, the banks’ customers or creditors. Not the tax payers. Could it be the incumbent top management? Surely not!
I would put zero weight on (1) and roughtly equal weights on the other four possible explanations.
What is to be done? Banks that don’t lend to the non-financial enterprise sector and to households are completely and utterly useless, like tits on a bull. If they won’t lend spontaneously, it is the job of the government to make them lend. Banks have no other raison d’être. I can think of three ways to get them to lend using the coercive powers of the state.
(A) All domestic non-financial enterprises that currently have access to bank financing and whose loans, overdraft facilities, credit lines or whatever other financial arrangements expire during the coming year, have the right to an automatic one-year extension of the expiring arrangements on the same financial and non-financial terms as the expiring arrangements. This mandatory ‘creditor standstill’ helps existing borrowers by providing them with a breathing space. It does, however, do nothing for new enterprises or enterprises that are not currently borrowing.
(B) Aggregate lending targets for lending to the domestic non-financial business sector are set by the government for each bank (last year’s total plus five percent, say). The banks themselves can decide who to lend to and on what terms. Any shortfall of actual lending from the target is translated pound for pound into a Deficient Lending Tax. Since not meeting the target amounts to throwing money away, the banks will lend.
(C) Nationalise the banks (paying as little as possible to the existing shareholders), fire the existing management and board of directors, and have the government appoint a new executive and a new board that are serious about meeting lending targets. With 100 percent share ownership by the state, there is no risk of lawsuits about the executive or board of the bank not meeting their fiduciary duty to the shareholders. Full state ownership would make transparent and formal what is already true in substance: but for the financial support of the government (past, current and promised/anticipated in the future), there would no longer be more than at most a handful of viable cross-border banks in the north-Atlantic region.
It would have to be make clear that state ownership of a bank does not mean that the bank’s existing or new debt is sovereign-guaranteed. Limited liability applies even when the state is the only shareholder. Whether existing or new bank debt of state-owned banks benefits from the full faith and credit of the sovereign government can be decided on a case-by-case basis.
With both Alistair Darling and Mervyn King hinting darkly at the possibility of nationalisation of the remaining privately owned banks as a possible remedy for the bank lending strike, these proposals cannot even be considered radical.
Things are critical. Unless the banks start lending in normal volumes very soon, this recession could indeed become another Great Depression. We cannot wait for the banks to find their juju. The government may have to take it to them.
Shipping Woes: More Than Just Pirates
As Somali pirates hold captive the Sirius Star, a Saudi ship with almost $100 million in oil on board, and Indian, British, Russian, and German ships battle pirates up and down the Gulf of Aden, one might imagine that the battle against piracy is the largest crisis faced by the merchant navy industry. After all, since January of this year, some 580 crew members have been held hostage, according to data collected by the International Maritime Bureau, and many millions of dollars have been paid in ransom. Insurance rates are up, ships are trying to avoid the Suez Canal (which ships get to via the Gulf of Aden, along the coastlines of Somalia and Yemen), and crews from India to Britain are refusing to board ships that pass through that zone. "This sort of thing can't be shut down immediately," says an aide to Indian President Pratibha Patil, who advises her on naval affairs. India's navy has fought at least three different pirate groups in the last week. "To some extent, the world's navies have to flex their muscles, and that takes time."
But what's missing in the news reports about the modern-day pirates and the political repercussions is a simpler fact: The world's shipping industry is already on its knees and has spent the past six months in a slow-motion collapse kicked off by the . And the pirates, it would seem, are the least of the problem. Just six months ago, despite the fact that the economy in the U.S. was already slowing down, the industry was steaming ahead. As ships of every flag, color, and size were crossing oceans, carrying in their often cavernous cargo bays the essentials of trade—oil, steel, cement, iron ore, and coal—shipping rates worldwide in June hit their highest peak ever. It cost nearly $234,000 a day to rent one of those large capesize vessels, the ones so big that they don't even fit through the Suez Canal. Last week, you and your friends could have rented one of those ships for a weekend bachelor party and football game for less than $4,000, according to data collected by the London-based Baltic Exchange.
What happened? And what does it mean for the world economy? Not good news. Let's start with shipping rates. They are the lowest they have been in six years, as measured by a relatively obscure indicator called the Baltic Dry Index. The index, which measures the cost of shipping most commodities other than oil, has been in free fall since the middle of the year, down 93% from its peak of 11,793 in May 2008. As a result, daily rates for chartering a merchant ship are still down by as much as 98% from just six months ago. With shipping rates so low, the first casualties, not surprisingly, are shippers. Stocks for companies that construct ships and operate container carriers have languished. For instance, Singapore-based Neptune Orient, the largest shipping carrier in Southeast Asia, on Nov. 19 announced it was cutting nearly 1,000 jobs, or 10% of its workforce. All of the lost jobs are in the U.S. and Canada.
Not too many people pay attention to the BDI other than shippers, but economists trying to read the tea leaves of global trade see it as a solid leading indicator of whether the world's economy is headed up or down. There's a good reason for that: A ship leaves from somewhere in the world with a cargo load of iron ore, cement, or coal, heading most likely for China, India, Western Europe, or the Americas; two months later, when the ship finally docks, that cargo gets used for roads, dams, cars, buildings, airplanes, anything that generates economic activity. As global trade hums along, the index gains, because the number of ships in the world is pretty steady at about 22,000, so increasing demand increases shipping costs.
But when the index drops, eyebrows go up, since lower demand for commodities today means lower economic activity a few months down the line. "These rates represent the cost of shipping goods that are maybe two to three weeks from being put on a boat, and about a month or so from being delivered," says Phillip Rogers, a researcher at Galbraith's, a London shipbroker. "A falling index means fewer of these goods are actually getting shipped."
Most of the index's fluctuations are tied to the cost of shipping steel around the world. China, which makes up almost 60% of the index and is among the world's biggest steel consumers, has seen its annualized rate of steel production drop from 570 million tons in June to less than 475 million tons in September, according to data provided by the Chinese government. The International Monetary Fund predicts the global economy will slow the most since 1982, primarily on the back of reduced trade that's exacerbated by the credit crisis. "We really are at the point where there is no real trade," says Jon Windham, an analyst with Macquarie Securities. "The recent correction in dry bulk freight rates is very troubling for industrial production numbers over the next few months."
But the falling demand for commodities—and their falling prices—is also a wait-and-watch game for manufacturers, who are delaying shipments as far out as possible to let commodities correct from the peak reached during the last bull run in commodities. Steel prices, for instance, are dropping almost every day and are down almost 20% globally from their July prices, mostly due to reduced demand. "The dry index has fallen for several factors, but the clearest factor is the reversal of sentiment," says Jeremy Penn, chief executive of the Baltic Exchange, which compiles the index. "But there are short-term factors, including [the drop in] the letters of credit."
Letters of credit are the second part of the equation. Before shippers can put commodities on a boat, they like to get letters of credit from the eventual purchaser—a bank guarantee that their client is capable of paying when the cargo arrives. But since the credit crisis has tightened, manufacturers are having more and more trouble getting letters of credit. "With the credit crisis causing banks to shy away from lending to one another for much longer than overnight, there have been reports of banks refusing to honor letters of credit from other banks," said Matt Robinson, an Australia-based analyst for Moody's (MCO), in a report issued on Oct. 23.
Nearly 90% of the world's shipments rely on letters of credit, according to the World Trade Organization. While the drop in the availability of letters of credit is still largely anecdotal—there is no centralized data available—reports of shipments being stranded are doing the rounds of transportation companies. Galbraith's, the London shipbroker, said in a news release in late October that "stories [are] coming from all parts of the globe referring to early redeliveries, withdrawal by buyers from ship purchase agreements, bankruptcy of numerous steel traders, credit facilities being closed without notice to companies with previously unblemished records."
And then there's the falling price of steel. Steel prices peaked earlier this year, leveling off demand, leading to a drop in the Baltic dry index. But now, even as steel prices have dropped significantly and shipping rates are ridiculously cheap compared to a year ago, nobody is ordering more steel or iron ore. So the movement of commodities across the globe has slowed to its lowest rate in six years. The credit crisis is making it tougher for the manufacturers to import, even at a time of falling commodity prices, and steel consumption is refusing to increase, even as both purchase and shipping rates drop.
General Electric: Genuine Risk of Collapse?
General Electric (GE), the legendary American institution, founded in 1878 by Thomas Edison, is in deep trouble. Its PR machine has been in constant spin mode as the company sinks deeper into despair. It is one of the few companies in the U.S. that still retains a AAA rating. Considering Moody's and S&P's track record, rating companies and financial instruments, that AAA rating is not worth the paper it is written on. One look at GE's balance sheet will convince you they do not deserve a AAA rating. AAA companies do not need to take the desperate actions that GE has taken in the last few months.
The virtual crash in its stock price indicates that there is something seriously wrong with GE. The stock reached $53 at its peak in 2000. It closed below $17 this past week, the lowest level since the mid-1990s. CEO Jeffrey Immelt, who took over from icon Jack Welch in 2001, has made his mark by managing the company to a 68% decline in its stock price. You will not see anyone on CNBC take a hard look at GE's financial statements or ask the CEO tough questions, because Mr. Immelt signs their paychecks. While shareholders have taken a bath, Mr. Immelt, a Harvard MBA, raked in $72.2 million of compensation between 2002 and 2007. A company that is known for its pay for performance mantra evidently does not hold its CEO to the same standards.
The first signs of cracks in this global institution appeared in April 2008. GE has met their earnings projections consistently for decades. It is widely known that they are masters of "legal" earnings manipulation. Accounting rules allow for wide discretion in reserves and estimates. GE Capital has always been a black box within the larger company. GE does not provide detailed financial information about this division. This lack of detail has allowed GE to use this division as its backstop for meeting earnings estimates. During a better than expected quarter, they take extra reserves and have the quarter meet estimates or beat by one cent. During a down quarter, they use those excess reserves to meet estimates. The GE Capital division would also sell liquid assets at the end of a quarter to guarantee smooth sailing. This earnings management had lulled analysts and stockholders into being complacent regarding GE's business.
In mid-March Mr. Immelt confirmed publicly that GE would meet earnings expectations of $.50 to $.53 per share for the quarter ending March 31. With 2 weeks left in a 12 week quarter, Mr. Immelt was confident in their results. When GE reported earnings of $.44 per share in early April, the world was shocked. The stock, which had reached a yearly high of $37, dropped 16% to $31. Knowing that GE always has excess reserves to manage their earnings, with only two weeks left in the quarter, made the magnitude of the earnings miss beyond belief. Former CEO Jack Welch went on CNBC and said, "I'd be shocked beyond belief, and I'd get a gun out and shoot him if he doesn't make what he promised now. Here's the screw-up: you made a promise that you'd deliver this, and you missed three weeks later. Jeff has a credibility issue." Mr. Welch is absolutely right. Jeffrey Immelt has no credibility left. His excuse was, "We had planned for an environment that was going to be challenging...[but] after the Bear Stearns event, we experienced an extraordinary disruption in our ability to complete asset sales and incurred marks of impairments and this was something that we clearly didn't see until the end of the quarter." A top CEO should have a better handle on his business.
The next daggers into Mr. Immelt's credibility occurred in late September and early October. On September 25, with the stock trading at $25.50, Jeff Immelt lowered GE's earnings guidance, suspended its $15 billion stock buyback plan and declared they needed no outside capital. He reaffirmed their commitment to maintaining a AAA rating with these actions. One week later he convinced Warren Buffett to invest $3 billion in the company by paying him an annual dividend of 10% while granting him warrants to purchase $3 billion of common stock at $22.25. It then sold $12 billion of additional shares at $22.25 to the public. These were not the actions of a company or CEO that is in control. AAA rated companies do not have to pay 10% interest rates. Credit default swaps protecting against GE Capital default traded as if GE is a junk bond credit.
The issuing of $12 billion in common stock at $22.25 per share is an act of extreme desperation and brings into question whether GE has a lucid strategy. How can investors have confidence in a company that bought back 97 million shares for $3.1 billion at an average price of $31.69 in the first nine months of 2008, and then issued $12 billion worth of stock at $22.25 in October? Not only did they buyback $3.1 billion of stock in 2008, but they also bought back $27 billion of stock in the prior three years at an average price of $36.46. This is a twist on the old saying, buy high and sell low. If Mr. Immelt was not so focused on trying to beat short term earnings goals by wasting $30 billion of cash on share buybacks, he wouldn't have had to beg Warren Buffett for $3 billion last month at very poor terms from GE's perspective. A CEO is responsible for preparing their company for a worst case scenario and should never risk the company in an attempt to meet short term goals. Mr. Buffett may have made one of the few mistakes of his glorious investing career. He has lost $762 million on his investment in 1 ½ months, a return of -25%.
Most people know GE as an industrial conglomerate that makes light bulbs, appliances, and jet engines. Their advertising agency has positioned GE as a "green" company with an advertising campaign called "Ecomagination", stressing wind power, hybrid locomotives, and environmentally friendly products. The truth is that GE should have an ad campaign called "Bankomagination". GE is a bank disguised as an industrial conglomerate. GE Capital is a division of GE, which truly dominates the results of this company. GE Capital has three subdivisions (GE Commercial Finance, GE Money, and GE Consumer Finance). In 2003, GE Capital generated $5.9 billion of GE's $17 billion of profits, or 35%. By 2007, GE Capital was generating $12.2 billion of their $29 billion of profits, or 42%. Being a bank during the boom years of 2004 to 2007 did wonders for GE's bottom line. Being a bank now is a rocky path to destruction.
GE Capital is enormously leveraged to consumers throughout the world. It issues credit cards for Wal-Mart, Lowe's, IKEA, and hundreds of other retailers throughout the world. GE Capital provides private label credit card programs, installment lending, bankcards and financial services for customers, retailers, manufacturers and health-care providers. It also owns 1,800 commercial airplanes and leases them to 225 airlines worldwide. GE Capital provides credit services to more than 130 million customers — like retailers, consumers, auto dealers and mortgage lenders. Their financial products and services include a suite of offerings, from credit cards to debt consolidation to home equity loans. GE Capital has also been a huge benefit to the industrial side of the business. GE Capital provides financing for customers that buy GE power turbines, jet engines, windmills, locomotives and other big ticket items. The crucial question is whether the people and companies who received loans from GE Capital can pay them back. GE's future is highly dependent on the answer to this question.
The AAA rating of GE allows GE Capital to borrow funds at lower rates than all banks in the United States. Their cost of capital has been 7.3%. Losing that rating would be disastrous to GE Capital. Between 2002 and 2006, GE Capital did what most other banks did and levered up. Their ratio of debt to equity rose from 6.6 to 8.1, while profits quadrupled. GE Capital jumped into the subprime mortgage market in 2004, buying WMC Mortgage. It sold it in 2007, after racking up losses of $1 billion in 2007. It also unloaded a Japanese consumer lending company at a $1.2 billion loss in 2007. It is clear that risk management has taken a back seat to profits at GE Capital. GE Capital's profits plunged 38% in the 3rd quarter, the main reason for GE's earnings miss. Analyst Nicholas Heymann of Sterne Agee wrote: "Investors now understand that GE uses the last couple weeks in the quarter to 'fine-tune' its financial service portfolios to ensure its earnings objectives are achieved. It turns out it really wasn't miracle management systems or risk-control systems or even innovative brilliance. It was the green curtain that allowed the magic to be consistently performed undetected."
Egan-Jones, an independent rating agency, calculates that GE is levered ten-to-one, a more conservative and higher number than the company's eight-to-one figure. Cofounder Sean Egan believes that, depending on the off-balance-sheet holdings, actual leverage could be still higher. His firm rates the company single-A. Looking at GE's Balance Sheet between 2003 and today, clearly shows a deteriorating situation. Long-term debt grew from $172 billion in 2003 to $381 billion by the 1st quarter of 2008, a 121% increase. Their long term debt to equity ratio grew from 68% to 77%. Short-term debt grew from $157.4 billion in 2003 to $218.7 billion in the latest quarter, a 40% increase. The 70% increase in profits between 2003 and 2007 were undoubtedly juiced by the use of prodigious amounts of debt. Stockholder's equity is at the same level as 2004. With cash of only $59.7 billion and short-term debt of $218.7 billion, the freezing up of the credit markets has put GE at major risk when trying to rollover their debt.
All indications point to a company in trouble. Mike Shedlock, a brilliant financial analyst, recently quoted an insider at GE Capital. "Sales personnel are not allowed to make any more loans this year, and are being told to try to get their customers to pay off their loans. All prepayment penalties are waved for closing loans and GE Capital is about to launch a new incentive scheme for the salespeople that makes it worth their while to get their customers to agree to participate." This sounds like the actions of a company desperately trying to pay down debt.