Family of migrant fruit worker from Tennessee, camped near packinghouse in Winter Haven, Florida
Ilargi: As Obama builds an economic team consisting entirely of Wall Street insiders, a decision he, and all of us, will come to deeply regret, the economy keeps on tanking like there's not even a tomorrow morning.
A 1.5% rate cut in England, an 0.5% cut in continental Europe with a promise of more, and none of it has any positive effects anymore: shares tank regardless. Governments will have to start buying companies outright, or let them go down, that is all that's left. The Dow Jones lost 5.1% yesterday, and is so far today well on its way towards shedding another 5%.
Amidst the overall malaise, two firms stand out because they approach penny-stock territory, also known as the never ever land of no return. They are Ford and Ambac. GM and Chrysler are still working on a merger, for which Paulson will hand out dozens of billions of dollars. Ford will beg for a similar purse. But to what end does the taxpayer invest in Detroit? To save jobs, obviously, but how viable will these jobs be two, three years from now?
Look, the world simply has a giant surplus in car manufacturing capacity. Sales are sinking through the floor, and the credit crisis is only now starting to hit potential buyers, with many years of downward motion in the offing. In view of that, Ford and GM are likely to be the first to go, since European and Asian carmakers are better equipped to deal with the deterioration, in just about any shape and form.
Even Toyota experiences trouble these days, and they will be able to react much more decisively in the fight for a share of a shrinking market. It makes no economic sense to continue bleeding public funds into what are -and have been for years- failed companies. We'll have to swallow hard, lose 2.5 million jobs and try to find different occupations for the newly jobless. Having them keep on building products for which there is no market is foolish, as all former East bloc countries can tell you.
Like Ford, Ambac is a cat with ninety lives, but after the most recent ratings downgrade by Moody's, it really looks like it's a done deal this time. Down 40% yesterday, and 20% more today. There is a limit somewhere. Paulson may well decide over the weekend to purchase the monoline. If letting AIG fail was viewed by the deciders as too big a risk, they probably won't want to fool around with a company that has more exposure than anybody really knows.
Ambac is almost certain to hold huge numbers of really expensive and hideously ugly surprises, which could ricochet across the globe, leaving many, often large, broke(n) companies in its wake. The problem is that, as is the case with AIG, there is much more toxicity brewing in Ambac's books and vaults than we are being told. After gobbling up $144 billion of your money, or almost $500 for every American citizen, AIG has once again come back begging for more.
The reason why they will get what they want once more is that the alternative would be dangerous to the survival of the companies that do or did employ the very people who now advise Obama on finance and economics. That conflict of interest is simply too perverted for words. These no-no’s and bozo’s made this mess, and they are not, nor will they ever be, capable of cleaning it up. For one, because they will not let the hands that feed them fail, and besides that also because they all have the same failed Keynesian botched theories in their thick skulls. They lack the tools to do the job, both practically and morally.
It’s nice for Barack to get congratulations from president Ahmanidinnerjacket, but there's work to do here, and so far it looks like the very first fork in the road proves too much for him. And no, we'll have none of that talk about 'he needs time'. He doesn't have that time. Sure, it sounds nice to say that a man won't truly build character until he stares into the abyss.
But you know what? You are already staring into the abyss, and both you and Obama completely fail to see it for what it is. That's no way to build character.
Ilargi: Case in point: if Detroit scales back it operations by 50%, 2.5 million jobs will be lost. GM October sales were down 45%. We call that the writing on the wall. The cheerleaders who wrote this report can talk all they want about the terrible consequences of scaling back, but at least that is less idiotic than producing cars just to let them sit in the lot. Consumer demand is plunging throughout the entire economy, not just for automobiles. Are we going to let everyone keep their jobs at the expense of everyone else? How absurd would you like it? I haven't seen any recent claims about making a profit on the AIG bail-out, but that's about the level of emptiness we're talking here.
Collapse of automaking industry would crush U.S. economy
A leading think-tank has drawn a doomsday picture for the North American auto industry showing that if Detroit's automakers shrink further or even fail, the U.S. economy will suffer a crushing blow. In a report released Wednesday, the Center for Automotive Research in Ann Arbor, Mich., outlined what would happen in two separate scenarios if General Motors Corp., Ford Motor Co. and Chrysler LLC were forced to scale back or shut entirely.
If all three Detroit manufacturers were to cease operations, the U.S. economy would lose 2.95 million direct and indirect jobs in the first year. Governments would lose at least $156.4 billion US in taxes over the first three years. If Detroit cut output and employment by 50 per cent to meet ever-shrinking market share, 2.46 million jobs would be lost initially. Governments would lose $108 billion in revenue over three years, according to the analysis. "The circumstances are such that either of these scenarios is possible, and indeed one or the other is probable, within the next 12 months," the non-profit think-tank said.
The report bolsters the case that the government of president-elect Barack Obama needs to act decisively to speed up financial aid to the domestic industry. Its authors argue the re-elected government of Prime Minister Stephen Harper will also have to get involved if it wants to preserve Canada's auto sector. "The cost of a failure on a cash basis is a lot greater than the cost of keeping these guys in the game," CAR chairman David Cole said in an interview. "We think that [lawmakers] will recognize that a failure here is something that is just not good in any way shape or form for the economy."
U.S. auto sales have slid to lows not seen in 25 years, contributing to combined losses totalling $28.6 billion US for GM, Ford and Chrysler in the first half of 2008. The Detroit manufacturers are struggling to add more small cars and fewer big trucks to their lineups and their financing arms are scaling back loans and leasing to customers. GMAC Financial Services, GM's auto loans unit, on Wednesday reported a third-quarter loss of $2.5 billion. GM's U.S. auto volumes dropped 45 per cent in October. The automaker, burning through more than $1 billion US a month, is in talks to buy Chrysler from its owner, Cerberus Capital Management. Analysts estimate the automaker needs $10 billion to engineer a merger with Chrysler.
Chrysler U.S. sales fell 35 per cent in October. It is "very likely" the company will file for bankruptcy protection if it does not find a buyer or alliance partner, consultants at AutomotiveCompass LLC said in a recent report. Shares in GM rose as much as seven per cent in New York trading Wednesday on speculation by investors that Obama's administration would push for an expanded loan program for carmakers beyond the $25 billion US already earmarked to help them build more fuel-efficient vehicles. Ford stock rose as much as three per cent, but shares in both companies retreated by the close.
The president-elect said in a speech last month that aid to car manufacturers should be on a "fast track" and that more funding should be given if required. "What we need is to make sure that a vital industry like autos . . . which is such a big part of the overall economy, doesn't lead us into a deeper and harsher downturn," John Snow, chairman of Cerberus, told CNBC. "The collapse of the auto industry at this time would be devastating for a new president."
S&P 500 Profit Estimates Coming Down With a Vengeance
Analysts are slicing profit forecasts for U.S. companies in the fourth quarter and 2009 as third- period results miss projections at the highest rate in almost 11 years. "Estimates have been coming down with a vengeance," said Dirk van Dijk, director of research at Zacks Investment Research Inc. in Chicago. "It's just plain ugly out there." Companies in the Standard & Poor's 500 Index may see fourth-quarter earnings advance 15 percent, down from 42 percent projected at the end of August, according to a Bloomberg survey of analysts' estimates. Profits in 2009 may grow 13 percent, analysts say now, compared with the 24 percent predicted two months ago.
Financial firms worldwide have posted almost $700 billion in credit-related losses and writedowns since the beginning of 2007, in the worst economic crisis since the Great Depression. The S&P 500 is down 35 percent this year, headed for its worst annual performance since 1937. "Wall Street has underestimated the negative impact on corporate earnings of the ongoing global economic deterioration," said Alec Young, an S&P equity strategist in New York. "We're still finding out where the bottom is."
Third-quarter earnings retreated 9.6 percent at the 415 S&P 500 companies reporting results through yesterday, dragged down by financial, auto and retail businesses. More than 30 percent of companies missed analysts' earnings estimates, the most since the fourth quarter of 1997, according to Bloomberg data. Bank of America Corp., the largest U.S. consumer bank, missed estimates last month when it reported third-quarter profit dropped to $1.18 billion, or 15 cents a share, from $3.7 billion, or 82 cents, a year earlier. Twenty analysts surveyed by Bloomberg had estimated 61 cents a share, on average.
"The financial services are getting whacked, and I mean that in the `Sopranos' sense of the word," van Dijk said, referring to the U.S. television drama about an organized crime family in New Jersey. "It's just a massacre across the board." The banks aren't alone. Office Depot Inc., the world's second-largest office-supplies retailer, missed analysts' adjusted profit estimates Oct. 29, as sales slumped in North America. Best Buy Co., the top U.S. electronics retailer, fell short of earnings projections Sept. 16 after spending more to enhance U.S. shops. Boeing Co., the world's second-biggest commercial aircraft maker, posted profit below expectations Oct. 22 as revenue sank.
The third-quarter earnings drop helped send the stock market to the lowest valuation in 23 years. The S&P 500 was valued at 10.7 times estimated profit when trading opened Oct. 28, the cheapest compared with the multiple using trailing profit since 1985. Since then, the index has jumped 12 percent. The financial turmoil has caused companies to delay 2009 projections and withdraw growth targets, making it harder to estimate what will happen next year, S&P's Young said.
Caterpillar Inc., the world's largest maker of bulldozers and excavators, put off issuing its full-year projection while Western Union Co., the world's biggest money-transfer business, withdrew long-term profit targets set in June because of "uncertainty" in global markets. "There's no visibility," Young said. "I'm not even looking at '09 numbers because I don't trust them. They're too high."
Credit-Default Swap Disclosure Hides Truth on Risk
The most comprehensive report on unregulated credit-default swaps didn't disclose bets in the section of the more than $47 trillion market that helped destroy American International Group Inc., once the world's biggest insurer. A study by the Depository Trust and Clearing Corp. fails to include privately negotiated credit-default swaps that insurers such as AIG, MBIA Inc. and Ambac Financial Group Inc. sold to guarantee securities known as collateralized debt obligations. It includes only a "small fraction" of mortgage securities, according to Andrea Cicione at BNP Paribas SA in London.
New York-based DTCC's report, released on its Web site Nov. 4, showed a total $33.6 trillion of transactions on governments, companies and asset-backed securities worldwide, based on gross numbers. While designed to ease concerns about the amount of risk banks and investors amassed on borrowers from companies to homeowners, the study may have missed as much as 40 percent of the trades outstanding in the market, Cicione said. The data are "likely to underestimate the amount of net CDS exposure," he said in an interview. "A broadening of the coverage to the entire market is what investors really need."
Cicione, who correctly forecast in January that the cost of protecting European companies would rise, said increased transparency in the CDS market is "definitely a welcome development." Trading of credit derivatives soared 100-fold the past decade as banks, hedge funds, insurance companies and other investors used the contracts to protect against losses or speculate on debt they didn't own. The growth was driven in part by CDOs, securities that parcel bonds, loans and credit-default swaps, slicing them into varying layers of risk. Banks worldwide have taken $693 billion in writedowns and losses on loans, CDOs and other investments since the start of 2007, according to data compiled by Bloomberg.
Investors hedging against losses on CDOs helped push the cost of default protection to a record last week. The benchmark Markit CDX North America Investment Grade Index reached 240 basis points on Oct. 27. The index closed at 187 basis points in New York yesterday, according to Deutsche Bank AG. The Markit iTraxx Europe rose to 195 basis points from as low as 20 in June 2007. It was 138.5 basis points, according to JPMorgan Chase & Co. prices at 10:35 a.m. in London.
Credit-default swaps, contracts conceived to protect bondholders against default, pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements. An increase indicates a deterioration in the perception of credit quality; a decline signals the opposite. A basis point on a credit-default swap protecting $10 million of debt from default for five years costs $1,000 a year.
AIG first disclosed to investors in August 2007 that it held more than $440 billion of credit-swap trades linked to CDOs. The New York-based company was brought to the edge of bankruptcy in September after the value of the transactions plunged. The insurer was forced to come up with more than $10 billion in collateral to back the contracts after its debt rankings were cut. It accepted an $85 billion government loan in exchange for ceding control to the U.S.
MBIA and Ambac, previously the world's two biggest bond insurers, lost their top AAA ratings earlier this year because of potential losses on credit swaps sold to guarantee CDOs backed by home loans. Moody's Investors Service cut New York- based Ambac's bond insurance rating four levels yesterday to Baa1, three steps above junk, because of potential losses on the derivatives. A market survey this year by the New York-based International Swaps and Derivatives Association, which includes credit swaps on CDOs and other contracts that may not be captured by DTCC's Trade Information Warehouse, estimates more than $47 trillion in gross contracts are outstanding.
The Federal Reserve Bank of New York, which urged dealers to curb risks and improve transparency in the credit swaps market over the past three years, said regulators will continue to push for more disclosure. Among the information the Fed wants to see are prices at which the derivatives trade, according to a New York Fed spokesman. "There appear to be gaps," said Henry Hu, a law professor at the University of Texas in Austin who has pressed for the creation of a data warehouse encompassing all privately negotiated derivative trades to offer a better understanding of their risks. "Hopefully, regulators are getting more information," he said.
Because the DTCC registry captures only commonly traded contracts that can be confirmed over electronic systems, not every swap trade is in the company's report, spokeswoman Judy Inosanto said. Among those not included are credit-default swaps on CDOs, she said. MBIA, the Armonk, New York-based insurer crippled by ratings downgrades earlier this year following losses from such contracts, has said it sold $126.3 billion in guarantees on slices of CDOs backed by corporate bonds, mortgages and other debt. Ambac sold $60.7 billion in guarantees on these so-called tranches, mostly through credit swaps, the company said.
Insurers including AIG, MBIA and Ambac typically sold protection on the highest ranking slices of such deals, meaning they'd be required to make good on payments only after a substantial part of the underlying debt defaults. The failures of Lehman Brothers Holdings Inc., Washington Mutual Inc. and three Icelandic banks that were widely held in CDOs linked to corporate debt caused no losses on tranches MBIA guaranteed, Mitchell Sonkin, the company's head of insured portfolio management, said in a conference call yesterday.
New York-based Lehman and WaMu, based in Seattle, filed for bankruptcy. Iceland's government took over its three biggest lenders last month after they were unable to raise short-term funding, triggering pay-outs on credit-default swaps. Investors holding the riskier slices of CDOs that weren't guaranteed lost more than 90 percent because of the bank failures. "The worry is that these bespoke tranches are being eaten away, and who knows if and when these losses will get realized," Tim Backshall, chief strategist at Credit Derivatives Research LLC in Walnut Creek, California, wrote in a note to clients yesterday.
IMF thesis gives no reason to think the worst is over
The European Commission's latest dire survey of business confidence - described by one analyst as a "war bulletin" - is clear evidence that the long-expected hammering of corporate earnings has arrived. It bears out one of the more startling statistics of recent weeks: that Volvo's European truck sales in the third quarter fell from last year's 42,000 to just 115. At long last, sector analysts are beginning to catch on. According to Merrill Lynch, the ratio of earnings downgrades to upgrades, in both Europe and the US, was last month the highest in 21 years surveyed.
Even the top-down strategists, who have been warning of this for many months, are getting gloomier. Citigroup now thinks global earnings could fall 50 per cent from top to bottom. And that, as I shall discuss in a moment, could be an underestimate. Bizarrely, though, the market still seems to find profit warnings surprising. Last week the UK engineer GKN, which has two-thirds of its sales to the auto industry, said this year's profits would be down 20 per cent. The shares fell 10 per cent on an otherwise quiet day. The news of collapsing world car sales, it appears, had somehow passed investors by.
That makes yet more pressing the question of how far corporate earnings have to fall. But first, let me touch on an arresting thesis set out in the latest World Economic Outlook from the International Monetary Fund. In a study covering 17 developed economies over three decades, the IMF came up with three findings of particular relevance.
First, recessions preceded by a financial crisis tend to be deeper and longer than others. Second, they tend to be worse again if the crisis is in banking, rather than in securities markets or foreign exchange. And third, the countries hardest hit are those with so-called arm's length financial systems, such as the US or UK. If banks are free to innovate, they tend to build up more pro-cyclical leverage.
In practical terms, the IMF found that recessions linked to banking crises lasted twice as long on average as those not linked to any financial crisis, and the cumulative loss of output was about four times as great. The present recession, plainly, ticks all the boxes - a fact that makes it unlike any in recent memory. That of 1990-91, for instance, was only partly financial and not much to do with banking, being preceded by the Japanese stock market collapse and a junk bond crash in the US. There was a severe Scandinavian banking crisis after that recession had got under way, but that was primarily local. What we have today is an increasingly global banking crisis, which is bad news all round.
With that, let us turn to the Citigroup thesis on the coming earnings recession. Citi envisages a 50 per cent fall globally, of which 10 per cent has happened already. And partly with the IMF findings in mind, it says the process could last up to three years. Crucially, though, Citi assumes that corporate return on equity will only fall to the 8 per cent trough seen in the past two earnings recessions of 1992-93 and 2001-02. The fall seems steeper this time merely because of the starting point - the return on equity at the peak having been a record-breaking 16 per cent.
But if the IMF thesis is right, there is every chance this recession will be more severe than the other two. There are also several factors at work that were less powerful before. One has to do with pensions. The true scale of deficits by this time is anyone's guess, but one estimate last week suggested US corporations might have to put an aggregate $50bn into their funds in each of the next two years. In the old days the effect, such as it was, would have been hidden, not displayed on the face of the accounts.
Similarly, corporations of all kinds now have to mark all kinds of assets to market. Earnings will therefore be dented by the writedown of paper profits recorded in the bubble years. What about valuation? Citi puts the global price-earnings ratio now at 10.4 times. And since one-fifth of the projected fall in earnings has already happened, that puts the trough p/e at 17 - bang on the long-run average.
Therefore, Citi says, the 50 per cent earnings fall it envisages is in the price. That is not dissimilar to the finding I wrote about last week, that the present p/e in the US is in line with the 10-year trailing average. But, as I also said last week, that does not by any means imply the market has finished falling. Equities are going through a welcome spot of calm at the moment. I do not expect it to last.
Workers' hours slashed to keep productivity rising
U.S. firms cut back their employees' working hours in the third quarter at the fastest rate in six years, keeping productivity growth rising faster than expected, according to Labor Department data released Thursday. Productivity in the nonfarm business sector increased at a 1.1% annualized rate as output fell 1.7% and hours worked dropped 2.7%. The decline in output was the largest since the recession in 2001.
Economists surveyed by MarketWatch had expected productivity to increase at a 0.3% annual rate. "Productivity growth is on track to get much worse before it gets better," wrote Nariman Behravesh, chief economist for HIS Global Insight. "Companies will likely have trouble cutting hours and jobs fast enough to offset the drop in output." Unit labor costs -- a key gauge of inflationary pressures from labor markets -- rose 3.6%, less than the 4.2% growth anticipated by economists.
Real hourly compensation fell 1.9% in the quarter and is down 0.9% in the past year, marking the largest annual decline in 13 years. In the past year, U.S. productivity is up 2% and unit labor costs are up 2.3%. Hours worked are down 1.7%, and output is up 0.3%. Workers' real compensation has fallen over the past year, suggesting that workers were not able to demand greater wages to offset the higher prices they paid for energy and food. If employees don't get raises to match the increase in prices, the inflationary spiral is severed. In the manufacturing sector, productivity fell 1% in the third quarter, while unit labor costs jumped 6.1%.
Manufacturing output fell 5.8%, the biggest drop since 2001, while hours worked decreased by 4.9%. Real hourly compensation in manufacturing also fell, down 1.6%. In a separate report Thursday, the Labor Department said the number of U.S. residents continuing to collect state unemployment benefits rose to a 25-year high last week, further evidence that the labor market is extremely weak. Productivity, a concept that's simple in theory but elusive in practice, is output divided by hours worked. Productivity gains are the key to higher living standards, higher wages, increased profits and low inflation.
High productivity growth means the economy can grow rapidly without inflation, raising living standards and theoretically allowing workers to get big raises without hurting the boss's profits. But a low rate of productivity growth can mean a sluggish economy and increased inflationary pressures. Unfortunately for those who want easy answers, in practice productivity is extremely difficult to measure, particularly in the services. Most economists focus on the longer trend, rather than on the volatile quarterly numbers. Productivity averaged about 2.7% annually from 1948 to 1970, then slowed to 1.6% from 1971 to 1995. Since then, productivity has grown about 2.5% annually. In 2007, productivity increased 1.4%.
Continuing jobless claims hit 25-year high
The number of U.S. residents collecting state unemployment benefits reached the highest level in 25 years, rising by 122,000 to a seasonally adjusted 3.84 million in the week ending Oct. 25, the Labor Department reported Thursday. Meanwhile, the number of first-time applications for benefits fell by 4,000 to 481,000 in the week ending Nov. 1, the government agency added.
The jobless claims report shows businesses are laying off workers at a rapid pace, while finding a replacement job is ever harder. "The jobless claims data continue to point to a rapidly contracting labor market and a continued rise in the unemployment rate," wrote John Ryding and Conrad DeQuadros of RDQ Economics. The figures come just a day before the government will report on the October labor market. Economists surveyed by MarketWatch are looking for nonfarm payrolls to plunge by 210,000 and for the unemployment rate to rise by two-tenths to 6.3%. The October report is expected to be the worst in five years.
The economy has lost jobs for nine consecutive months. So far in 2008, nonfarm payrolls have fallen by 760,000 to 137.3 million. Typically, state unemployment benefits run out after 26 weeks for those who are eligible. A federal law extends unemployment benefits for an extra 13 weeks under the separate federal program. Congress is expected to extend benefits again when it passes a new stimulus plan.
Benefits are generally available for those who lose their full-time job through no fault of their own. Those who exhaust their unemployment benefits are still counted as unemployed if they are actively looking for work. Compared with the same week a year ago, new jobless claims are up about 45%, while continuing claims are up 46%. Initial claims represent job destruction, while the level of continuing claims indicates how hard or easy it is for displaced workers to find new jobs.
The four-week average of seasonally adjusted initial jobless claims -- which smoothes out one-time events such as holidays or weather -- was unchanged at 477,000, down from the peak of 485,000 three weeks ago. That was a seven-year high. The insured unemployment rate -- the proportion of covered workers who are receiving benefits -- increased by a tenth to 2.9%, the highest in five years. In a separate report, the Labor Department said U.S. firms cut their employees hours at the fastest pace in six years during the third quarter. Productivity rose at a 1.1% annual rate, while unit labor costs increased 3.6%.
Big Three collapse could cost 2.5 million jobs
The potential failure of one or more of the three U.S.-based automakers would cut up to 2.5 million jobs in the first year as production ground to a halt throughout the industry, according to an auto industry consultant group on Wednesday. The impact on carmakers, suppliers and the operations of transplant automakers in the United States would reduce personal income by more than $125 billion in the first year, the Center for Automotive Research said in a study.
U.S. automakers already had been struggling amid a three-year domestic downturn in auto sales before the financial crisis increasing investor concerns that the companies would not be able to hold out until the market recovers. General Motors Corp. and Cerberus Capital Management have been in talks about a potential merger of GM and Cerberus-owned Chrysler. Ford Motor Co. is thought to be in better shape than its rivals, but also has been burning through cash at a swift rate.
The center studied the potential impact if all three U.S. automakers failed, or if one or more failed, and said either scenario is possible, and "indeed one or the other is probable, within the next 12 months." The study was not commissioned by a third party organization or a company, said Ann Arbor, Michigan-based CAR. However, the center has worked with automakers and auto parts suppliers on various projects.
The center expected "short-term shocks" for all automakers, followed by gradual increases in domestic production by international automakers and surviving Detroit automakers and a "high likelihood of many U.S. supplier company insolvencies." After the first-year impact of job losses, a rebound in domestic production at the surviving Detroit-based automakers and at the transplant automakers would pare those job losses to about 1 million by 2011, the center found.
The study did not take into account the impact on the interdependent Canada or Mexico auto industries that rely on U.S.-produced parts and components.
U.S. carmakers may not be able to wait for Obama
President-elect Barack Obama courted distressed U.S. automakers during his campaign and pledged to help them, but the industry's health is so bad it may not be able to wait for him to take office. "He's not here until January (20th) and that's a long time in the life of these companies at the moment," John Engler, a former Michigan governor and president and chief executive of the National Association of Manufacturers, said on Wednesday.
Engler expects fundamental changes in industry before Obama's inauguration. Engler was not specific. General Motors Corp said on Wednesday it plans to reveal new cost cuts when it reports quarterly earnings on Friday. Results at GM and Ford Motor Co are expected to be dismal. Both GM and Ford congratulated Obama on his election and associated overall U.S. economic weakness with Detroit's worsening financial prospects.
Automakers hold out hope the Bush administration, reluctant to bail out Detroit, will act before yielding power to Obama. Carmakers, their allies in Congress and other industries have called on the Treasury Department to extend loans or other capital as a stop gap. In coming weeks, companies and their lobbyists plan to "dial up" their urgency. Industry plans to underscore its belief that its immediate problems are not of its own making -- that the dire predicament is closely linked to the global credit crunch and survival depends on federal intervention.
While GM and Ford struggle, prospects at Chrysler LLC are the most uncertain. People involved in discussions about its future say the smallest of the U.S. manufacturers could merge, be spun off or be pushed into bankruptcy if not helped soon. Engler said a Chrysler failure could cost up to 1 million jobs throughout the economy. "It's not just the three auto companies, it's suppliers, all the way down the chain," Engler said.
While Obama is not yet in office, industry sources say he could still pressure the Bush administration and exert leverage on the Democratic-led Congress, if he believes action is needed to avert a broad economic crisis in manufacturing. House of Representatives Speaker Nancy Pelosi called on Wednesday for a $61 billion stimulus plan to spur the U.S. economy, but said passage later this month would depend on Senate Republicans and the mood of the White House. Pelosi met on Monday with auto industry allies in Congress and key committee chairmen. There is no consensus yet on an aid proposal for Detroit.
Carmakers, their lobbyists and congressional officials have suggested up to $25 billion in direct loans with few or no strings attached to help them through the current crisis, officials said. Government red tape is holding up another $25 billion in advanced technology loans for automakers that was approved in September. During the campaign, Obama called on the Bush administration to accelerate that financing. The United Auto Workers (UAW) has suggested billions in congressionally approved aid could go to covering retiree health care costs, freeing up money that companies would otherwise have to contribute for benefits.
Same-Store Sales Hit Multiyear Low In October
Retailers posted the weakest same-store-sales since at least 2000, with many firms reporting results below already-dour expectations, as consumers stayed home as markets around the world plunged last month on increased economic fears. Those worries sent consumer confidence plunging to a record low by one measure and left companies fighting over a smaller number of shoppers.
But Wal-Mart Stores Inc. topped its modest expectations as consumers continue to be more price-sensitive. Excluding the retail giant, U.S. same-store sales fell some 3.5% to 4%, the worst performance in years, excluding the changing timing of holidays that impacted some year-to-year comparisons. Despite the bad results, many retail shares were higher Thursday amid a another broad stock-market selloff, clawing back a bit of the losses the sector's stocks have seen of late. For example, J.C. Penney Co. is still down 25% the past month despite rising 4.5% Thursday.
Numerous retailers reported double-digit declines, led by teen retailer Abercrombie & Fitch Co.'s 20% decline. Upscale retailers like Abercrombie have been feeling the pain more than lower-end stores, which are showing the best overall strength. But discounters weren't excluded from October's pain, with Costco Wholesale Corp. posting a 1% drop on the rallying dollar and Target Corp. reporting another month of weak results with a 4.8% decline. Target President and Chief Executive Gregg Steinhafel called the results "very disappointing" and said the woes should continue into the holidays and beyond.
Closeout retailer Big Lots Inc. (BIG) reported a surprise 0.2% drop in same- store-sales for the fiscal third quarter ended Saturday as sales of seasonal goods, toys and home merchandise disappointed. The company cut its earnings outlook for the period, pushing the stock down 16%.
Beyond Wal-Mart, another bright spot was smaller Costco and Sam's Club rival BJ's Wholesale Club (BJ), which posted a 6.6% increase excluding gasoline sales. The strength also prompted the company to boost its fiscal third-quarter earnings forecast by 9 cents to between 45 cents and 49 cents a share.
The Thomson Reuters same-store-sales index fell 0.7%, double the decline expected, while the decline excluding Wal-Mart was 4.1%. The results are the worst since the company began collecting same-store-sales estimates in 2000. "Consumers are clearly putting their wallets under lock and key and reacting to the severe economic conditions at play right now," said Patricia Walker, a partner with the North American retail practice of Accenture Ltd. (ACN). The fact that some discount retailers aren't able to capitalize in the current environment is also telling, Walker said. "It seems to me that consumers are not only trading down but some are trading out."
The figures show that consumer spending has only worsened since the summer. The federal government said last week that such expenditures for the third quarter fell by the biggest amount in 28 years. Many expect the woes to continue, resulting in the worst holiday-sales season in years. And some say things need to be bad so the economy corrects itself after years of consumers overextending themselves on easy credit. "To fix our current economic mess we need to diminish the activity that undermined our economy and encourage the behavior that will restore balance," Peter Schiff, president of brokerage firm Euro Pacific, recently said.
Wal-Mart said U.S. same-store sales, excluding fuel, rose 2.4% last month. The company had projected 1% to 2% growth. Sales climbed 2.2% at its namesake brand and 3.6% at Sam's Club. Eduardo Castro-Wright, head of Wal-Mart's U.S. operations, said traffic at namesake stores was higher and seasonal sales were strong. Helping the cause was "competitive pricing, especially on basics throughout the store." Sam's Club was aided by strength in staples such as fresh food, dry groceries and consumables, a sentiment shared by BJ's. For November, Wal-Mart expects total U.S. same-store sales to rise 1% to 3%, with falling gasoline prices providing a tailwind into the holidays.
Meanwhile, Costco reported a 1% decrease in October same-store sales; analysts were expecting growth approaching 4%. Assuming no change in currency values, Costco said total same-store sales would have risen 3%. Department stores were projected to be weak, as they have been for more than a year, and they actually came in slightly worse than dour expectations. J.C. Penney posted a 13% decrease, while Saks Inc. (SKS) had a 17% slide and Kohl's Corp. reported a 9% drop. All three cited weak traffic levels. Apparel chains beyond Abercrombie also reported big declines, including Gap Inc. with a 16% drop as all three of its chains had similar-size decreases. Nonetheless, margins have stayed significantly higher, and the company's fiscal-year earnings guidance remains intact.
TJX Cos., the parent of offprice retailers Marshalls and T.J. Maxx, saw a temporary stop to recent gains and reported a 6% decline, which the company blamed on the strengthening dollar. The drop would have been 1% without it, said TJX. Elsewhere, Urban Outfitters Inc. said its same-store sales for the fiscal third quarter ended Friday climbed 10%, extending recent strength. Its namesake chain had 17% growth. But investors were unimpressed, sending shares down 6.2%. Another strong point was fellow teen retailer Buckle Inc., which extended its 15-month streak of double-digit increases with 14.5% growth for October.
Bank of Japan Helpless as Yen Rises on Carry Trade Fall
The Bank of Japan may be powerless to prevent the yen from rising to a 13-year high, according to the world's biggest foreign-exchange traders. Deutsche Bank AG, UBS AG and Barclays Plc predict the yen will recover from its steepest weekly decline since 1999 as investors reduce carry trades that fund purchases of higher- yielding assets by borrowing in Japan. The currency will appreciate to 90 per dollar from 97.74 today in Tokyo even if the Bank of Japan intervenes to stem the biggest annual gain since 1998, they said.
"Once the market realizes that we're now in a global recession, there's further deleveraging to come," said Geoff Kendrick, a senior currency strategist in London at UBS, the second-biggest trader in the $3.2 trillion-a-day market. Traders "are capitulating" after five years of bets against the yen, he said in a Nov. 4 interview. The currency's 14 percent gain against the dollar this year and 30 percent advance versus the euro prompted Japan's government to announce last month it may buy or sell currencies to influence exchange rates, as the world's second-largest economy stumbled. Gross domestic product shrank by an annualized 3 percent in the second quarter as exports dropped 2.5 percent, according to government data.
Canon Inc., the world's largest camera maker, blamed the yen's rally when the Tokyo-based company forecast its first profit decline in nine years last month. Sony Corp., the second- largest maker of consumer electronics, said net income fell 72 percent in the quarter ended Sept. 30. Tokyo-based Sony gets 77 percent of its revenue outside Japan, according to data compiled by Bloomberg. The yen's real effective exchange rate, a measure of its value against 15 of Japan's trading partners, rose 11.2 percent in October, the biggest gain since the Bank of Japan started the index in 1970.
Finance Minister Shoichi Nakagawa said last month Japan was prepared to restrain the yen, which would be the first time the government has bought or sold currencies to influence exchange rates in four years. The BOJ, which trades on behalf of the Ministry of Finance, sold 14.8 trillion yen ($151 billion) in the first quarter of 2004, when it traded as high as 103.42 per dollar. The currency still ended the year stronger, at 102.63.
"An intervention to change the yen's rising trend would be like trying to stop a tsunami with one hand tied behind your back," Toru Umemoto, chief currency analyst in Tokyo at Barclays Capital, said in an interview on Oct. 28. The unit of London-based Barclays Plc is the third-largest foreign-exchange trader. The currency pared its advance in the past eight days as global stocks rallied, reducing pressure on the government to step into the market. The yen traded at 97.74 at 2:41 p.m. in Tokyo, compared with 90.93 per dollar on Oct. 24, the strongest since 1995. It climbed 0.3 percent today.
UBS says the yen will rise to 90 per dollar in a month. Deutsche Bank, the largest trader, sees that level reached this year, while Barclays' forecast is for six months. The banks are outliers on Wall Street, where the mean estimate for the yen is 99 at yearend, according to a Bloomberg survey. UBS expects the yen to rise to 119 per euro at year-end, from 125.99 today. Deutsche Bank forecasts 113 and Barclays predicts 120.
Carry trades grew during the past five years, driving the yen to 124.13 in June 2007, as central banks increased interest rates to fight inflation while Japan kept its key rate at 0.5 percent. Investors borrowing in the yen could sell the currency and profit by buying assets in Australia, where policy makers raised benchmark borrowing costs as high as 7.25 percent in March from 4.25 percent in 2002.
The strategy lost favor as the financial crisis caused banks and financial companies to report $693 billion of losses and writedowns since the start of 2007 and curbed demand for higher-yielding assets. Slowing economies also hurt the carry trade as central banks lowered interest rates to prompt growth. The Reserve Bank of Australia slashed its rate by 2 percentage points since Sept. 2, and the Bank of Japan cut its rate by 0.20 percentage point last week.
The dollar may drop as low as 80 yen if it penetrates the 90 level because Japanese investors are losing appetite for overseas investments and need to hedge bets from the past decade, wrote Masafumi Yamamoto, head of foreign-exchange strategy in Tokyo at Royal Bank of Scotland Group Plc, in an Oct. 27 note to clients. The yen climbed as high as 79.75 on April 19, 1995, as the bursting of a stock and property market bubble prompted the nation's investors to bring money home.
Investors are favoring the yen because Japanese institutions avoided the worst of the credit-market crisis. Losses in Asia totaled $27.2 billion, according to data compiled by Bloomberg. Japan's recession will be shallower than the U.S. and Europe because damage from the global credit crisis has been limited, Jun Saito, the Cabinet Office's top economist, said in an interview yesterday in Tokyo. The yen may also strengthen because of so-called power reverse dual currency notes, said David Deddouche, a foreign- exchange strategist for Paris-based Societe Generale SA, France's second-largest bank. PRDCs combine exchanges of interest-rate payments with options granting the right to buy and sell currencies. The products, which typically have a duration of 25 years or more, pay a fixed coupon the first year and then pay rates that rise when the yen depreciates and fall when it strengthens.
Sellers have the right to cancel the contracts early should a weaker yen push interest payments above a certain level. With yen gains preventing the exercise of this option, banks that sold the contracts have been left with 25 years or more of payments that they may have to hedge as much as $100 billion related to the trades by buying yen, Deddouche said.
ECB Cuts Rates by 0.5%, More to Come
European Central Bank President Jean- Claude Trichet said he can't rule out a further reduction in interest rates after today's half-point cut because the global financial crisis may lead to an extended economic slump. "The intensification and broadening of the financial turmoil is likely to dampen global and euro-area demand for a rather protracted period," Trichet said after reducing the bank's key lending rate to 3.25 percent, the second cut in less than a month. "Price, cost and wage pressures should also moderate. I don't exclude that we will decrease rates again."
Central banks around the world are paring borrowing costs as the financial turmoil curbs growth. The Bank of England today unexpectedly lowered its key rate by a third to 3 percent and the Swiss central bank followed with an emergency half-point cut. The euro region's economy is probably already in a recession and will stagnate in 2009, the European Commission said this week. Economists predict the bank will continue to reduce borrowing costs at the most aggressive pace in its 10-year history, taking its key rate to 2.5 percent by April.
"The ECB is coming from this very hawkish tone just one and half months ago and it would have damaged their reputation if they did more than the 50 basis points," Carsten Brzeski, an economist at ING Group in Brussels, said before Trichet spoke. "But ultimately, they will follow." Trichet said the ECB's rate-setting Governing Council also discussed a 75-basis-point reduction.
Inflation slowed to 3.2 percent in October after reaching a 16-year high of 4 percent in July. The ECB aims to keep the rate below 2 percent. Oil prices have more than halved from a peak of $147 a barrel and inflation expectations have stabilized. Part of "the important sentiment we have" is not only that inflation risks are diminishing, "there's also been a regaining of the control of inflation expectations." Economic growth in the euro area will slump to just 0.1 percent next year, the worst performance since 1993, the Brussels- based European Commission forecast on Nov. 3. It said the economy, which contracted in the three months through June, will probably continue to shrink in the third and fourth quarters.
The International Monetary Fund today predicted economic contractions in the euro region, the U.S. and Japan next year. "Global action to support financial markets and provide further fiscal stimulus and monetary easing can help limit the decline in world growth," the IMF said. Manufacturing orders in Germany, Europe's largest economy, dropped by a record 8 percent in September, the government said today.
Bank of England Cuts Interest Rate by 1.5 Points to Lowest Level Since 1955
The Bank of England unexpectedly cut the benchmark interest rate by 1.5 percentage points to the lowest since the 1950s as policy makers tried to limit damage caused by the worst banking crisis in almost a century. The nine-member Monetary Policy Committee, led by Governor Mervyn King, reduced the bank rate to 3 percent, the biggest single step in more than a decade. The move was predicted by none of the 60 economists in a Bloomberg News survey.
"It's absolutely staggering and deeply impressive," said Brian Hilliard, director of economic research at Societe Generale in London. "They are clearly grasping the nettle and taking deep action. Boy, this is going to have an impact." The seizure in credit markets has left Britain on the edge of its first recession since 1991, prompting a 50 billion-pound ($80 billion) bank rescue package from the government and a half-point emergency rate cut on Oct. 8. With the economy headed into recession, the danger is that inflation will slow more than policy makers want.
"The risks to inflation have shifted decisively to the downside," the Monetary Policy Committee said in a statement. Policy makers "judged that a significant reduction in Bank Rate was necessary now in order to meet the 2 percent target" for inflation.
Switzerland Unexpectedly Cuts Rates
The Swiss central bank unexpectedly cut its main lending rate by 50 basis points and said the economy may contract next year. The central bank, led by Jean-Pierre Roth, lowered its three-month Libor target to 2 percent today from 2.5 percent, it said in a faxed statement from Zurich. The SNB wasn't scheduled to decide on interest rates until Dec. 11. The Bank of England today cut its main interest rate by 150 basis points as policy makers tried to keep the economy from tipping into recession.
"The global economic outlook has deteriorated more severely than anticipated, which will impact growth in Switzerland in the next few quarters," the bank said. "The economic slowdown, the decline in the price of oil and the appreciation of the Swiss franc are reinforcing the expected drop in inflation." Today's action is the bank's second inter-meeting cut in a month, as the financial market crisis causes stocks to plunge and forces governments to buy troubled assets. UBS AG, Switzerland's biggest bank, got a $59.2 billion aid package Oct. 16 after piling up the biggest losses of any European lender from the global credit crisis.
"Extraordinary times call for extraordinary measures," said Reto Huenerwadel, senior economist at UBS AG in Zurich. With other central banks acting aggressively, the Swiss franc "would have gone through the roof" if they hadn't acted. The franc fell against the euro and dollar after the SNB's announcement. The Swiss currency weakened to 1.5022 per euro by 1:13 p.m. in Zurich. Against the dollar, the franc slipped to 1.1698 from 1.1580.
The financial market crisis is reverberating through the global economy, causing stocks to plunge and forcing governments to buy troubled assets and take equity in struggling banks. UBS AG, Switzerland's biggest bank, got a $59.2 billion aid package Oct. 16 after piling up the biggest losses of any European lender from the global credit crisis.
With investors shunning riskier assets and investing in so- called safe-havens, the Swiss franc has jumped more than 5 percent against the euro since Oct. 1. The pace of the franc's appreciation and higher money market rates are a "big challenge" for the central bank, Roth said in an interview with the Neue Zuercher Zeitung on Nov. 1.
Iceland keeps interest rates at 18%
Iceland's central bank on Thursday said it would keep its key interest rate at 18 per cent, after raising the rates at the end of October. Inflation at the end of October hit almost 16 per cent, and could climb to 20 per cent early next year, the central bank said in its monetary bulletin that also projected that GDP would drop by over 8 per cent in 2009.
Stabilizing the Icelandic currency would bring down inflation and rates the bank said, adding that extending current wage agreements without further wage hikes was a factor. The central bank, or Sedlabanki, raised interest rates from 12 to 18 per cent on October 28. In mid-October it had cut the rates from 15.5 per cent to 12 per cent.
The contraction of the North Atlantic nation's economy was predicted to impact private consumption. Unemployment was estimated to increase to 10 per cent at the end of 2009 from currently 2.4 per cent, the bank said. The decision to raise interest rates was in line with the terms of a recent agreement with the International Monetary Fund (IMF) for a 2.1-billion-dollar emergency loan to help stabilize Iceland's economy.
The IMF deal is yet to be formally approved by the IMF board, and according to reports in Reykjavik a decision could come on Monday. Iceland is meanwhile seeking additional loans of some 4 billion dollars, and has secured loans from Nordic neighbours Norway and the Faroe Islands. Icelandic newspapers Morgunbladid and Frettabladid on Thursday reported that some major European members of the IMF were opposed to approving the IMF loan.
Britain and the Netherlands have been in talks with Iceland over how to cover deposits of British and Dutch savers holding deposits in the collapsed Icelandic internet bank Icesave. Icesave was operated by Landsbanki, one of the Iceland's three largest banks, recently nationalized under special legislation. The commercial banks have run up liabilities at least five times that of Iceland's gross national product in recent years.
AIG Sales May Not Repay U.S. Loan, Forcing New Deal
American International Group Inc., the insurer taken over by the U.S. government, may have to renegotiate terms of its $85 billion rescue as the company struggles to find buyers for some of its units. "It may make sense and be pragmatic for the government to renegotiate," said David Havens, a UBS AG credit analyst in Stamford, Connecticut. The loan's interest rate "makes it extraordinarily difficult for AIG to fix itself," he said.
Chief Executive Officer Edward Liddy has yet to announce the sale of a business after saying in September he might disclose transactions that month. New York-based AIG got an $85 billion loan on Sept. 16 to stave off bankruptcy and two additional U.S. credit lines totaling $58.7 billion last month to make up for further losses. AIG owed $83.5 billion on Federal Reserve credit lines as of last week, a figure scheduled to be updated today.
AIG probably will report a third-quarter net loss of $3.84 billion on Nov. 10, the fourth straight unprofitable period, according to five analysts surveyed by Bloomberg. The company, which originates, insures and invests in home loans, was squeezed for cash after posting about $48 billion of writedowns and unrealized losses from the collapse of the subprime loan market since the beginning of last year. AIG shares have plunged more than 95 percent since Dec. 31.
While losses mount at AIG, the company's competitors have less buying power because of lower stock prices and the increased cost of borrowing. The Standard & Poor's 500 Index has dropped 26 percent since the end of August and the cost of borrowing dollars for three months in London was 2.51 percent as of yesterday, 1.5 percentage points more than the Federal Reserve's target interest rate for overnight bank loans.
"Clearly, we'd prefer to be doing this asset sale a year ago or two years ago than right now, but there'll be plenty of excellent demand for what are really good assets," Liddy said Oct. 22 in a PBS interview. AIG spokesman Joe Norton and Andrew Williams, a spokesman for the Federal Reserve Bank of New York, declined to comment. The insurer slipped 7 cents, or 3.4 percent, to $1.99 at 9:48 a.m. in New York Stock Exchange composite trading. Liddy, 62, plans to sell life insurance operations in the U.S., Europe and Japan, along with the firm's reinsurer, airplane lessor, consumer finance unit and asset manager, leaving what he called a "nimbler" company.
AIG, once the world's largest insurer, could raise $115 billion by disposing of all its units, Thomas Gallagher, an analyst at Credit Suisse Group AG, estimated in September. Sales prospects fell the next month as shares of U.S. life insurers dropped about 44 percent on concern investment losses would sap capital. "Confidence in the sector has come under considerable pressure," Nigel Dally, a New York-based analyst at Morgan Stanley, said in an Oct. 27 note. Taxpayers may lose money unless the AIG bailout is restructured to reduce the need for quick sales, said shareholders including former CEO Maurice "Hank" Greenberg, who controls the largest block of privately held AIG stock.
The current plan "cannot be successfully accomplished" because of the "crippling combination of declining asset values and extremely poor market conditions," Greenberg wrote in an Oct. 30 letter to Liddy. The government should buy non-voting preferred stock with an annual dividend of 5 percent to 6 percent to replace the loan, Greenberg said in an Oct. 13 letter to Liddy. Under terms of the Sept. 16 credit line, AIG must pay principal, fees and annual interest of more than 8.5 percent within two years. "If they just let AIG work through their issues over a lengthier period of time, it would provide the government with a greater opportunity to recover its capital," UBS analyst Andrew Kligerman said in an interview. "The current market is putting pressure on AIG's assets, on its insurance properties and on buyers." Kligerman has a "neutral" rating on AIG.
Standard & Poor's said yesterday in a statement that the credit ratings of AIG's property and casualty units, which Liddy intends to keep, may be downgraded because of price competition and possible investment losses. "Competitors are actively pursuing AIG's accounts and key underwriting personnel," S&P said. AIG agreed in September to turn over an 80 percent stake to the U.S. after running short of cash because credit-rating downgrades forced the insurer to post more than $10 billion in collateral to clients who bought protection on bonds.
The contracts, called credit-default swaps, plunged in value as the assets they guaranteed declined. AIG sold protection on $441 billion of fixed-income investments, including $57.8 billion in securities tied to subprime mortgages, as of June 30. The insurer also lost money on investments made using collateral from securities it loaned to third parties. AIG said Oct. 8 it can get as much as $37.8 billion in cash from the Fed to pay off its securities-lending partners. AIG then got access to another $20.9 billion under the Federal Reserve's commercial paper program designed to unlock short-term debt markets, the firm said Oct. 30.
Ambac downgrade requires $3.2 billion more collateral
Ambac Financial Group will need to post an additional $3.2 billion in collateral, after Moody's Investors Service on Wednesday cut its ratings on the bond insurer, according to research firm CreditSights. The collateral needs could also leave the company with a $2.8 billion cash shortfall at its financial services unit, CreditSights analysts said in a report late on Wednesday.
Moody's cut Ambac Assurance Corp's rating four notches to "Baa1," the third-lowest investment grade, from "Aa3." Ambac's third-quarter loss and the possibility of even greater expected losses in extreme stress scenarios were both reasons for the downgrades, Moody's said. The diminished ability of Ambac to write new business and its impaired financial flexibility were also reasons, the rating agency added. Ambac's shares fell 22.6 percent on Thursday to $1.55.
The cost to insure Ambac Financial's debt for five years with credit default swaps jumped to an upfront cost of 35 percent the sum insured on Thursday, from 26 percent on Wednesday, in addition to annual premiums of 5 percent, according to CMA DataVision. That means it would cost $3.5 million in a lump sum to insure $10 million for five years, plus payments of $500,000 per year. Ambac said in a statement that it "can find no justification for Moody's actions," and that the downgrade will increase pressure on its financial services business.
This business is comprised of Ambac's swap agreements and Guaranteed Investment Contracts. "Ambac noted in its conference call that it is working closely with its regulators to receive permission to use the resources of Ambac Assurance to support this liquidity issue," CreditSights said. "Meanwhile, $1.1 billion of the company's $9.9 billion fixed income investment portfolio is backed by short-term investments which may be sold to shore up cash," it added. Ambac said that Moody's action fails to account for federal efforts to improve liquidity of financial institutions, as well as early termination of some of its contract exposures.
For example, Lehman Brothers' bankruptcy is expected to result in the early terminations of approximately $1.2 billion in GIC liabilities, Ambac said. Approximately $900 million is also expected to terminate before the end of September and the remaining $300 million by the end of October, the bond insurer said. Moody's also cut its ratings on Ambac Financial Group's unsecured debt into junk territory, with a four-notch downgrade to "Ba1," one step below investment grade, from "A3."
Ambac is attempting to revive its business by reactivating its Connie Lee Insurance Co as a new municipal bond insurer.
"Ambac's current capital position is solid but its longer-term viability is in serious jeopardy," CreditSights said.
Bond Risk Rises as Ambac Cut Triggers Forced Selling Concern
The cost of protecting corporate bonds from default rose after a rating downgrade at Ambac Financial Group Inc. triggered concern investors may be forced to sell securities covered by the bond insurer. Credit-default swaps on the Markit iTraxx Europe index of 125 investment-grade companies rose 6.5 basis points to 139, according to JPMorgan Chase & Co. prices at 10:08 a.m. in London. In Tokyo, the benchmark iTraxx Japan index increased 15 basis points to 230, Morgan Stanley prices show.
Ambac's insurance financial strength rating was reduced four steps to Baa1 by Moody's Investors Service citing the company's "diminished business and financial profile." The cut will trigger downgrades to securities guaranteed by the New York-based company around the world and may force investors to dump assets, according to Royal Bank of Scotland Group Plc analysts.
"We are starting to get to the point where there may be some technical pressure from forced selling, which could push spreads wider," Michael Cox, a London-based credit strategist at RBS, wrote in a note to investors today. "The future for Ambac is now pretty bleak."
Ambac's guaranteed investment contracts require it to terminate transactions or post collateral if it is downgraded. That could leave the company with a cash shortfall of at least $2.8 billion, based on figures released yesterday after the company reported a $2.43 billion net loss.
The New York-based company also took third-quarter charge of a $2.7 billion to reflect a decline in the value of securities it had guaranteed using credit-default swaps. That type of mark-to- market loss, which doesn't always indicate an expected cash payment, this time forced the bond insurer to set aside about $2.5 billion to make good on those contracts, the company said in a statement. The cost of default protection rose as stocks fell in Europe and Asia and U.S. index futures dropped as disappointing results from Toyota Motor Corp., Cisco Systems Inc. and Adidas AG deepened concern the economic slump will stifle profit growth.
Bank of England Governor Mervyn King may need to lower benchmark interest rates to zero from the current level of 4.5 percent as the financial crisis tears through Britain's economy, according to economists including Citigroup Inc.'s Michael Saunders. The bank will cut by 0.5 percent later today, according to 45 of the 60 economists in a Bloomberg News survey. Credit-default swaps are used to protect against or speculate on default. They pay the buyer face value in exchange for the underlying securities, or cash equivalent, if a borrower fails to adhere to its debt agreements. A basis point, or 0.01 percentage point, is worth 1,000 euros on a swap that protects 10 million euros ($1.29 million) of debt from default.
Contracts on the Markit iTraxx Crossover Index of 50 companies with mostly high-risk, high-yield credit ratings increased 12 basis points to 740, JPMorgan prices show. The Markit CDX North America Investment Grade Index of credit-default swaps linked to 125 companies in the U.S. and Canada increased 6 basis points to 187 at the close of trading in New York, according to Deutsche Bank AG.
Moody's cuts Ambac Financial to junk on loss
Moody's Investors Service on Wednesday cut its ratings on Ambac Financial Corp into junk territory, and also cut its insurance arm, citing the bond insurers' losses from risky residential mortgages. Ambac and competitor MBIA Inc both reported large third-quarter losses on Wednesday, hurt by further writedowns and limited new business, and sending both companies' shares into a tailspin.
Ambac's third-quarter loss and the possibility of even greater expected losses in extreme stress scenarios were both reasons for the downgrades, Moody's said. The diminished ability of Ambac to write new business and its impaired financial flexibility were also reasons, the rating agency added.
Moody's cut Ambac Financial's unsecured debt four notches to "Ba1," one step below investment grade, from "A3," and cut its insurance arm, Ambac Assurance Corp, four notches to "Baa1," the third lowest investment grade, from "Aa3." The outlook for both ratings is "developing," meaning they may be lowered further, raised or left unchanged.
"Should Ambac's regulatory capital position continue to deteriorate, there would be further negative pressure on the firm's ratings," Moody's said. Positive developments, meanwhile, could include Ambac forming agreements with its counterparties to tear up mortgage exposures, or government initiatives to mitigate mortgage defaults.
Second Mortgages Sting MBIA
The housing crisis is not over for bond insurer MBIA. The company is still losing money on dodgy mortgage-backed securities that it insured at the height of the U.S. housing bubble. MBIA posted a sharply increased third-quarter loss as it increased its loan-loss reserves on second-lien mortgages, loans that don't get paid in a foreclosure until the primary loans are satisfied.
The results did not sit well with investors. The Armonk, N.Y.-based firm fell 20.0%, or $2.10, to $8.37, during morning trading. Its smaller rival Ambac Financial Group fared worse, losing 25.6%, or 87 cents, to $2.53. The insurers' shares are now off 74.8% and 89.7%, respectively, from their year-ago levels. The bond insurance industry has been hemorrhaging losses as the credit crunch worsens and the financial products the companies insured have plunged in value. MBIA lost $806.5 million, or $3.48 per share, during the third quarter, far worse than its deficit of $36.6 million, or 30 cents per share, during the similar quarter last year. It has lost an aggregate $1.5 billion during the first nine months of 2008.
The company added $961.0 million to its loss reserves on $16.7 billion of second lien residential mortgage-backed securities it backs. This was because the insurer saw delinquencies on this type of debt increase during the period after two quarters of relatively flat performance. The other half of MBIA’s $33.7 billion residential mortgage-related portfolio involves first liens, of which $9.5 billion are prime, $3.5 billion are less-than-perfect-credit Alt-A, and $4.0 billion is subprime. MBIA also backs $42.7 billion in commercial mortgage backed investments which have seen a have seen a slow increase in delinquencies. MBIA's total insured portfolio stood at $778.0 billion at the end of the period.
MBIA also recorded a $155.7 million pretax loss on efforts to delever its asset liability management company. It also took set aside $66.0 million pretax loss on projected future claims on its the collateralized debt obligations it insures. The second figure had already been included in earlier write-downs. On the upside, MBIA's premiums business surged thanks to a large reinsurance contract with rival Financial Guaranty Insurance. That deal alone accounted for $812.0 million of the $928.0 million in premiums written during the period. Last year, MBIA had $229.0 million during the period. Downgrades by credit agencies have made it expensive for FGIC, which is owned by Blackstone Group, to borrow money.
MBIA has taken legal action against two loan sellers and servicers, and filed a claim against a third, regarding certain defaulting bundles of second-lien mortgages. The insurer is alleging that certain past loans do not meet eligibility requirements for its protection and that it should therefore not be liable for losses. Ambac, which was also forced to fortify its reserves against bad residential mortgage loans, said it expects to pull in at least $500.0 million in legal damages related to underwriting shenanigans such as this.
In February, billionaire investor Warren Buffett offered to reinsure $800.0 billion worth of municipal bonds guaranteed by MBIA, Ambac and FGIC. All three rejected the proposal. Municipal bonds are the traditional business of the insurers, but as the housing market boomed in the early years of this decade they moved into more exotic, mortgage-related securities, with disastrous results.
MBIA, Ambac Losses Widen on Higher Claims Forecast
MBIA Inc. and Ambac Financial Group Inc., the bond insurers crippled by credit-rating downgrades, posted wider losses than analysts anticipated after slumping credit markets forced them to increase reserves for claims. MBIA dropped 22 percent in New York trading as the company reported a $806.5 million net loss after setting $961 million aside for guarantees on home-equity loan bonds. Ambac fell 41 percent as it recorded a $2.43 billion net loss after reserving $3.1 billion.
The combined reserves are the largest taken to date and show the credit slump has chipped away at the companies' optimistic predictions that claims won't increase. The losses likely will prompt scrutiny from Moody's Investors Service, which is reviewing the insurance ratings of both companies after stripping them of their Aaa ranking this year. The companies are seeking to be involved in the U.S. government's financial rescue plan.
"The big issue for bond insurers is their ratings," said Jim Ryan, an analyst with Morningstar Inc. in Chicago. "If the rating agencies pile on, that could create more problems." Armonk, New York-based MBIA's operating loss, which excludes some debt price markdowns, was $2.22 a share, missing the $1.04 average loss estimate of six analysts surveyed by Bloomberg. Ambac had a loss of $7.81 a share, compared with an estimated loss of $1.09. Ambac fell $1.39 to $2.01 in New York Stock Exchange composite trading today. MBIA dropped $2.30 to $8.16.
MBIA is down 56 percent in New York trading this year and Ambac by 92 percent. The stocks rose yesterday on optimism the government may broaden its financial rescue package to allow Ambac and MBIA to participate, helping reduce losses. "This may be the last, best hope, that the Feds come through," said Matt Fabian, an analyst and managing director at Concord, Massachusetts-based Municipal Market Advisors. "There just is no demand for their product."
MBIA has insured no new deals in the municipal bond market since early July after being stripped of its last Aaa credit rating by Moody's, while Ambac insured no deals during the third quarter or in October, according to Thomson Reuters data. Bond insurers should be eligible to participate in the federal government's $700 billion Troubled Asset Relief Program, or TARP, because the industry is important to the stability of the financial system, Ambac Chief Executive Officer David Wallis said during a conference call today.
"We think our issues are liquidity, not solvency," Wallis said. "Treasury and others need to be persuaded. They don't want to throw good money after bad." Wallis said there had been no formal response to the industry's suggestions about participating in the program. The increased loss provisions "reflect our analysis of the impact of weakening economic conditions and a greater number of defaults on improperly originated and serviced mortgage loans," MBIA CEO Jay Brown said in the company's statement today.
MBIA decided against taking additional reserves in the second quarter. Brown said at the time that the company was "confident in our continuing analysis of our housing-related exposures." MBIA said it provided $600 million of the cash raised earlier this year to its asset management business. MBIA also said it had received regulatory approval for the business to tap its bond insurance subsidiary for an additional $2 billion through a repurchase agreement. The transactions "eliminate the need to sell assets to meet ratings triggered termination requirements or future liability maturities in the current highly stressed credit environment," MBIA said.
Ambac may face significant liquidity issues if its bond insurance unit is downgraded because it will trigger payments by its asset management business, Wallis said on the call. Ambac is talking with its regulators about addressing the issue, he said. "Housing related data continues to vacillate, having taken a turn for the worse over the past few months after showing positive signs earlier in the year," Wallis said in his company's earnings statement.
Ambac took a $2.7 billion charge to reflect a decline in the value of securities it had guaranteed using credit-default swaps. That type of mark-to-market loss, which doesn't always indicate an expected cash payment, this time forced the bond insurer to set aside about $2.5 billion to make good on those contracts, according to the statement. Ambac also took a charge of $607.7 million for expected claims on bonds backed by home equity loans. The company won't pay a dividend because the third-quarter loss caused negative shareholders' equity, Chief Financial Officer Sean Leonard said during the call.
Ambac, MBIA and the rest of the industry have posted record losses after expanding from guarantees on municipal bonds that rarely default to insuring securities tied to mortgages that are now going delinquent. Ratings companies downgraded about $118 billion of prime-jumbo and Alt-A bonds in September following a record $200 billion of downgrades in August, according to an Oct. 3 report from JPMorgan Chase & Co. MBIA's insurance unit was cut to A2 by Moody's in June and AA by Standard & Poor's. Moody's is reviewing the rating for a possible downgrade. Ambac's insurance arm is rated Aa3 by Moody's, where it is also on review, and AA by S&P.
"For years, MBIA and Ambac thought the rating agencies would always stand behind them and that eventually markets would normalize," said David Merkel, chief economist at Finacorp Securities in Newport Beach, California. "Now, Moody's and S&P have their own reputations to protect." Assured Guaranty Ltd. and Warren Buffett's Berkshire Hathaway Assurance have grabbed most of the market as MBIA and Ambac flounder. Berkshire backed 44 percent of all new bonds insured by cities and states last quarter, and Assured guaranteed 45 percent, according to Thomson Reuters data.
UK house prices dive 15%, $48.000, in record drop
British house prices fell by a record 15 per cent in the year to October as the country's deteriorating economy wiped £30,000 off the value of an average UK home. On a monthly basis, house prices fell by 2.2 per cent between September and October, according to Halifax, Britain's biggest mortgage lender.
The dismal figures have emerged just hours before the Bank of England is widely expected to cut interest rates by at least half a percentage point to 4 per cent, though some business leaders are hoping for a deeper one percentage point cut. Banks are under growing pressure from the Government to pass on the interest rate cut to its mortgage customers after it emerged earlier this week that borrowers are still waiting to benefit from last month's reduction to borrowing costs.
On Tuesday, Lord Mandelson, the Business Secretary, strongly rebuked British banks for their failure to help customers by passing on lower interest rates. Today's 15 per cent fall in house prices is the biggest annual decline since Halifax began keeping records in 1983 and is worse than the biggest drop in house prices that occurred during the last recession in the early 1990s. The average house now costs £168,176, down from £197,698 in October last year.
Martin Ellis, Halifax's chief economist, said: "Housing market conditions remain challenging in the face of the significant pressures on householders' incomes and the reduction in the availability of mortgage finance since last summer." "Prices are still falling and they're falling at a faster pace than we’ve seen before," Mr Ellis added.
UK car sales tumble 23% to worst decline since 1991
Car sales during October showed their worst annual decline for seventeen years, falling by just below by a quarter in the worst set of figures seen since the last recession. During October, cars sales fell 23 per cent to 128,352, reflecting the sharply deteriorating economy and the worst of several months of accelerating declines where sales of luxury cars, such as the Bentley, as well as people carriers have been hit particularly hard.
Sales of new cars fell 21 per cent in September, despite the introduction of new '58' number plates, and by 19 per cent in August. According to the Society of Motor Manufacturers and Traders, which releases the data, sales last fell by more than a quarter back in June 1991. The weak figures were underlined by dismal results from the world's largest carmaker, Japan's Toyota, which said that this year's operating profit would be 63 per cent lower than expected due to an "unprecedented" sales collapse in Europe, the US as well as faltering trade in China and India.
Toyota said that operating profit for the year to March would amount to between Y600 billion, compared to the previous Y1.6 billion forecast. In its second quarter, to September, operating profits fell 72 per cent to Y169.5 billion, while net profit sank 69 per cent to Y139.8 billion yen. In Europe, Toyota's operating income decreased by 59.6 billion yen, to 8.7 billion yen, although it did not give out any UK specific data. Toyota has two plants in the UK, making Avensis and Auris cars at Burnaston, in Derbyshire, while the second makes engines in Deeside, North Wales.
Mitsuo Kinoshita, executive vice president, Toyota Motor, described the sales crisis as "an unprecedented situation" and blamed the financial crisis for "negatively impacting the real economy worldwide". Toyota said it had established an "Emergency Profit Improvement Committee" to find ways of cutting costs to maintain the company's income.
Obama will bring step-change to US economic policy
The paralysing wait between the election of Franklin Roosevelt in 1932 and his inauguration four months later was the most dangerous point of the Great Depression. It saw policy drift in Washington and the era's last disastrous wave of bank failures. This will not happen again. The interegnum has been reduced to two months. The campaign machinery of Barack Obama is the most disciplined in US political history. The transition is being run by John Podesta, a former White House chief of staff who remembers how the Clinton team squandered weeks in Little Rock before starting to assemble a government.
Mr Obama knows he has no such luxury in this fast-moving crisis. He takes over a country that is now losing almost half a million jobs a month, and may soon lose much of its car industry. The budget deficit is likely to reach $1.2 trillion (£750bn) – or 8pc of GDP – when all the Bush bail-outs are totted up. So far foreigners are continuing to fund America's debt needs, although Taiwan has fired a warning shot by refusing to roll over holdings of Fannie Mae and Freddie Mac agency bonds. Any false step by Mr Obama that causes foreigners to withhold capital could quickly set off another round of this crisis.
As soon as next week the leaders of the G20 bloc gather in Washington to construct the new financial order, a revived Bretton Woods. The summit is a minefield, camouflaged with interegnum pieties. Bretton Woods means a fixed exchange-rate system, that is to say the antithesis of the floating currency regime that is so deeply linked, in so many subtle ways, to flourishing free markets. Thankfully, Mr Obama is well advised – by Paul Volcker, Warren Buffett and George Soros – notwithstanding Rupert Murdoch's jibe that his economic plans are "rubbish". His likely pick to replace Hank Paulson at the Treasury is Tim Geithner, the head of the New York Fed, the crisis fireman of the last year and perhaps America's safest pair of hands.
Whoever is chosen, we are about to see a strategic shift in US economic policy. Mr Obama's first stimulus package of $200bn will not be used to prop up middle-class spending. It will go on roads, bridges, ports, and the like, the start of a public works blitz to employ people and build things. "Some 30pc of the 570,000 bridges in the US are unsafe," said Felix Rohatyn, former Lazard chief and now a Democrat elder, epitomised by the Minneapolis collapse in 2007. "We have a terrible infrastructure problem, which is unforgivable for the world's leading power. We have the potential for an economic relaunch similar to that of Roosevelt in the 1930s."
Companies will face tax penalties if they shun Mr Obama's scheme to extend health coverage to the 47m Americans without insurance. He means it: his mother spent the last months of her life dying from ovarian cancer struggling to pay for treatment. Moreover, the full might of a Democratic Congress stands behind him. The president-elect is not a hard-core protectionist, although he tilted that way to survive the Democratic primaries against Hillary Clinton. He is a disciple of Professor Jagdish Baghwati, who thinks the Smoot-Hawley tariff act of 1930 caused the Wall Street crash to metastasize into a global slump.
Even so, things are going to change for America's trading partners. Europe's EADS will have a tough time under this Congress winning a share of the Pentagon's $35bn military tanker contracts. Countries that repress trade unions or breach eco rules will face the risk of tariffs. Mr Obama has debts to the labour movement. He backs the Employee Free Choice Act, which eliminates the free ballot in union elections. "If enacted, it will bring about the most revolutionary change in the law governing union organising in the past 50 years," said Maurice Baskin, chair of Venable's employment group.
There are plans for a windfall tax on oil, stiff rises on fuel duty, and a $150bn fund to bring solar and wind power and green energy to the point of critical mass. He backs nuclear power, but new coal plants may not be viable under his swingeing carbon trading charges. The aim is to vastly reduce America's reliance on oil imports. Taxes will go up as the Bush cuts expire in 2011, or before, hitting the rich with a triple whammy of higher rates on capital gains and dividends, and a surtax on incomes over $200,000.
Taken together, the Obama "manifesto" may prove as far-reaching as the Reagan revolution. The pendulum has swung back. At first glance it looks like a switch to European social democracy, but Washington's "permanent government" always finds a way of moderating change. Mr Obama inherits an almighty mess. It is the result of pushing US domestic debt from 130pc of GDP to over 220pc in a half a century of rising leverage. This game has run its course. There will be a slow, painful purge over coming years.
By dint of lucky timing, however, he may take office just as the economy starts to carve a long bottom. The Fed's drastic rate cuts have greatly reduced the chance of calamity next year. There are glimmers of hope in US housing as the stock of unsold homes falls from 11 months' supply to 9.9. Libor lending rates have come down to a four-year low. The credit freeze is starting to thaw. Nothing can prevent a deep recession, but Mr Obama will not be blamed. Indeed, he is perfectly placed to capture the political bonanza of recovery.
Funding Drought Slams Chinese Plans as Banks Shun Plea to Lend
Wang Yi, who employs 300 people making children's raincoats on China's east coast, is worried his company won't survive the next year as exports dry up. The apparel manufacturer, which supplies European supermarket chains Tesco Plc and Aldi Group, needs a 600,000 yuan ($88,000) loan by Jan. 31 to stay afloat. China's state-owned banks rejected his previous applications.
"There's no point trying them again," says Wang, 40, standing in his two-story factory in Pinghu, about 90 kilometers (56 miles) southwest of Shanghai, where one floor is half empty. "They prefer big customers." China's largest banks, with 4 trillion yuan of cash, are resisting government efforts to boost lending to 42 million small and medium-size companies that drove the economic boom of the past decade. On Nov. 2, the central bank scrapped curbs on loans after three interest rate cuts in seven weeks failed to revive economic growth that has sagged to its slowest in five years.
Half the nation's toy exporters have closed this year, and 67,000 smaller enterprises filed for bankruptcy in the first half, according to government statistics. Companies with assets of less than 40 million yuan provide three-quarters of urban jobs and 60 percent of China's gross domestic product. "Their failure will lead to unemployment and may threaten social stability," says Frank Gong, JPMorgan Chase & Co.'s Hong Kong-based chief China economist. After five years of economic growth above 10 percent, the rate may slow to 5.8 percent this quarter, according to a Nov. 3 estimate by Credit Suisse Group AG. That would be the lowest rate since at least 1994, according to data compiled by Bloomberg.
In its latest move to reverse that trend, China's central bank said Nov. 2 it would no longer cap commercial bank lending, state-owned Xinhua news agency reported, scrapping a limit imposed in 2007 to prevent the economy from overheating. In August, the People's Bank of China raised the quota by 5 percent to 3.8 trillion yuan, directing lenders to funnel the additional funds to firms with assets of less than 10 million yuan and farmers. Banks have so far turned a deaf ear. With delinquency rates on loans to small companies running almost four times those of other loans, they want to avoid the state-directed lending that led to a $500 billion government bailout over the past decade.
"It's wishful thinking for the government to try to talk banks into lending to stimulate the economy," says Li Qing, a Shanghai-based analyst at CSC Securities HK Ltd. "Banks are holding onto their purse not because they are bound by the quota, but because they are expecting mounting defaults and failures." Nationwide, loans to small businesses by China's 20 biggest lenders rose 6.2 percent to 3.2 trillion yuan in the first six months of 2008, less than half the 14.1 percent growth in overall lending, according to the China Banking Regulatory Commission.
In Zhejiang province, where Wang is based and 99 percent of companies are small and privately owned, loans are increasingly hard to come by. Industrial & Commercial Bank of China Ltd., the nation's largest, offered 5 billion yuan of new loans to small enterprises in the province during the first six months of 2008, less than half the year-earlier figure, according to the bank. "Getting a loan takes longer and involves more procedures for small companies," says Wang, who is being squeezed by a 20 percent dip in sales as well as higher commodity prices and an appreciation of the yuan, which reduces revenue from exports.
"Every line of business I know is scaling back to preserve capital as survival is the most important thing," he says. "The whole mess in the U.S. and Europe means 2009 will be worse." Banks are reluctant to reverse the tightening of risk management that was carried out with advice from foreign investors, including Goldman Sachs Group Inc., that have paid $21 billion for stakes in Chinese lenders since 2005. "Chinese banks are getting smarter and they won't blindly follow lending directives from the top any more," says Leo Gao, who helps oversee the equivalent of $2.3 billion at APS Asset Management Ltd. in Shanghai. "We've seen banks start to cut back loans to real estate and exporters since the second quarter as they know an outbreak of bad loans is on the horizon."
Bank of China Ltd. reformed its credit policies with help from Temasek Holdings Pte, which owns a 4.1 percent stake. The bank now asks borrowers for more documents to prove they have orders that will provide revenue to repay a loan, as well as more collateral and third-party guarantees. It also has moved decision-making from local branches to centralized units at provincial headquarters. Lending to smaller companies is "challenging," because each loan uses the same resources as are required to serve bigger corporations, reducing returns on these higher-risk transactions, says Wang Zhaowen, a Beijing-based spokesman for the bank.
"It's a dilemma and we are trying to find a way out," he says. "Never again will we lower lending standards to meet government directives. Otherwise, we just slip back to the old path." About 8.5 percent of the bank's advances to small and medium-size companies were at least 90 days overdue on June 30, compared with 2.6 percent of total lending. Decades of state-directed lending left China's four biggest banks with bad loans equal to almost 40 percent of outstanding loans in 1998. They were still sitting on $171 billion of soured debt, or 6.1 percent of total advances, at the end of June, compared with 0.5 percent for international banks in China.
"Banks will pay a heavy price for being good corporate citizens," says Dorris Chen, a Shanghai-based analyst at BNP Paribas SA. "And they alone can't keep these companies from failing." Some banks that specialize in dealing with smaller firms are already feeling the pinch. China Minsheng Banking Corp., the nation's first privately owned bank, said overdue loans increased 22 percent in the first half from the end of last year.
Factory owner Wang is now trying the Pinghu city cooperative bank, a regional lender whose interest rates are as much as 20 percent higher than state banks. He doesn't think he'll need to try the last resort, a loan shark who charges four times that. "With all the policies on easing lending, I'm optimistic," he says. "Even if I get it, next year is going to be tough."
Wall Street’s Pay Is Expected to Plummet
The first clues are emerging that Wall Street pay will plummet this year — but perhaps not enough to satisfy the financial industry’s critics. Bonuses, which soared to record heights in recent years, could drop by 20 to 35 percent across the industry, according to a private study to be released on Thursday. Bonuses for top executives could plunge by 70 percent.
But to some, those figures, from the consulting firm Johnson Associates, demand the question: Why should Wall Street executives get any bonuses at all? Banks’ profits have plunged, and the government is spending hundreds of billions of dollars to shore up the industry and prevent its problems from dragging down the economy. A report on Wednesday from the New York State Assembly said Wall Street bonuses could tumble 41.3 percent next year, which could further widen a budget deficit.
The annual Johnson study, a closely watched analysis based on a survey of banks and money management firms, as well as on compensation figures disclosed in corporate filings, arrives as the industry is under growing political pressure to hold down pay. Nine of the nation’s biggest banks began handing over data on Wednesday to Attorney General Andrew M. Cuomo of New York on how much they plan to pay in bonuses this year, as well as how much they paid in 2006 and 2007. Several of the banks have asked Mr. Cuomo for more time to provide the figures.
In an interview on Wednesday, Mr. Cuomo suggested that even 70 percent declines for top executives might not be enough, given a financial blowup that culminated in a $700 billion federal rescue for the industry. Many critics, Mr. Cuomo among them, contend that outsize pay encouraged bankers to take outsize risks in the first place. The crisis that followed led to the bankruptcy of Lehman Brothers, the emergency sales of Bear Stearns and Washington Mutual and federal rescues for the insurance giant American International Group and the mortgage companies Fannie Mae and Freddie Mac.
“Given this economic situation, how do you justify any performance bonus at all, is my initial point,” Mr. Cuomo said. Bankers and traders have been rewarded for taking risks that Wall Street clearly failed to manage. “When you incentivize that type of behavior, you shouldn’t be surprised when you find very risky, overly creative, short-term, highly leveraged products,” he said. Mr. Cuomo added that he would closely examine the books of the nation’s biggest banks to ensure that no government money went into bonus pools. Henry A. Waxman, the California Democrat who heads the House Committee on Oversight and Government Reform, has asked for similar pay information from banks.
Wall Street executives, even at banks like Goldman Sachs and Morgan Stanley, which produced decent profits this year, are increasingly aware that large bonuses could set off an enormous public reaction. Many executives and top bankers and traders gorged on huge bonuses during the boom years earlier this decade, in many cases on profits that later disappeared as the subprime mortgage meltdown bloomed into a crisis. Last year, financial groups paid out about $33.2 billion in bonuses, according to the New York State Comptroller.
For instance, Richard S. Fuld, chief executive of Lehman Brothers, received about $34.4 million last year, though much of that was in stock that later became worthless. Mr. Fuld will leave as chief executive at the end of the year, with no bonus or severance payments, the firm said. Lloyd Blankfein, Goldman Sachs’s chief, received a package worth $68.5 million last year. Nothing like that is expected this year, given the industrywide plunge in profits.
According to Johnson Associates, top executives are expected to be hardest hit, partly because their payouts are disclosed in corporate filings and executives want to avoid a public outcry. Alan Johnson, managing director of Johnson Associates, said chief executives at banks were likely to get the bulk of any bonus in stock, a method that would probably trickle down. “Whatever you get paid is likely to be in paper,” Mr. Johnson said. “There is not going to be much cash.” That is not likely to please bank employees, who have watched their companies’ shares plunge.
Among different areas of banking, the study suggests that fixed-income traders will see bonuses decline 40 to 45 percent. Investment banks typically pay out about 50 percent of revenue as compensation, and year-end bonuses can account for a large percentage of employees’ pay. In the past, fat bonuses led to big spending on lavish apartments and other luxuries, and leaner times are expected to hurt New York’s economy. In previous lean years, Wall Street banks justified large payouts by arguing that top employees would flee for higher-paying jobs. But with tens of thousands of Wall Street jobs disappearing, that argument may no longer hold. “Where are people going to go?” one senior banking executive asked.
Which will bury California first, Pension or Bond Obligations?
I am both amazed and angry. No, I’m not speaking of the presidential race. Arnold has recently acknowledged that our revenue stream is a bit short to cover expenses. No, no longer $3 billion dollars. How about a new number closer to $10 billion. Mind you we just signed the state budget after being late by 85 days and somehow exaggerated our income.
So while many of us do take the time to keep up with “stuff” like this the highly informed California electorate has just voted approval of Prop 1A by a vote of 5,072,778 YES votes and 4,661,366 fiscal responsible people who said NO. Don’t they get it? Where do they think we will get the funds to pay off this latest Bonded indebtedness? Another test will be to see if any lender is willing to trust us to make the payments unless we are receptive to a premium interest rate due to our “superb” state bond rating.
The $9.95 billion price tag of Prop 1A is just the down payment for a 800 mile high speed rail system that might eventually cost us around $81 billion. The following text, that mentions our PERS program is from the NJ Housing Bubble web site: “The $240 billion California Public Employees’ Retirement System, the largest U.S. pension plan, agreed at a Feb. 19 board meeting to hold between 0.5 percent and 3 percent of its assets in commodities, spokesman Clark McKinley said. CalPERS, facing pressure from state and local governments to boost returns, would reduce its bond holdings to 19 percent from 26 percent.
U.S. states owe an estimated $2.73 trillion in pension and benefit payments to retirees over the next 30 years, according to a December report from the Pew Center on the States. They are short almost 27 percent, or $731 billion, of that amount. The Government Accountability Office said last week that 58 percent of 65 large state and local pension plans were adequately funded in 2006, down from 90 percent in 2000.”
With a fixed payout for every PERS participant, and a shaky Wall Street, these mandatory pension obligations put us at great risk. Check out Bridgeport, CT or Vallejo, Ca as to their financial woes. If we are not careful our entire state will go “belly up.” So while we face massive retirement and health care obligations we continue to spend our grandkids into the poor house that will eventually result in cutbacks on basic services such as police and fire protection and K-14 education. But, there is a positive side. We can take the highly subsidized bullet train from LA to Sacramento to visit our elected officials in 2030 if the project is ever completed.
What Happens when Countries Go Bankrupt?
First it was mortgage lenders. Then large banks began to wobble. Now, entire countries, including Ukraine and Pakistan, are facing financial ruin. The International Monetary Fund is there to help, but its pockets are only so deep.
No, Alexander Lukyanchenko told reporters at a hastily convened press conference last Tuesday, there is "no reason whatsoever to spread panic." Anyone who was caught trying to throw people out into the street, he warned, would have the authorities to deal with. Lukyanchenko is the mayor of Donetsk, a city in eastern Ukraine with a population of a little more than one million. For generations, the residents of Donetsk have earned a living in the surrounding coalmines and steel mills, a rather profitable industry in the recent past. Donetsksta, a local steel producer, earned €1.3 billion ($1.65 billion) in revenues last year.
But last Tuesday the mayor, returning from a meeting with business leaders, had bad news: two-thousand metalworkers would have to be furloughed. Lukyanchenko doesn't use the word furlough, instead noting that the workers will be doing "other, similar work." But every other blast furnace has already been shut down, and one of the city's largest holding companies is apparently gearing up for mass layoffs. Under these conditions, how could panic not be rampant in Donetsk, the capital of Ukraine's industrial heartland? In Mariupol, a steelworking city, a third of the workers have already been let go. The chemical industry, Ukraine's second-largest source of export revenue, is also ailing. In the capital Kiev, booming until recently, construction cranes are at a standstill while crowds jostle in front of currency exchange offices, eager to convert their assets into US dollars.
Donetsk is in eastern Ukraine, 8,100 kilometers (5,030 miles) from New York's Wall Street and 2,700 kilometers (1,677 miles) from Canary Wharf, London's financial center. But such distances are now relative. The world financial crisis has reached a new level. No longer limited to banks and companies, it is now spreading like wildfire and engulfing entire economies. It has reached Asia and Latin America, Eastern Europe, Iceland the Seychelles, the Balkan nation of Serbia and Africa's southernmost country, South Africa. It is a development that has investors and speculators alike holding their breath. Some are pulling their money out of troubled countries, while others are betting on a continued decline -- and in doing so are only accelerating the downturn. Central banks are desperately trying to halt the downward trend, but in many cases the plunge seems unstoppable.
At first, it seemed as if the crash could be limited to Iceland. But now countries like Ukraine, Pakistan and Argentina are proving to be almost as vulnerable as the small island nation in the North Atlantic. It seems as though another country is added to the growing list of nations on the verge of collapse almost daily. A national bankruptcy isn't just some theoretical construct. Argentina experienced it in 2001 and Russia three years earlier. Germany has gone bankrupt twice in its more recent history, once in 1923 and the second time after 1945. A country has reached this final stage if, as a result of war or blatant mismanagement, it has gambled away all trust, can no longer service its debt or convince anyone to lend it any money, no matter how high an interest rate it promises to pay.
This is what is currently happening to Iceland. The central bank in the capital Reykjavik increased its prime rate by six points to 18 percent last week. Venezuela, where inflation is also high, is now offering 20 percent to stimulate interest in its government bonds. At the moment, however, investors are shying away from all risk. In the end, the rating agencies will have no choice but to downgrade the problem countries to their lowest level of creditworthiness. When that happens, lenders will have no choice but to write off much of their money. For citizens, national bankruptcy would probably lead to massive inflation. The threshold countries, described until recently as "emerging" economies, are in for an especially rough ride. "The dream that they would be spared seems to have come to an end," says Rolf Langhammer, vice-president of the Kiel Institute for the World Economy.
Countries like Russia and Brazil owe their recent success in large part to the boom in commodities the world has experienced in recent years. But now prices for oil, copper, wheat and corn have plunged and a giant spiral of debt has begun to turn. The companies and banks that borrowed vast amounts of money abroad for their investments can no longer service their debt, and investors are pulling out their capital. As foreign currency becomes scarce and imports unaffordable, the currencies of these countries are losing value, which only increases the mountain of debt.
According to Stephen Jen, a currency specialist with the US bank Morgan Stanley, the flow of capital to threshold countries could drop by more than half -- from the current level of €575 billion ($730 billion) to €230-270 billion ($292-343 billion) -- if world economic growth drops to only 1 percent in 2009. The demise of these countries, says Jen, represents the new "epicenter of the global crisis." The looming crisis has the countries in most dire need lining up for emergency loans from the International Monetary Fund (IMF). But all they are doing is buying time -- a few weeks, or perhaps even months -- and hoping that the general situation will soon improve.
The signs of looming national bankruptcy are plentiful, and bankers in the Uruguayan capital of Montevideo know them well. In late 2001, they were the first to see the coming crash in Argentina. Men traveled across the Rio de la Plata, from Buenos Aires to Montevideo, carrying suitcases filled with US dollars. They stood in long lines at the city's banks, depositing the contents of their suitcases into accounts and safe deposit boxes there. Uruguay is South America's Switzerland, a safe haven for money in times of crisis. No one asks about where the millions come from.
Once the Argentine businessmen had transferred their dollars abroad, the second phase of the collapse began. The Argentine government froze all bank accounts, capping the maximum amount an accountholder could withdraw at only $250 (€198) a week. Small investors, those who had left their money in the banks, were the hardest hit. Tens of thousands of desperate citizens stormed the banks, and many spent nights sleeping in front of the automated teller machines. The last phase of the downturn began in the Buenos Aires suburbs. After consumption had dropped by 60 percent, young men began looting supermarkets. In December 2001, 40,000 people gathered on Plaza de Mayo in front of the Casa Rosada, the presidential palace. There, they banged pots and pans together day and night, until an unnerved President Fernando de la Rúa fled by helicopter.
The image of the fleeing president has burned itself into the collective memory of Argentineans. It marks the worst financial crisis of the last 100 years. De la Rúa's successor allowed the peso to float free on the world currency-exchange markets after it had been pegged to the US dollar at a ratio of 1:1. Tens of thousands of small business owners, who had incurred debt when the peso was still pegged to the dollar, filed for bankruptcy. Unemployment quickly ballooned to 25 percent. Five presidents passed through the Casa Rosada in the space of two weeks, until Nestor Kirchner, a provincial governor until then, assumed the presidency in 2003. Kirchner informed the country's international creditors that Argentina would not be able to repay its $145 billion (€115 billion) in foreign debt.
Is history repeating itself today? Economic experts have been warning for months that Argentina is again heading toward national bankruptcy. Men are traveling to Uruguay once again with suitcases filled with cash. In the space of only three weeks, more than $700 million (€553 million) was withdrawn from Argentine bank accounts. Government bonds have lost more than half of their value. ATMs are no longer giving out more than 300 pesos, and inflation is running rampant. And the sound of pots and pans being banged together is back. President Cristina Fernandez, who succeeded her husband Nestor Kirchner in 2007, increasingly resembles the hapless de la Rúa. Last week, she presented her version of the "Corralito" -- the term used to describe the freezing of bank accounts in 2001 -- when she ordered the nationalization of private pension funds, allegedly to prevent the funds from going bankrupt.
But economic experts believed that Fernandez's true objective in nationalizing the private deposits, which are worth $30 billion (€24 billion), is to avert a government bankruptcy. Columnist Mario Grondona criticized the president, likening her to "a captain trying to save a sinking ship by bailing it out with a bowl from the kitchen." Her husband was more decisive. He defied the IMF, which has sought to impose drastic rules on the country. He alienated international creditors by offering to buy back government bonds for only 25 percent of their face value. Since then, Argentina has received almost no new loans in the global financial marketplace.
Nevertheless, the country recovered from the crash with astonishing speed. In recent years, the Argentine economy has grown at impressive rates of 7 to 9 percent. At the first signs of the impending end of the boom, Venezuelan President Hugo Chavez came to the country's rescue by buying up Argentine bonds. But now the authoritarian Venezuelan leader can no longer serve as Argentina's savior. With oil prices sharply in decline, Venezuela itself is seen as yet another candidate for economic disaster. This has prompted President Fernandez to discreetly seek rapprochement with the hated IMF and the Club de Paris, a group of lending nations made up of some of the world's richest countries, in an attempt to reconnect Argentina to the international lending cycle.
Hungary is another country being hit hard by the financial crisis. Until recently, the Hungarian government would not have dreamed it would be forced to accept aid from the IMF. But in recent days Hungary barely avoided sliding into national bankruptcy, and only a €12.5 billion ($15.9 billion) IMF rescue package -- bolstered by billions more from the European Union and the World Bank -- prevented it from happening. The incident has historic significance. Hungary is the first country in the European Union obliged to accept an IMF loan of this nature. The conservative newspaper Magyar Nemzet writes that the move will turn Hungary into the "only colony of the International Monetary Fund" within the EU. The opposition party calls the plan "a disgrace." Brussels's contribution was €6.5 billion ($8.26 billion), while the World Bank contributed another €1 billion ($1.27 billion). The measures represent the most comprehensive international rescue package assembled in the current financial crisis.
How could this have happened, an EU member finding itself in such difficulties? Much of the blame for Hungary's current debacle lies with the failings of the past. The once-successful nation of 10 million people lived beyond its means for years. With government finances spinning out of control, the national debt ballooned to two-thirds of the country's GDP. "The funding for our excessively high standard of living came from other countries," admits András Simor, the governor of the central bank, not without a dose of self-criticism.
The Hungarians have always been considered shopaholics. Hundreds of thousands bought themselves big cars and went on shopping sprees in the chic boutiques on Váci Utca in Budapest -- all on credit. The real estate market boomed, turning close to 90 percent of Hungarian apartments are privately owned. Most mortgage loans were denominated in euros and Swiss francs. But that practice has taken its toll. As the Hungarian forint plunges in value, mortgage holders are suddenly paying astronomical interest rates. It was primarily this dependency on other countries that has fueled the crisis in Hungary. Ironically, Budapest was once seen as a role model for other countries seeking EU membership.
But instead of following in the footsteps of the Czech Republic and Slovakia, and introducing structural reforms after the collapse of communism, the Hungarians kept growing their national debt. A few days before the runoff vote in the 2002 parliamentary election, the conservative government of then Prime Minister Viktor Orban increased pensions by a substantial amount. Orban's successor, Peter Medgyessy, a socialist, introduced a 50 percent salary hike for teachers and healthcare workers. The current premier, Ferenc Gyurcsány, also chose borrowing as his preferred method, at least initially. Only when the planned introduction of the euro threatened to become a more distant possibility for his country did Gyurcsány change course and encourage saving, at least to the extent possible. The opposition fought against the necessary reforms with missionary zeal. A referendum eventually broke the deadlock, and Gyurcsány was forced to put his savings plans on ice.
Nevertheless, the socialist was able to celebrate a few modest successes. The country's public deficit was brought down from more than 9 percent of gross domestic product in 2006 to about 3 percent more recently. But this was still not enough to help the country withstand the tremors of the financial crisis. "Before we were able to reach a safe harbor," says central bank Governor Simor, "the hurricane caught up with United States" After receiving international credit assurances, neighboring Austria can finally breathe a sigh of relief. Its financial institutions, including Erste Bank, the Raiffeisen savings bank and Austria-Creditanstalt, have a strong presence in Hungary, where they control 22 percent of the banking sector. These days, it is quite possible that a crisis in small countries could end up pulling larger ones into its vortex.
Further east, the Ukrainian Central Bank last Thursday set the official exchange for the country's currency at 5.70 hryvna per US dollar. But its effort was in vain. By noon, currency traders in Odessa were already charging 9 hryvna for a dollar, until they were forced to close when their supply of greenbacks ran out. Ukrainians with rents to pay in dollars -- a common practice in many parts of the country -- suddenly faced the prospect that they couldn't pay their landlords come Nov. 1. Europeans are familiar with the constant trouble between Yulia Tymoshenko, the prime minister, and President Viktor Yushchenko, her curmudgeonly rival. But it is less well known that Ukraine was in a better economic position than Hungary until recently.
Massive amounts of foreign capital began flowing into the country in 2007. The Ukrainian market was attractive and brought in unexpectedly large investments. At the same time, the price of steel, Ukraine's top export, was ballooning on the world market. The price of a ton of steel in July, €189 ($240), was already €55 ($70) higher than at the beginning of the year. After the government had forecast 6.5 percent GDP growth, the precipitous drop in Ukraine's economy came as a shock to Kiev's political elite, especially in a country that was barely integrated into the global financial system. Ukraine was in a "state of euphoria," and yet it was unable to cope with the massive influx of capital, say the Eastern Europe specialists at the University of Bremen. Pensions and wages were raised, in some cases savings accounts lost at the end of the Soviet era were replaced and banks issued loans without examining their borrowers' creditworthiness. This stimulated consumption, with consumers increasingly spending their newfound riches on imports. But then the price of steel plummeted.
In only one year, the foreign debt rose from €27 billion ($34.3 billion) to €78 billion ($99 billion), of which €23 billion ($29 billion) is due by the end of 2009. But Kiev is no longer receiving any loans from abroad, while Ukrainians are withdrawing their savings from domestic banks to the greatest extent possible. Europe's largest nation is a textbook example of how an economic cycle can collapse in only a few months. The Ukraine specialists in Bremen assume that the country could face "a deep national crisis" in 2009, the "consequences of which are difficult to predict."
A vicious circle has already been put in place, now that steel mills are cancelling their coal orders. The coals mines, most of which survive on loans, can no longer pay the utilities, which in turn are shutting off the power supply. Winter is around the corner and Kiev has not yet reached a definitive agreement with Moscow over natural gas prices. Indeed, Moscow could be tempted, once again, to take advantage of the plight of its reviled neighbor.
It is "like a tornado" that increases in strength every day, says one industry leader. Some are already calling for a return of the barter economy, an antiquated system of trading among companies, which was implemented in the early 1990s when money was scarce. "It would be like turning away from the market economy," warns former President Leonid Kravchuk.
The head of the Ukrainian central bank characterizes the €13 billion ($16.5 billion) that the IMF is now providing as "technical bankruptcy." But the IMF is also attaching conditions to its bailout for Ukraine. They include a freeze on social services, increasing natural gas prices, privatizing government-owned businesses and eliminating subsidies.
Last week, the Ukrainian parliament held a heated debate over a crisis program. But the president and the prime minister did what they have been doing for months, taking advantage of the crisis to continue their duel. Tymoshenko, with her populist politics, is to blame for the plight, Yushchenko complained. Tymoshenko promptly responded by calling the president's decision to schedule new elections now "criminal." Ukraine never fulfilled obligations, warns one of the country's former leading economists. In an article titled "Kiev's Crackup," the Wall Street Journal writes that Ukraine's only hope for success is to find new political leaders.
Thousands of miles away last Wednesday, a powerful earthquake struck in Pakistan, killing about 300 people in poverty-stricken Beluchistan Province. It was yet another blow to country whose troubles are myriad and serious. The nuclear-armed country has been plagued by suicide bombings, corruption scandals and radical Islamists -- and now by the financial crisis. On the day before the quake, German Foreign Minister Frank-Walter Steinmeier was in Pakistan, on a visit that signaled Islamabad's importance for the West. Although Pakistan does not occupy a key position in the global financial system, the fear that this country, of all places, could collapse sends a cold shiver down the spines of observers.
Last Tuesday, according to reports, there were only two to three weeks separating Pakistan, a nation of 165 million, from bankruptcy. Pakistan, says Steinmeier, "was hit hard." He supports an immediate IMF loan to Pakistan to the tune of several billion euros. Islamabad's economy has been in a free fall for months. Skyrocketing prices for oil and food drove up the inflation rate, while ongoing terrorist attacks by Islamist extremists drove away investors. Few doubt that the current situation could lead to anarchy in Pakistan, a country already under stress from numerous forces. If the government fails completely, the consequences will be more serious that in other nation threatened by the financial crisis.
In speeches to business leaders in Lahore and Karachi Shaukat Tarin, a former banker at Citibank and the current financial advisor to Pakistan's prime minister, promised an entire package of measures. But without money they are not feasible. They include government subsidies for agriculture, expansion of the energy sector to do away with the country's chronic power outages and simplification of the tax system. In addition, President Asif Ali Zardari is proposing a program he calls the "Benazir Card," named after his murdered wife Benazir Bhutto, which would entitle seven million needy citizens to monthly welfare benefits. Poverty is a mounting problem in Pakistan, where inflation is at 25 percent and a budget deficit and shortage of currency reserves have led to significant subsidy cuts and growing hunger.
Quick action is needed. It would be catastrophic were the unity of Pakistan threatened -- a unity already fragile given the lack of authority the government and its representatives has in many tribal regions. An estimated €11.5 billion ($14.6 billion) in aid will be needed for the next two years, although Shaukat Tarin puts that number at only €2.3 billion ($2.9 billion). Commitments so far, however, include only €1 billion ($1.27 billion) from the World Bank and the Asian Development Bank. Now that China has only offered to build two nuclear power plants, instead of contributing a hoped-for $1 billion (€790 million) financial injection, the only remaining big spender is the unpopular IMF.
An IMF loan would be tied to savings requirements, but these would not necessarily apply to the defense budget. The army is the only stabilizing force in the country. Weakening it would not be helpful in the war on terror. Pakistan's military has already put a stop to the construction of its €160 million ($203 million) new headquarters in Islamabad. But irking the keepers of the country's nuclear bombs with additional savings requirements would be dangerous. The West's greatest concern is that Pakistan's nuclear arsenal (an estimated 60 warheads and 70 delivery missiles) could end up in the wrong hands.
Only foreign capital can prevent more and more of the poor seeking their salvation among the radical mullahs. Pakistan cannot be allowed to become insolvent, and for this reason the IMF's offer of assistance is inescapable. Indeed, there is already evidence of improvement for Pakistan. In two weeks, a group called Friends of Democratic Pakistan, which includes the United States, the EU, Japan and a few Gulf nations, will meet in Abu Dhabi. And now that the German foreign minister paid a visit to Saudi Arabia last week, the wealthy oil-producing nation is also on board. Steinmeier had urged the hesitant Saudi king to take part in the Pakistan rescue program, apparently with success.
But what happens if the IMF runs out of money? The Washington-based financial fire department has already promised to pony up €27 billion ($34.3 billion) for Iceland, Ukraine and Hungary. This is about one-fifth of the funds the IMF currently has available for such packages, and Pakistan is looming. Should the virus of financial failure continue to spread, the €156 billion currently available to the IMF would soon be exhausted. If that happened, the major industrialized nations would have to inject additional funds and provide the IMF, possibly through loans, with fresh capital for the high-risk countries. Global investors would hardly be interested.
And what happens if capital flight from the faltering threshold countries fuels the greed of speculators even further? For months now, they have been betting their money on, not just the ruin of banks and insurance companies, but the demise of entire countries. "It's blood in the water for the hedge fund sharks," wrote Britain's Sunday Telegraph, noting that economies like Hungary's are simply too weak to resist. "Major players in the foreign currency market, like hedge funds and banks, are betting on the further decline of Eastern European currencies," says Hans-Günter Redeker, chief strategist with the foreign currency division of French banking conglomerate BNP Paribas.
The gamblers have also set their sights on Ukraine, Poland, the Czech Republic, Romania and Turkey. Even Russia, the natural resource paradise, is seen as a worthwhile bet, because it will hardly be able to defend the ruble for much longer, given the massive exodus of capital. The entire world is currently spooked by the Argentine ghost. Even if wealthy countries reach out to ailing nations, some governments will not survive the storm. Even this would not be truly dramatic. But if the industrialized nations then decide to leave the threshold countries to their own devices, the ensuing wildfire will burn indefinitely.