Mr. and Mrs. Clarence White and their sons at home in Maine
Sometimes I think of songs when I read and write. Today it was Adam Green's Jessica. Oh so appropriate:
where has your love gone
It's not in your music, no
You need a vacation
to wake up the cavemen
And take them to Mexico
Jessica, Jessica Simpson
You've got it all wrong
Your fraudulent smile
The way that you faked it
The day that you died
My body's in shambles
Incrusted with brambles,
that sharpen the air I breathe
What's on the menu
Jessica can you
take down my order please
Jessica, Jessica Simpson
You've got it all wrong
Your fraudulent smile
The way that you faked it
The day that you died
Tomorrow gets closer
A purple bulldozer
is calling you on the phone.
Your love life preceeds you
Your son-in-law feeds you
injections of cortizone
Jessica, Jessica Simpson
You've got it all wrong
Your fraudulent smile
The way that you faked it
The day that you died
Jessica Simpson, where has your love gone
It's not in your music,
so where has it gone then
It’s not all that hard, I think. When I look at the boys at the Fed, the Treasury and Goldman, I just don't trust them to be stupid enough to get it all wrong, not every single decision every single day. It makes much more sense to me that they make these so-called mistakes on purpose, and let people think they are mistaken. For all I can see this works great; they hardly ever lose their jobs, and even if they do, they get enough of the loot to retire comfortably. The only other job I know where such blatantly poor records are rewarded that way is that of weatherman.
Outside of Manhattan and Washington, though, I'm sure many of the decider class truly are as ignorant and stupid as they look. This morning, i saw some fragments of politicians in Holland’s parliament talking about the credit crisis, and all I could think was: you don't have a clue, you don't know what you're saying, you got it all wrong.
And I'm convinced you can see the same pattern in countries all over the planet. Which is worrisome, very. All these ignoramuses talk about is a fast recovery of their economies, having everything under control, and there's no need not to run a deficit. Recovery is around the corner, it's all just an unfortunate accident. Or even better: the political left in Holland thinks it's a really great idea to "use" the crisis to push through standards for 'green' and 'sustainable' housing. No matter that home sales were found to be down 50% since Nov. '07, and construction has just about died entirely. There is not a soul among them who thinks of wondering if perhaps there is no recovery in sight: it's better for their careers if there is, and so there must be. Well, at least it's a simple worldview, though a bit fairy for my taste.
The problem with it is, of course, as I keep on pointing out here, that 95% of the billions of dollars and euros that are being spent by governments to rescue their corporations are simply wasted, sucked up by black holes of existing debt. You can try to save a real estate industry, or a car industry, or a bunch of banks, but doing that is really stupid and useless when home sales and prices are set to fall by 80% (which they are all over the planet), when car sales do the same move down (wonder what those prices will do), and when banks have far less deposits (everyone's broke, nobody saves), and a rate of gambling debt so high it's safe to make a bet on quite a few entire countries becoming insolvent.
See, if these things happen, if there is no return to what homes, cars and banks used to mean to societies, in terms of the scale of their economic impact, then politicians like the ones in Holland are not just making mistakes, they are doing that which is 180 degrees wrong. They are taking the money that is left from the cold and hungry hands of the people who voted for them, and throwing it down a limitless pit.
So what are the chances we won't get back to where we were before, the only thing our politicians seem to recognize? (Really, I get the idea of all these drivers on a road trying to navigate by looking only in their rear-view mirrors). Here’s a number from today:
Total U.S. credit-market debt stood at $51 trillion at the end of the second quarter, making the ratio of debt to gross domestic product 357 percent. In 1929, of all years, debt was 185 percent of GDP
And there are of course so many other numbers that look gross. What I'm trying to say is that even if people like politicians don't share my view that we won't ever get back to where we were, it's criminally negligent of them to not consider the possibility, to not make any preparations to protect their voters, the people who've given them their trust, against the things that they should be able to see at least clearly might happen. And that I know will.
That is unforgivable: to forgo critical thinking at the peril of your constituents. That will lead to endless repeats of what we've recently seen in Mumbai, and Athens, and it will come ever closer to home for all of us. And what hurts is that it's not necessary, not to the extent that the rulers’ ignorance is now rapidly making it.
Worst Spending Slump Since 1942 Extends 'Scary' U.S. Recession
The biggest slump in U.S. consumer spending since 1942 will extend the recession and push the jobless rate to the highest level in a quarter century, according to economists surveyed by Bloomberg News. Household spending will drop 1 percent in 2009, the biggest decline since after the attack on Pearl Harbor, according to the median estimate of 51 economists surveyed Dec. 4 through Dec. 9. By the middle of next year, the economy will have shrunk for a record four consecutive quarters, the survey showed. "That sounds scary enough to me," said Jeffrey Frankel, an economics professor at Harvard University and a member of the group that determined the start of the recession. "Consumers have carried the weight of expanding demand for a long time at the expense of a serious deterioration of their balance sheets."
A drop in spending has brought the auto industry to the brink of collapse, and mounting unemployment, a lack of credit, and falling property and stock values will prompt Americans to turn even more frugal. President-elect Barack Obama has pledged to pursue the biggest public-works plan since the 1950s to stem the already year-old economic slump. "It’s a serious recession, and there’s a good chance it will break the 16-month record since the Depression," said James O’Sullivan, a senior economist at UBS Securities LLC in Stamford, Connecticut. "We’re at the stage where the weakness is feeding on itself. The next few months look pretty rough."
The National Bureau of Economic Research last week announced the U.S. contraction began in December 2007. The longest economic slumps since 1945 were the 16-month downturns that ended in March 1975 and November 1982. The Great Depression lasted 43 months, from August 1929 to March 1933. Economists cut fourth-quarter forecasts for gross domestic product by more than a percentage point from last month, predicting the economy will shrink at a 4.3 percent annual rate, the biggest plunge since 1982. The world’s largest economy will contract at a 2.4 percent pace in the first three months of 2009 and at a 0.5 percent rate the following quarter, the survey showed. Combined with the 0.5 percent drop in this year’s third quarter, it would be the longest slide since quarterly records began in 1947.
Consumer purchases, the biggest part of the economy, may drop at a 4 percent rate this quarter, the survey showed. Following the 3.7 percent slump from July through September, it would be the first time on record that spending declined in excess of 3 percent in consecutive quarters. The spending slump will continue into the first half of 2009, according to economists. The drop in sales will prompt employers to keep cutting staff, sending the employment rate to 8.2 percent by the end of next year, a 25-year high, the survey showed. "It’s the perfect storm for the consumer," said Peter Kretzmer, a senior economist at Bank of America Corp. in New York. "With rising unemployment, we’re talking about a very serious recession. If credit conditions don’t ease, it’s difficult to see the recession ending" soon.
Investors concerned about the worst financial crisis in at least 70 years have rushed to the safety of U.S. government debt, causing three-month Treasury bills to trade yesterday at negative rates for the first time. Economists project the Federal Reserve will cut the benchmark rate target to 0.5 percent when they meet in Washington next week and hold it there for all of 2009, the survey showed. "The Fed is moving aggressively and will continue to do more," UBS’ O’Sullivan said. Stimulus measures from the central bank and the government are "absolutely needed," he said. Automakers are among those seeking help. Congressional approval of a $15 billion rescue stalled yesterday and General Motors Corp. and Chrysler LLC say they need the aid to survive. Retailers also are concerned about the November-December holiday season, which brings in one-third or more of annual revenue and is predicted to be the worst in years. "The big problem is that there’s no bottom in sight for consumers and for businesses," said John Lonski, chief economist at Moody’s Capital Markets Group in New York. "The negative sentiment makes it difficult to stabilize the situation. It’s very worrisome."
Businesses are pulling back as Americans retrench. Dow Chemical Co., the largest U.S. chemical maker, this week said it will cut 5,000 jobs, permanently shut 20 facilities, temporarily idle 180 plants and reduce the company’s contractor workforce by about 6,000."The entire industrial supply chain all the way to whatever the consumer buys outside of food and health is in a recessionary mode," Chief Executive Officer Andrew Liveris said on a conference call. "Across the board, everywhere." The downturn will help contain inflation, the survey showed. Consumer prices will rise 1.6 percent this year and next, the smallest back-to-back gain since 1964-65, according to the median. It’s "a recession with adjectives," Martin Feldstein, a member of the NBER group that announced the downturn, said in a Bloomberg Television interview yesterday. "A deep recession, a long recession, a damaging recession."
Fed Weighs Selling Its Own Debt
The Federal Reserve is considering issuing its own debt for the first time, a move that would give the central bank additional flexibility as it tries to stabilize rocky financial markets. Government debt issuance is largely the province of the Treasury Department, and the Fed already can print as much money as it wants. But as the credit crisis drags on and the economy suffers from recession, Fed officials are looking broadly for new financial tools. Fed officials have approached Congress about the concept, which could include issuing bills or some other form of debt, according to people familiar with the matter.
It isn't known whether these preliminary discussions will result in a formal proposal or Fed action. One hurdle: The Federal Reserve Act doesn't explicitly permit the Fed to issue notes beyond currency. Just exploring the idea underscores many challenges the ongoing problems are creating for the Fed, as well as the lengths to which the central bank is going to come up with new ideas. At the core of the deliberations is the Fed's balance sheet, which has grown from less than $900 billion to more than $2 trillion since August as it backstops new markets like commercial paper, money-market funds, mortgage-backed securities and ailing companies such as American International Group Inc.
The ballooning balance sheet is presenting complications for the Fed. In the early stages of the crisis, officials funded their programs by drawing down on holdings of Treasury bonds, using the proceeds to finance new programs. Officials don't want that stockpile to get too low. It now is about $476 billion, with some of that amount already tied up in other programs. The Fed also has turned to the Treasury Department for cash. Treasury has issued debt, leaving the proceeds on deposit with the Fed for the central bank to use as it chose. But the Treasury said in November it was scaling back that effort. The Treasury is undertaking its own massive borrowing program and faces legal limits on how much it can borrow.
More recently, the Fed has funded programs by flooding the financial system with money it created itself -- known in central-banking circles as bank reserves -- and has used the money to make loans and purchase assets. Some economists worry about the consequences of this approach. Fed officials could find it challenging to remove the cash from the system once markets stabilize and the economy improves. It's not a problem now, but if they're too slow to act later it can cause inflation. Moreover, the flood of additional cash makes it harder for Fed officials to maintain interest rates at their desired level. The fed-funds rate, an overnight borrowing rate between banks, has fallen consistently below the Fed's 1% target. It is expected to reduce that target next week.
Louis Crandall, an economist with Wrightson ICAP LLC, a Wall Street money-market broker, says the Fed's interventions also have the potential to clog up the balance sheets of banks, its main intermediaries. "Finding alternative funding vehicles that bypass the banking system would be a more effective way to support the U.S. credit system," he says. Some private economists worry that Fed-issued bonds could create new problems. Marvin Goodfriend, an economist at Carnegie Mellon University's Tepper School of Business and a former senior staffer at the Federal Reserve Bank of Richmond, said that issuing debt could put the Fed at odds with the Treasury at a time when it is already issuing mountains of debt itself.
"It creates problems in coordinating the issuance of government debt," Mr. Goodfriend said. "These would be very close cousins to existing Treasury bills. They would be competing in the same market to federal debt." With Treasury-bill rates now near zero, it seems unlikely that Fed debt would push Treasury rates much higher, but it could some day become an issue. There are also questions about the Fed's authority. "I had always worked under the assumption that the Federal Reserve couldn't issue debt," said Vincent Reinhart, a former senior Fed staffer who is now an economist at the American Enterprise Institute. He says it is an action better suited to the Treasury Department, which has clear congressional authority to borrow on behalf of the government.
Is the Fed Taking the First Steps to Selective Default and Devaluation?
We have been looking for an out-of-the-box move from the Fed, but this was not it. The big kahuna move would have been for the Treasury and the Fed to make an arrangement in which the Fed is able to purchase Treasury debt directly without subjecting it to an auction in the public market first. This is known as 'a money machine' and is prohibited by statute. But as usual the Fed surprises us all with their lack of transparency. They are asking Congress about permission to issue their own debt directly, not tied to Treasuries.
This is known in central banking circles as 'cutting out the middleman.' Not only does the Treasury no longer issue the currency, but they also no longer have any control over how much debt backed currency the Fed can now issue directly. If the Fed were able to issue its own debt, which is currently limited to Federal Reserve Notes backed by Treasuries under the Federal Reserve Act, it would provide Bernanke the ability to present a different class of debt to the investing public and foreign central banks. The question is whether it would be backed with the same force as Treasuries, or is subordinated, or superior.
There will not be any lack of new Treasury debt issuance upon which to base new Fed balance sheet expansion. The notion that there might be a debt generation lag out of Washington in comparison with what the Fed issues as currency is almost frightening in its hyperinflationary implications. This makes little sense unless the Fed wishes to be able to set different rates for their debt, and make it a different class, and whore out our currency, the Federal Reserve notes, without impacting the sovereign Treasury debt itself, leaving the door open for the issuance of a New Dollar.
What an image. The NY Fed as a GSE, the new and improved Fannie and Freddie. Zimbabwe Ben can simply print a new class of Federal Reserve Notes with no backing from Treasuries. BenBucks. Federal Reserve Thingies. Perhaps we're missing something, but this looks like a step in anticipation of an eventual partial default or devaluation of US debt and the dollar.
You know what they say: When the going gets tough, the debt holders get screwed.
We are going to have to tie Andrew Jackson down in his grave.
Bernanke’s GM Rejection Aimed at Re-Establishing Rescue Limits
More than a year into the credit crisis, Federal Reserve Chairman Ben S. Bernanke is still trying to establish how far he’s willing to go to aid troubled companies. Bernanke, in a letter released yesterday, rejected the idea that the central bank should provide assistance to automakers, saying that such aid would involve the Fed in "industrial policy," an area best left to Congress. The letter came in response to a Dec. 3 inquiry from Senate Banking Chairman Christopher Dodd. The exchange reflects uncertainty over the limits of the Fed’s willingness to act following conflicting signals Bernanke has sent this year. While the Fed rescued Bear Stearns Cos. and American International Group Inc., it refused to intervene on behalf of Lehman Brothers Holdings Inc. -- only to see Lehman’s failure trigger widespread losses and worsen the credit crisis.
Bernanke is attempting to re-establish a clear line: that the central bank will only assist firms vital to the financial system, a definition that would exclude companies such as General Motors Corp. "He’s absolutely right to draw that line," Martin Feldstein, the Harvard University economist who chaired President Ronald Reagan’s Council of Economic Advisers, said in an interview with Bloomberg Television. The Fed is responsible for the "health and stability of the financial sector," and "it would be a very big departure to start doing auto companies and who-knows-what-else," Feldstein said. Bernanke’s comments came in a letter dated Dec. 5 to Dodd, who requested the Fed chief’s position on the automakers’ reorganization plans and whether the central bank has authority to lend to the companies.
"American manufacturing is just as important to our nation’s economy as a healthy financial sector," Dodd said in a statement. "I look forward to continuing my oversight and work with the Fed to accomplish the goals that we both agree will secure American jobs and stabilize our economy." Congressional Democrats and White House negotiators last night agreed on the outlines of a $15 billion plan to give GM and Chrysler LLC federal loans to stay in business while requiring them to restructure their operations. "Bipartisan hard work has paid off and I understand an agreement has been reached," Senator Carl Levin, a Michigan Democrat, said in a statement late yesterday. GM and Chrysler have said they need at least $14 billion in combined aid to keep from running out of cash by early next year. The legislation would include the appointment of a so- called car czar who could force the companies into Chapter 11 bankruptcy if the companies don’t come up with their own plan by March 31, a Bush administration official told reporters on the condition of anonymity.
"What the Fed does should be ratified by the Treasury and ultimately by the Congress," Feldstein said. "If the Congress is telling us right now, ‘No, we don’t want to provide that money to the auto companies,’ then surely the Fed shouldn’t be providing it." Bernanke said in the letter to Dodd that the central bank can only lend in emergency circumstances when the financing can "be secured to its satisfaction." It’s "unclear" whether the three U.S. automakers could "meet this requirement." "Even if the companies have sufficient collateral, lending to an auto manufacturing company would represent a marked departure from that policy, and would take us into distinctly new realms of policymaking," Bernanke said. "In particular, it would raise the question as to whether the Federal Reserve should be involved in industrial policy, which has traditionally been outside the range of our responsibilities."
The "critical unknown" in the automakers’ plans is "their ability to develop and produce vehicles that the public wants to buy," Bernanke said. The comments represent Bernanke’s first public remarks on whether the Fed would lend to the beleaguered industry. Two regional Fed-bank chiefs said last week that the issue was best left to Congress. The letter also refines Bernanke’s position on the rescue of individual companies following criticism by economists and investors in recent months that his approach was inconsistent toward Bear Stearns, Lehman and AIG. "In the absence of an appropriate, comprehensive legal or regulatory framework, the Federal Reserve and the Treasury dealt with the cases of Bear Stearns and AIG using the tools available," Bernanke said in a Dec. 1 speech. Lehman didn’t have enough collateral, making its collapse "unavoidable," he said.
After the failure of Lehman jolted credit markets, Congress passed the $700 billion Troubled Asset Relief Program on Oct. 3, authorizing Treasury to inject capital into banks. Under the Nov. 23 rescue of Citigroup Inc., the Fed agreed to backstop a $306 billion pool of distressed assets after the bank, the Treasury and the Federal Deposit Insurance Corp. assumed initial losses. "We now have tools to address any similar situation that might arise in the future," Bernanke said in his speech last week. The Fed’s decisions during the past year to support financial firms and short-term debt markets were aimed at ensuring financial stability and supporting the economy, Bernanke said in the speech. While the automakers have been affected by the credit crunch, it’s "difficult to assess" the broader consequences of one or more of the carmakers becoming insolvent, he said. Even so, Bernanke urged lawmakers to consider alternatives to direct aid, such as an "orderly bankruptcy reorganization with government aid, and government assisted mergers."
Greek fighting: the eurozone's weakest link starts to crack
The last time I visited Greece, I was caught in the middle of a tear-gas charge by police in Thessaloniki - a remarkably unpleasant experience, if you have not tried it. My eyes were in screaming pain for an hour. Protesters smashed up the shops on the main drag, broke the windows of my hotel, and torched a few cars. So the latest four-day episode in Athens and other Greek cities comes as no great surprise. The Greeks are a feisty people. This is meant as a compliment - broadly speaking - just in case any Greek readers should take it the wrong way. Hitler was so impressed by Greek bravery that he accorded Greek soldiers full military honours, almost the sole example among captive nations in the East - or at least professed to do so at first. That said, these riots are roughly what eurosceptics expected to see, at some point, at the periphery of the euro-zone as the slow-burn effects (excuse the pun) of Europe's monetary union begin to corrode the democratic legitimacy of governments.
Note two stories in Kathimerini (English Edition) "Athens riots spin totally out of control", And an editorial: "Greece has gone up in flames and the concept of democracy and law and order has been eliminated" Without wanting to rehearse all the pros and cons of euro membership yet again, or debate whether EMU is a "optimal currency area", there is obviously a problem for countries like Greece that were let into EMU for political reasons before their economies had been reformed enough to cope with the rigours of euro life - over the long run. In the case of Greece, of course, Athens was found guilty by Eurostat of committing "statistical achemy" to get into the system - ie, they lied about their deficits.
Be that as it may. Greece's euro membership has now led to a warped economy. The current account deficit is 15pc of GDP, the eurozone's highest by far. Indeed, the deficit ($53bn) is the sixth biggest in the world in absolute terms -- quite a feat for a country of 11m people. Year after year of high inflation has eroded the competitive base of the economy. This is an insidious and slow effect, and very hard to reverse. Tourists are slipping away to Turkey, or Croatia. It will take a long time to lure them back. The underlying rot was disguised by the global credit bubble, and by the Greek property boom. It is now being laid bare. Greece has a public debt of 93 per cent of GDP, well above the Maastricht limit. This did not matter in 2007 when bond spreads over German Bunds were around 26 basis points, meaning that investors were willing to treat all eurozone debt as more or less equivalent.
It matters now. The credit default swaps on Greek sovereign debt were trading around 250 today (compared to 52 for Germany, 62 for the US, 120 for the UK, and 178 for Italy). It has moved into a class of its own. This is potentially dangerous because Greece needs to tap the capital markets for 40bn euros next year to roll over debt and fund the budget deficit, as well as 15bn euros or so in bond issuance by banks under the state's new guarantee. This is a lot of money. The Greek government will need budgetary discipline to convince markets that it has matters under control.
But governments facing riots and imminent defenestration are not good bets for fiscal discipline. There is a general strike in any case on Thursday. While the violence was triggered by the death of a 15-year old boy, the underlying motives of the protest obviously run deeper. The hard left can mobilize demos because the youth unemployment is endemic and because the goverment is being forced by economic constraints to adopt a hair-shirt policy at a very bad moment.
At some stage a major political party - perhaps PASOK - will start to reflect whether it can carry out its spending and economic revival plans under the constraints of a chronically over-valued currency (for Greek needs). Then there will be a problem. I am a little surpised that the riot phase of this long politico-economic drama known as EMU has kicked off so soon, and that it has done so first in Greece where the post-bubble hangover has barely begun. The crisis is much further advanced in Spain, which is a year or two ahead of Greece in the crisis cycle.
My old job as Europe correspondent based in Brussels led me to spend a lot of time in cities that struck me as powder kegs - and indeed became powder kegs in the case of Rotterdam following the murder of Pim Fortyn, and Antwerp following the Muslim street riots (both of which I covered as a journalist). Lille, Strasbourg, Marseilles, Amsterdam, Brussels, all seemed inherently unstable, and I do not get the impression that the big cities of Spain and Italy are taking kindly to new immigrants.
The picture is going to get very ugly as Europe slides deeper into recession next year. The IMF expects Spain's unemployment to reach 15pc. Immigrants are already being paid to leave the country. There will be riots in Spain too (there have been street skirmishes in Barcelona). Hedge funds, bond vigilantes, and FX traders will be watching closely. In the end, a currency union is no stronger than the political will of the constituent states. No doubt events will be ugly in Britain as well. My comments are not intended to suggest that British behaviour is better. Far from it. But I am certain that the British people still feel that the authorities who set economic policy are ultimately answerable to Parliament and to the democratic system. Will the Greeks, the Spanish, the French feel that way about the European Central Bank and the Stability Pact when the chips are really down?
Congress reaches agreement on $15bn loan to GM and Chrysler
The White House and Congressional leaders on Tuesday night reached an agreement to extend ailing General Motors and Chrysler up to $15bn (£10bn) in emergency loans, bringing the survival of the two historic carmakers a step closer. A senior official from President George W. Bush's administration and Congressional aides told the Associated Press that the two sides had agreed – after five days of near round-the-clock talks - on legislation to put before the House of Representatives and the Senate.
The first vote in the Senate could come as early as Wednesday although Congressional officials are preparing to work into the weekend if necessary. The centrepiece of the proposed legislation is the creation of a government "car tsar" who will oversee the loans and force through a restructuring of the troubled industry. The so-called car tsar will be appointed by President Bush, with a number of names in the frame, including former Federal Reserve chairman Paul Volcker. However, the President is more likely to choose someone eithe from the automotive industry or from world of commerce who is used to re-engineering large companies short of cash.
The tsar will have the authority to return the funds to the US government if the companies do not implement sufficiently tough restructuring measures. Other conditions on the loans will include restrictions on executive pay and bonuses and restrictions on dividends for General Motors, a publicly-listed company. The financing will be provided at an interest rate of 5pc, with the government receiving warrants for up to 20pc of the two company's capital and will be exercisable if their value appreciates. The $15bn is coming from previously allocated funds from the Department of Energy, designed to allow Detroit's Big Three, GM, Chrysler and Ford, to restructure themselves to build greener, more fuel-efficient vehicles.
Originally Congressional leaders wanted to use the Treasury's $700bn bank bail-out fund to finance the auto makers, but the White House resisted as it felt such a move might open the floodgates for companies in other industries who are feeling the pinch of the economic downturn. A statement on the agreement between the White House and Congressional leaders is expected on Wednesday morning in Washington.
AIG Faces $10 Billion in Losses on Bad Bets
American International Group Inc. owes Wall Street's biggest firms about $10 billion for speculative trades that have soured, according to people familiar with the matter, underscoring the challenges the insurer faces as it seeks to recover under a U.S. government rescue plan. The details of the trades go beyond what AIG has explained to investors about the nature of its risk-taking operations, which led to the firm's near-collapse in September. In the past, AIG has said that its trades involved helping financial institutions and counterparties insure their securities holdings. The speculative trades, engineered by the insurer's financial-products unit, represent the first sign that AIG may have been gambling with its own capital.
The soured trades and the amount lost on them haven't been explicitly detailed before. In a recent quarterly filing, AIG does note exposure to speculative bets without going into detail. An AIG spokesman characterizes the trades not as speculative bets but as "credit protection instruments." He said that exposure has been fully disclosed and amounts to less than $10 billion of AIG's $71.6 billion exposure to derivative contracts on debt pools known as collateralized debt obligations as of Sept. 30. AIG's financial-products unit, operating more like a Wall Street trading firm than a conservative insurer selling protection against defaults on seemingly low-risk securities, put billions of dollars of the company's money at risk through speculative bets on the direction of pools of mortgage assets and corporate debt. AIG now finds itself in a position of having to raise funds to pay off its partners.
The fresh $10 billion bill is particularly challenging because the terms of the current $150 billion rescue package for AIG don't cover those debts. The structure of the soured deals raises questions about how the insurer will raise the funds to pay the debts. The Federal Reserve, which lent AIG billions of dollars to stay afloat, has no immediate plans to help AIG pay off the speculative trades. The outstanding $10 billion bill is in addition to the tens of billions of taxpayer money that AIG has paid out over the past 16 months in collateral to Goldman Sachs Group Inc. and other trading partners on trades called credit-default swaps. These instruments required AIG to insure trading partners, known on Wall Street as counterparties, against any losses in their holdings of securities backed by pools of mortgages and other assets. With the value of those mortgage holdings plunging in the past year and increasing the risk of default, AIG has been required to put up additional collateral -- often cash payments.
AIG's problem: The rescue plan calls for a company funded largely by the Federal Reserve to buy about $65 billion in troubled CDO securities underlying the credit-default swaps that AIG had written, so as to free AIG from its obligations under those contracts. But there are no actual securities backing the speculative positions that the insurer is losing money on. Instead, these bets were made on the performance of pools of mortgage assets and corporate debt, and AIG now finds itself in a position of having to raise funds to pay off its partners because those assets have fallen significantly in value. The Fed first stepped in to rescue AIG in mid-September with an $85 billion loan when the collateral demands from banks and losses from other investments threatened to send the firm into bankruptcy court. A bankruptcy filing would have created losses and problems for financial institutions and policyholders all over the world that were relying AIG to insure them against the unexpected.
By November, AIG had used up a large chunk of the government money it had borrowed to meet counterparties' collateral calls and began to look like it would have difficulty repaying the loan. On Nov. 10 the government stepped in again with a revised bailout package. This time, the Treasury said it would pump $40 billion of capital into AIG in exchange for interest payments and proceeds of any asset sales, while the Fed agreed to lend as much as $30 billion to finance the purchases of AIG-insured CDOs at market prices. The $10 billion in other IOUs stems from market wagers that weren't contracts to protect securities held by banks or other investors against default. Rather, they are from AIG's exposures to speculative investments, which were essentially bets on the performance of bundles of derivatives linked to subprime mortgages, commercial real-estate bonds and corporate bonds. These bets aren't covered by the pool to buy troubled securities, and many of these bets have lost value during the past few weeks, triggering more collateral calls from its counterparties. Some of AIG's speculative bets were tied to a group of collateralized debt obligations named "Abacus," created by Goldman Sachs.
The Abacus deals were investment portfolios designed to track the values of derivatives linked to billions of dollars in residential mortgage debt. In what amounted to a side bet on the value of these holdings, AIG agreed to pay Goldman if the mortgage debt declined in value and would receive money if it rose. As part of the revamped bailout package, the Fed and AIG formed a new company, Maiden Lane III, to purchase CDOs with a principal value of $65 billion on which AIG had written credit-default-swap protection. These CDOs currently are worth less than half their original values and had been responsible for the bulk of AIG's troubles and collateral payments through early November. Fed officials believed that purchasing the underlying securities from AIG's counterparties would relieve the insurer of the financial stress if it had to continue making collateral payments. The plan has resulted in banks in North America and Europe emerging as winners: They have kept the collateral they previously received from AIG and received the rest of the securities' value in the form of cash from Maiden Lane III.
The government's rescue of AIG helped prevent many of its policyholders and counterparties from incurring immediate losses on those traditional insurance contracts. It also has been a double boon to banks and financial institutions that specifically bought protection on now shaky mortgage securities and are effectively being made whole on those positions by AIG and the Federal Reserve. Some $19 billion of those payouts were made to two dozen counterparties just between the time AIG first received federal government assistance in mid-September and early November when the government had to step in again, according to a confidential document and people familiar with the matter. Nearly three-quarters of that went to French bank Société Générale SA, Goldman, Deutsche Bank AG, Crédit Agricole SA's Calyon investment-banking unit, and Merrill Lynch & Co. Société Générale, Calyon and Merrill declined to comment. A Goldman spokesman says the firm's exposure to AIG is "immaterial" and its positions are supported by collateral. As of Nov. 25, Maiden Lane III had acquired CDOs with an original value of $46.1 billion from AIG's counterparties and had entered into agreements to purchase $7.4 billion more. It is still in talks over $11.2 billion.
Treasury Bills Trade at Negative Rates as Haven Demand Surges
Treasuries rose, pushing rates on the three-month bill negative for the first time, as investors gravitate toward the safety of U.S. government debt amid the worst financial crisis since the Great Depression.The Treasury sold $27 billion of three-month bills yesterday at a discount rate of 0.005 percent, the lowest since it starting auctioning the securities in 1929. The U.S. also sold $30 billion of four-week bills today at zero percent for the first time since it began selling the debt in 2001. "It’s the year-end factor," said Chris Ahrens, an interest-rate strategist in Greenwich, Connecticut, at UBS Securities LLC, one of the 17 primary dealers that trade directly with the Federal Reserve. "Everyone wants to be in bills going into year-end. Buy now while the opportunity is still there."
The benchmark 10-year note’s yield tumbled 11 basis points, or 0.11 percentage point, to 2.63 percent at 4:48 p.m. in New York, according to BGCantor Market Data. The 3.75 percent security due in November 2018 gained 31/32, or $9.69 per $1,000 face amount, to 109 23/32. The yield touched 2.505 percent on Dec. 5, the lowest level since at least 1962, when the Fed’s daily records began. The two-year note’s yield fell 10 basis points to 0.84 percent. It dropped to a record low of 0.77 percent on Dec. 5. If you invested $1 million in three-month bills at today’s negative discount rate of 0.01 percent, for a price of 100.002556, at maturity you would receive the par value for a loss of $25.56.
Indirect bidders, a group that includes foreign central banks, bought 47.2 percent of the four-week bills, compared with 31.7 percent in the prior auction. Primary dealers bought 52.1 percent, while direct bidders such as individual investors purchased 0.7 percent. "It’s been such a horrible year people want to show they have the good stuff on their balance sheets, not the bad stuff, but with yields already so low it pushes these even lower," said Theodore Ake, the head of Treasury trading in New York at Mizuho Securities USA Inc., another primary dealer. The rate on four-week bills peaked at 5.175 percent on Jan. 29, 2007. The government began issuing the four-week bills in July 2001, according to Stephen Meyerhardt, a spokesman for the Bureau of Public Debt in Washington. The bills are intended to reduce the government’s reliance on irregularly issued cash management bills. Meyerhardt wasn’t aware of the three-month bill ever trading at a negative rate before.
Treasuries of all maturities have returned 11.4 percent this year, according to Merrill Lynch & Co.’s U.S. Treasury Master Index. That compares with a 39 percent loss in the Standard & Poor’s 500 Index, including reinvested dividends. Bonds have surged as the U.S. housing slump pushed up the cost of credit globally, causing equity markets to tumble. The world’s biggest financial companies incurred almost $1 trillion in writedowns and credit losses since the start of last year, helping push the major economies into recession. Treasuries rallied today as stocks snapped a two-day winning streak after companies from FedEx Corp. to Danaher Corp. forecast earnings that disappointed investors as the deepening recession crimps sales. The S&P 500 lost 2.3 percent.
"The bottom line is there’s still a good amount of cash on the sidelines, and people are trying to figure out how they want to allocate that capital," said Richard Bryant, a trader of 30- year bonds at primary dealer Citigroup Global Markets Inc. "The answer is still Treasuries for a lot of people." The National Association of Realtors’ index of signed purchase agreements, or pending home resales, fell a less-than- forecast 0.7 percent to 88.9 from a revised 89.5 in September, according to a report from the group today in Washington. Futures contracts on the Chicago Board of Trade show 100 percent odds t the Fed will lower its 1 percent target rate on overnight loans between banks to 0.25 percent on Dec. 16. The probability was 38 percent a week ago. Rate predictions based on the futures are not considered as accurate as they once were because the central bank hasn’t sought to bring the daily effect rate to the level of its target.
Money-market mutual funds that buy mostly Treasuries are starting to turn away new investors as the record low yields pull down returns for shareholders and squeeze managers’ fees. At least three Treasury money-market funds run by JPMorgan Chase & Co., Evergreen Investments and Allegiant Asset Management recently stopped taking outside cash, according to Web site notices and regulatory filings. Barring new customers protects returns for investors already in the funds because managers don’t have to buy as many new Treasuries with yields lower than current holdings. Higher fund yields also prop up management fees.
The record low borrowing costs for the Treasury Department may turn out to benefit President-elect Barack Obama as he faces a widening budget deficit while pledging to embark on the biggest U.S. public works plan since the 1950s to stimulate the economy. The U.S. is headed toward $1.5 trillion in debt sales as the budget deficit approaches $1 trillion in the 2009 fiscal year according to Bank of America Corp. The deficit this year was $455 billion. The Treasury will sell $28 billion of three-year notes tomorrow and $16 billion of 10-year notes the following day. The $44 billion total is about $3 billion more than expected by Wrightson ICAP LLC.
Investors are expecting a lot of deflation
The U.S. Treasury completed a remarkable auction of four-week Treasury bills today. No surprise that there was a ton of demand for the only investment still viewed as a safe haven — there were bids worth $120 billion for the $30 billion of bills being sold. But how low did bidders go on the yield they’d accept to own the bills? All the way down to zero. That’s right, the U.S. government just borrowed $30 billion at a cost of zero percent interest. That follows yesterday’s auction of 3-month T-bills at the microscopic rate of 0.005%, the lowest since the long-running 3-month maturity first hit the market in 1929.
According to a Bloomberg report on the bond market today, the 3-month bills are now trading at a negative yield, meaning buyers get a guaranteed loss, albeit a small one. One trader cited by Bloomberg noted that companies are eager, even desperate, to show they hold only ultra-safe T-bills on their balance sheets for fourth quarter earnings reports so they’re willing to accept the negative or zero yields. That’s an awfully high price to pay for sleeping soundly at night, but if you have more money than can be easily kept under bank insurance deposit limits, there aren’t many alternatives.
And it implies that investors are so worried about the safety and possible decline in value of most investments that they’re willing to lend merely on the assurance of getting their principal back intact. While some analysts fear runaway inflation from all the government bailouts and borrowing, the T-bill market at least is giving a pretty clear signal that’s not what is on big investors’ minds. They’re worried about the opposite, widespread deflation from the ongoing credit crisis, like the falling prices that occurred during the Great Depression.
UPDATE: Perhaps not surprisingly, economist Nouriel Roubini, who has been arguing for a coming wave of painful deflation, has jumped all over the latest T-bill results. He says the situation is developing into a "liquidity trap." Because investors get paid no more to hold bonds than cash, they become further reluctant to lend. That makes it harder for the government to stimulate the economy through fiscal policy (such as lower interest rates), he says:The consequence of falling prices (i.e. the prime reason why nominal interest rates should be that low) is that the real value of nominal liabilities will rise as do real interest rates once the nominal interest rate hits the zero bound. The incentive towards hoarding cash and saving instead of investing is thus self-reinforcing as the deflationary spiral takes hold. Any increase in money supply (like quantitative easing) goes into servicing higher real debt levels—> breaking a deflationary spiral therefore requires fiscal stimulus or balance sheet restructuring or both.
The web post has a bunch of useful links for background on the subject, as well. There’s also a downside for the little guy when T-bill rates get this low. A handful of fund firms like JP Morgan and Evergreen have even closed their money market funds to new investors because if the funds got more deposits they’d have to buy more T-bills in the current tight market. That would depress the funds’ yields for everybody already invested. It’s an unheard and almost unimaginable situation.
Unemployment cash shortage
Five states, including Ohio, are in danger of running out of funds they use to pay unemployment benefits, meaning they may have no choice but to increase taxes on employers, cut benefits for laid-off workers or borrow the cash. This comes at a time when job cuts are accelerating and states are facing huge deficits going into next year. States with unemployment funds that are running low are mostly larger ones that are tied closely with manufacturing. Michigan, Indiana, Ohio, New York and South Carolina all have reserves of less than three months to cover benefits.
States aren't allowed to stop paying unemployment insurance benefits to out-of-work employees so they must come up with money. Indiana is planning to borrow $330 million from the federal government to cover unemployment claims, something it hasn't done in 25 years. State lawmakers also may be forced to tax businesses to rebuild the fund. Some businesses in Michigan will pay an extra $67.50 per employee next year to make up a $473 million deficit in the state's unemployment benefits trust fund. The state has borrowed money to keep the fund afloat the past two fiscal years. Ohio Gov. Ted Strickland is asking Congress to replenish the state's fund so that Ohio isn't forced to borrow money and potentially face high interest rates and tax increases on employers.
Unemployment benefits are funded through a tax paid by employers. Nineteen states -- from Arkansas to Wisconsin -- are at risk of running out of funds in less than a year unless they're replenished as required under federal law, according to a Monday report by the National Conference of State Legislatures. The U.S. Department of Labor suggests that states keep enough money to cover benefits for one year. Some of those states have gotten into trouble because they opted to cut taxes years ago instead of building up their unemployment benefits trust funds, said Rick McHugh, unemployment coordinator with the National Employment Law Project, an advocacy group for the unemployed based in New York.
"It takes years, if not decades, to work yourself into this situation," he said. Some states, though, simply can't keep up with the growing demand for benefits, he said. A government report released last week showed the proportion of workers receiving jobless benefits has matched a level last reached in September 1992.
US clothing slump hits shipments
The slump in US clothing sales since the summer has led to a precipitous drop in the number of overseas factories shipping to the US, import documents show. Panjiva, a firm that analyses information drawn from shipping manifests filed with US Customs, said the number of global suppliers actively serving the US market fell from 22,099 in July to just 6,262 in October, a decline of more than 70 per cent. The firm, which has provided data to customers including Kellwood, a leading branded clothing company, and Hudson’s Bay Company, the Canadian retailer, lists as “active” any supplier that has made a shipment into the US over the previous three months. Josh Green, chief executive of Panjiva, said the numbers “paint a frightening picture of the state of the world’s suppliers”.
Mr Green said the decline contrasted with the picture last year, when he said there was a slight increase in the number of active suppliers over the same three-month period. Panjiva also said 40 per cent of the suppliers still listed as active had seen year-on-year drops of 75 per cent or more in the volumes they were shipping to the US. The percentage of active suppliers based in China and Hong Kong has remained steady at about 60 per cent – suggesting that the effects of the slowdown are being felt equally across the global clothing supply chain. Eric Autor, international trade counsel at the National Retail Federation noted that China had already been seeing some consolidation in the number of its export factories due to rising domestic costs, even before the US economic crisis worsened.
In China, government statistics estimate that at least 67,000 factories across all sectors closed during the first half of the year. He also argued that the credit crisis could be pushing some big apparel buyers to direct their orders to suppliers that they know well, to reduce risks of problems with fulfilment. “It may be that the retailers are focusing on those suppliers with whom they’ve had a longer and closer relationship,” he said. Panjiva’s data reinforce a picture of declining imports at the largest US retail container ports, where volumes are estimated to have fallen 8.5 per cent in November against last year. The monthly Port Tracker report produced for the NRF by IHS Global Insight said the decline marked the 16th straight month in which incoming container volume at leading US cargo ports had fallen.
Asian trade in 'free fall' as exports to West dry up
The economic downturn in Asia has taken a sharp turn for the worse as Japan slides into deep recession and exports contract in China, Korea, and Taiwan. A blizzard of grim data this week points to a full-blown trade slump across Asia, confirming fears that the region's strategy of export-led growth would backfire once the West buckled. Flemming Nielsen, from Danske Bank, said exports from Korea and Taiwan both shrank by over 20pc last month. "The numbers are terrible. Intra-Asian trade is in free-fall. Taiwan's exports to mainland China in November were down a whopping 42pc."
The Baltic Dry Index measuring freight rates for bulk goods began to collapse in June, dropping 96pc over the five months in the most dramatic fall in shipping fees ever recorded. It was a leading indicator of what we are now seeing in Asian trade. Fan Gang, a top adviser in Beijing, said China's exports would also show a decline when data is released this week. "Things are not good: industrial growth will be around 5pc and export growth will be negative," he said. Economic expansion of 5pc would be a major shock and entail recession in the Chinese context.
Japan's economy shrank 0.5pc in the third quarter and risks sliding back into deflation and perma-slump. Exports fell 7.7pc in October on crumbling demand for cars and machinery. Over 1,000 Japanese companies went bust last month as the high yen squeezed margins. Sony is laying off 16,000 staff. Japan's industrial output is expected to fall by a post-War record of 8.6pc in the fourth quarter. Tokyo is already planning "purchase vouchers" to kick-start spending in the world's second largest economy. A fresh stimulus package worth 20,000bn yen (£146bn) is being prepared for early next year. "We need policies to keep the economy from falling apart," said economics minister Kaoru Yosano. "Japan will endure hardship next year."
Zahra Ward-Murphy, from Dresdner Kleinwort, said Japan has slimmed down its bloated debt structure since its Lost Decade, but is still half-reformed and over-reliant on exports. "It has not rebalanced the economy towards internal growth: now exports are tanking," she said. Tokyo is once again running low on policy options. The Bank of Japan is wary of cutting rates below the current level of 0.3pc for fear of damaging the money markets, a key lubricant of the credit system. It may soon need to revert to emergency forms of monetary stimulus know as 'quantitative easing'. Earlier rescue plans have already pushed Japan's national debt to 170pc of GDP, the world's highest. Private savings have collapsed from 14pc of GDP in the early 1990s to 2pc today. Japan goes into this downturn without a cushion.
Foreign Direct Investment in China Fell 36.5% on Year
Foreign direct investment in China fell 36.5 percent in November from a year earlier as gains by the yuan stalled and the world’s fourth-biggest economy cooled. Investment was $5.3 billion, the commerce ministry said on its Web site today, the least in 14 months. The World Bank is forecasting China’s weakest growth in almost two decades next year after export demand and construction slumped. The central bank has stalled gains by the yuan against the dollar since mid-July and last month slashed interest rates by the most in 11 years.
"Foreign direct investment will continue to shrink slowly as lower interest rates and a weakening yuan squeeze yields for speculators and the outlook for China’s economy dims," said Lu Zhengwei, chief economist at Industrial Bank Co. in Shanghai. "Many factories that have closed along China’s coastal regions are foreign-invested." In the first 11 months, investment rose 26.3 percent to $86.4 billion, the commerce ministry said in the statement. The amount is already higher than last year’s record of $74.8 billion.
"We expect much slower foreign direct investment growth in 2009," Standard Chartered Bank Plc said in a report last month. "Companies were likely front-loading or exaggerating their investments in order to bring in funds and gain exposure to the yuan" in the first half of this year, the bank said.
World Bank Cuts East Asia Economic Growth Forecasts
East Asian economies will probably expand at the slowest pace in eight years in 2009 as easing export demand and declining investment and consumer spending portend "hard times" for the region, the World Bank said. East Asia, which excludes Japan and the Indian subcontinent, will expand 5.3 percent next year, slower than the 7.4 percent rate the World Bank predicted in April. Growth will probably be 7 percent this year, the Washington-based lender said its semi- annual report today. Fiscal stimulus and coordinated interest-rate cuts by governments and central banks around the world have failed to reverse a worldwide economic slump and the worst credit crunch in seven decades.
The World Bank yesterday lowered its global growth projections, and predicted international trade will shrink in 2009 for the first time in more than 25 years. "The contraction of output in the developed economies may well last longer and run deeper, delaying a recovery in growth in East Asia," the bank said. "In the near term, downside risks are substantial." The World Bank in April said inflation will pose a greater threat to the East Asia region than the global slowdown this year. As crude oil and commodity prices fall from record levels, and consumer price gains peaked, it is now pointing to a worsening economic outlook. "Prospects for weaker exports, together with a projected decline in capital inflows, will constrain investment spending," it said. "Private consumption is likely to be hit by more sluggish earnings, higher levels of unemployment, the reduction in household and corporate wealth, and an increased desire to save in uncertain times."
Asian governments and their counterparts around the world are spending hundreds of billions of dollars to protect their economies from the global financial crisis. Slowing inflation will allow the governments to boost growth through expansionary fiscal measures, the World Bank said. China last month announced a $582 billion economic stimulus plan, while South Korea unveiled a 14 trillion won ($9.7 billion) package of extra spending and corporate tax breaks, adding to almost $20 billion in income-tax reductions announced in September. "A number of countries in East Asia have some room to loosen policy, as fiscal positions have generally improved in recent years," it said. "To ensure fiscal stimulus packages achieve their objective of generating demand and jobs in the domestic economy, such packages will need to be well-targeted and temporary in duration."
The World Bank said developing East Asian economies will be more resilient during the slowdown compared with other emerging- market regions such as Latin America, which it projects will grow 2.1 percent next year. "East Asia is expected to do better than the other developing regions in the world" by growing 4 percent to 5 percent in the next year, Vikram Nehru, the World Bank’s chief economist for East Asia, said in an interview with Bloomberg Television on Dec. 8. "That’s not spectacular, but still reasonably good." East Asia probably contributed to a quarter of global growth this year, and that may rise to a third next year, the World Bank said. "The countries in the region will be better positioned to deal with the crisis to the extent that they are able to maintain macroeconomic stability, shift exports to faster growing regions in the world, substitute external with domestic demand, and continue with their structural reforms to strengthen competitiveness," the report said. The following table contains the World Bank’s revised growth estimates for 2008 and 2009:
China's exports, imports fall as economy hits wall
Chinese exports and imports unexpectedly fell in November from year-earlier levels, dramatically illustrating how abruptly the world's fourth-largest economy has slowed in response to the global credit crunch. The drop in exports was the largest since April 1999, while the decline in imports was the steepest since monthly records kept by bankers began in 1993. Other Asian export power houses, including South Korea and Taiwan, had already reported a drop in shipments last month as the shock to confidence that followed the collapse of Lehman Brothers in mid-September reverberated through the world economy. But the extent of the downturn in China was startling.
Economists had expected exports to rise 15 percent and imports to be up 12 percent compared with November 2007. But the data showed exports fell 2.2 percent from a year earlier and imports dropped by 17.9 percent. "Global demand for Chinese products is vanishing," said Gene Ma, an economist at China Economic Monitor, a Beijing consultancy. "Secondly, the credit freeze in importing countries has made it hard for Chinese exporters to sell abroad." Even though imports fell more sharply than exports, the trade surplus soared to an all-time high of $40.1 billion last month, eclipsing the previous record of $35.2 billion set in October, the customs administration reported. A plunge in the price of oil and other commodities cut China's import bill, but economists said the drop also reflected spreading weakness in home-grown demand as businesses and consumers battened down the hatches.
"It's just a start. Exports and imports will continue to fall in the coming months, probably until next June," said Zhang Shiyuan, an analyst with Southwest Securities in Beijing. The government has been unusually frank in acknowledging its worries that the economic downturn will cause unemployment to soar, jeopardising social stability. Export firms employ tens of millions of rural migrants. With factories closing by the thousands in southern China, many of these workers are heading home much earlier than usual for the Lunar New Year, which falls in late January. "With few policy options with which to revive exports, Chinese authorities are understandably focusing on measures to boost domestic demand and push forward with infrastructure initiatives, in an effort to absorb some of the migrant workforce," Jing Ulrich, head of China equities at J.P. Morgan, said in a note to clients.
The government launched a 4 trillion yuan ($586 billion) stimulus plan on Nov. 9 to boost infrastructure spending over the next two years and the central bank followed up on Nov. 26 by slashing interest rates by 1.08 percentage points -- four times its usual margin. A burning question among economists is whether Beijing will go one step further and engineer a drop in the value of the yuan to give exporters more of a competitive edge in global markets. The Chinese currency has risen sharply in value this year against a basket of currencies of its main trading partners. But the central bank raised eyebrows last week by allowing the yuan to weaken modestly against the U.S. dollar. Many economists cautioned against reading too much into the move, but others are not so sure.
"The government is likely to launch new policies soon to help the export sector, and that may include a change in exchange rate policy," said Zhu Jianfang, an economist with CITIC Securities in Beijing. In another sign that the economy has simply run into a wall, the statistics office reported earlier that wholesale price inflation collapsed to 2.0 percent in the year to November from October's reading of 6.6 percent. Economists polled by Reuters had expected a rate of 4.4 percent. The lowest forecast was 3.3 percent. "The situation is quite severe. We are slipping into a deflationary recession risk pretty fast," said Isaac Meng, an economist with BNP Paribas in Beijing.
Ilargi: First they vote to put Paulson beyond the law, and certainly above any meaningful criticism, and then they grandstand in a committee to criticize him. What a bunch of sad clowns. They don’t even know if they can block the 2nd $350 billion in TARP, but that doesn’t prevent the hot air from flowing.
Panel to Criticize Handling of Bailout
The panel overseeing the Treasury Department's $700 billion financial-rescue fund is expected to release a report Wednesday that is highly critical of the government's handling of the bailout, people familiar with the matter said. It will also press the Bush administration to act more aggressively to prevent foreclosures. The report isn't expected to contain any new findings but is expected to raise fresh questions about the program, which would further complicate the administration's deliberations over whether to ask Congress for the second half of the funds. The panel's top official, Harvard Law School professor Elizabeth Warren, is scheduled to describe her findings to the House Financial Services Committee today. Among other things, a draft of the report posed 10 questions to Treasury relating to the program's strategy, accountability and why it hasn't done more to help prevent foreclosures.
The roughly 30-page report is also expected to press Treasury to describe whether the money used to inject capital into the banking sector is a "giveaway" or a "fair deal," according to one person familiar with the report. Treasury Department officials had no comment on the forthcoming report, which they said they haven't seen. Republicans have complained that the panel has taken a partisan bent. One of the panel's four members, Rep. Jeb Hensarling (R., Texas), actually voted against issuing the report during a conference call Tuesday. Mr. Hensarling had problems with its "substance" and felt Republican views weren't adequately represented. "I have raised my concerns but thus far, perhaps due to the exigency of the circumstances, they have not yet been addressed," he said.
Another Republican on the panel, Sen. Judd Gregg of New Hampshire, stepped down shortly after being appointed, citing time constraints. Mr. Hensarling is scheduled to testify with Ms. Warren at the hearing, as is Treasury's Neel Kashkari, who is running the bailout program. Ms. Warren, who is noted for her long-standing push for tougher rules protecting consumers, is holding a field hearing next week in Nevada, where Senate Majority Leader Harry Reid (D., Nev.) is considering making remarks, people familiar with the matter said. The Treasury Department has faced a steady drumbeat of criticism about the way it has handled the first half of the $700 billion fund, which Congress authorized in October to help stabilize the financial system.
Congress could move to block Treasury's access to the remaining $350 billion portion of the fund, a prospect government officials fear could send financial markets reeling. House Financial Services Committee Chairman Barney Frank (D., Mass.), said Monday that Treasury would have to commit to using a large amount of the money to help prevent foreclosures in order to satisfy him. He said it would still be a tough sell with other lawmakers. "With most of my colleagues, they'll need police protection to even ask for the money," he said. Even though a growing number of lawmakers have criticized the program, it is unclear whether Congress could actually block the second $350 billion from being used. "I would see that being very difficult," Sen. John Ensign (R., Nev.) said of the prospect of Congress blocking the funds. "I would think they would come to us this week. That would be my guess. But who knows?"
Government officials initially sold the program to lawmakers and the public as a way of purchasing troubled assets from financial institutions. Treasury Secretary Henry Paulson quickly scrapped that plan and has instead decided to use most of the money to buy equity stakes in banks. The Congressional Oversight Panel's report is supposed to be the first of a series of monthly dispatches assessing the effectiveness of different parts of the program. Under federal law, the panel is supposed to report on Treasury's administration of the program, its impact on financial markets, its transparency and the "effectiveness of foreclosure mitigation efforts." The panel also looks at it "from the standpoint of minimizing long-term costs to the taxpayers and maximizing the benefits for taxpayers."
Ilargi: ‘T is the time of year for bad theater in Washington. And the New York Times plays cheerleader: "The former executives at Fannie Mae and Freddie Mac were questioned relentlessly on why they did not see the collapse in housing prices coming..." Oh, yeah, I’m sure they were. because this is the same Congress that is presently pushing Fan and Fred to purchase $40 billion in loans every single month. Luckily for the taxpayer, there won’t be that many to buy soon. But wait, maybe they can buy old and broken loans.
Ex-exec Faults Fannie and Freddie for ‘Orgy’ of Nonprime Loans
Fannie Mae and Freddie Mac engaged in "an orgy of junk mortgage development" that turned the two mortgage-finance giants into vast repositories of subprime and similarly risky loans, a former Fannie executive testified on Tuesday. The mortgage development, which began in 2005 and lasted until at least last year, happened as senior executives at the two government-sponsored enterprises ignored repeated warnings from internal risk officers that they were delving too deeply into dangerous territory, according to internal documents released at a Congressional hearing in Washington. The two companies have been taken over by the government.
The former executive, Edward J. Pinto, who was chief credit officer at Fannie Mae, told the House Oversight and Government Reform Committee that the mortgage giants now guarantee or hold 10.5 million nonprime loans worth $1.6 trillion — one in three of all subprime loans, and nearly two in three of all so-called Alt-A loans, often called "liar loans." Such loans now make up 34 percent of the total single-family mortgage portfolios at Fannie Mae and Freddie Mac, a level that will link them to eight million foreclosures, or one in six, in coming years, Mr. Pinto said. The nonprime loans "have turned the American dream of homeownership into the American nightmare of foreclosure," he said.
The hearing was the latest by Congress on the collapse of the two companies, which guarantee half of all mortgages nationwide and are the engine of the housing market. The former chief executives of Fannie Mae and Freddie Mac, Daniel H. Mudd and Richard F. Syron, and their predecessors, Franklin D. Raines and Leland C. Brendsel, faced pointed questioning from lawmakers. Referring to what he called "the total denial that’s going on here today and the refusal to answer simple questions," Representative Stephen F. Lynch, Democrat of Massachusetts, told the executives that "if you have accomplished anything here today, you have made conservatorship look very, very good."
But the testimony of Mr. Pinto, who was Fannie Mae’s chief credit officer in the late 1980s and who has studied the company’s financial statements, and other private analysts shed new light on the role of the housing giants in the subprime crisis. That role has not been fully recognized, in part because many subprime and Alt-A loans show up in databases as prime loans. Arnold Kling, an economist who once worked at Freddie Mac, testified that a high-risk loan could be "laundered," as he put it, by Wall Street and return to the banking system as a triple-A-rated security for sale to investors, obscuring its true risks. Charles W. Calomiris, a finance professor at Columbia, testified that nobody saw the crisis coming because the two mortgage giants "adopted accounting practices that masked their subprime and Alt-A lending," but he did not elaborate. The former executives at Fannie Mae and Freddie Mac were questioned relentlessly on why they did not see the collapse in housing prices coming and why they ignored warnings from their risk officers about stepping up purchases of nonprime loans.
Fannie Mae and Freddie Mac have long insisted that their involvement with subprime and other nonprime loans has been minimal. Asked about the increased purchases, Mr. Mudd insisted that "Alt-A loans were essentially a subset of overall A loans," and not subprime. But internal e-mail the committee obtained told a different story. A June 2005 presentation by Mr. Mudd described the crossroads faced by the company, which at the time was focused on prime loans amid an expanding subprime market. "We face two stark choices: one, stay the course; two, meet the market where the market is," he wrote. Another 2005 Fannie Mae document referred to "underground efforts to develop a subprime infrastructure and modeling for alternative markets." And in March 2006, Enrico Dallavecchia, Fannie Mae’s chief risk officer, wrote to Mr. Mudd to say, "Dan, I have a serious problem with the control process around subprime limits." Despite the concerns, Fannie Mae further increased its purchases of subprime loans, according to a January 2007 internal presentation.
Freddie Mac’s senior executives ignored similar warnings. Donald J. Bisenius, a senior vice president, wrote in April 2004 to a colleague that "we did no-doc lending before, took inordinate losses and generated significant fraud cases." "I’m not sure what makes us think we’re so much smarter this time around," he wrote. Housing analysts say that the former heads of Fannie Mae and Freddie Mac increased their nonprime business because they felt pressure from the government and advocacy groups to meet goals for affordable housing as well as pressure to compete with Wall Street. But Mr. Pinto said one in five Alt-A loans in recent years were made to investors, not to first-time home buyers. Another lever was what Representative Christopher Shays, Republican of Connecticut, said was more than $175 million in lobbying fees the companies spent over 10 years, in part to counter attempts at stronger oversight.
Low rates, high spending? It could just be a recipe for more economic woe
It's an unprecedented public spending spree fuelled by fears of another Great Depression. In Europe, countries are expected to give the green light to a European Commission plan calling for a fiscal stimulus package of €200-billion. China is earmarking 4 trillion yuan ($CAN735-billion). The incoming Obama administration intends to launch the biggest U.S. public works program in 50 years at a cost of at least $500-billion (U.S.), and possibly double that.
Egged on by Keynesian economists convinced that only massive government intervention can rescue the global economy from the abyss, policy makers are ignoring the few voices that have risen to oppose a strategy that they warn is fraught with risk. Public spending, they say, may not cure what ails individual economies and could saddle governments with far more headaches than they solve. Even countries such as Canada, which has run a relatively tight fiscal ship and steered clear of some of the more severe economic woes of its trading partners, faces pressure to join the spending binge. But vocal critics of the stimulus onslaught say Canada's reluctance to spend is sound.
"It all sounds really good, and politically it sells," said Peter Navarro, a professor of economics and public policy at the University of California at Irvine. "But there's a really good reason why fiscal stimuli have not been the preferred choice for stimulating economies over the last three decades," he said. The key problems: financing the vast expenditures, determining the right size of the stimulus, and getting the timing right so it actually works. If the spending hits the economy while it's recovering, it could spark another bubble and stoke inflation. If the costs soar to ridiculous heights, governments could face skyrocketing debt charges for a generation.
The projects that have the best chance of working are those that are cost effective and add a significant number of jobs while the recession is still in full swing, said Dale Orr, chief economist at IHS Global Insight Canada. Mr. Orr is completing a scorecard of the various Canadian spending and tax-cut options. He concludes the best bet is to simply move up small infrastructure projects that have already received the go-ahead and for which the financing has been allotted. Big projects of the kind planned by Mr. Obama will take too long to get off the drawing board and increase the risk of major mistakes.
"Accelerating small projects is by far the best," Mr. Orr said. "It's the only [option] that has no warts on it." There is also the question of timing. If the consensus is right, the Canadian economy could be out of recession by the end of the first or second quarter of next year and growing at a decent clip again by 2010. Although some forecasts are bleaker, many analysts think the U.S. economy will also be on the upswing by then and that lower gasoline prices will do far more than any government program to stimulate growth. "There is no chance that any fiscal stimulus in the budget of Jan. 27 is going to help Canada avoid a recession," Mr. Orr said. "And by the time anything is working, we'll be at least two-thirds of the way through the negative growth. The justification for fiscal stimulus will surely be finished." Nevertheless, as Prof. Navarro acknowledges, "the mainstream Keynesians have all jumped on board."
Indeed, the only point of difference between such prominent economists as Lawrence Summers, a key adviser to U.S. president-elect Barack Obama and Nobel laureates Joseph Stiglitz and Paul Krugman is how many billions should be committed right away. Prof. Krugman dismisses concerns that public spending takes too long to provide the needed boost to demand that will get an ailing economy rolling again. "It's very hard to see any quick economic recovery," he writes in an updated version of his book, The Return of Depression Economics. Indeed, Prof. Krugman predicts the global economy could be stuck in a prolonged Japanese-style slump for years without strong measures.
Even The Economist magazine, long a bastion of conservatism, recently editorialized that "bold, unorthodox remedies are needed to jolt the world economy back to life." Its solution for those countries that can manage it: massive fiscal stimulus. Yet that is precisely what Japan sought to do in the 1990s. The government brought in no less than nine fiscal stimulus packages at a total cost of ¥130-trillion ($1.78-trillion Canadian at today's exchange rate). "In light of the fact that during the 1990s the economy never recovered sustainable growth, the consensus view is that expansionary fiscal policies were by and large failures," University of Tokyo economics professor Hiroshi Yoshikawa writes in his book Japan's Lost Decade.
Yet after new figures Tuesday showing the Japanese economy is sinking faster than expected, the government has come under renewed pressure to add to the stimulus package it announced in September. Instead of cutting income taxes, Tokyo will hand out ¥2-trillion to households in cash. But critics say people may simply save the money. That's precisely why most economists say tax cuts will not work this time around. They point to the Bush tax cuts, which did little to stimulate growth because only about 20 cents of every dollar went toward consumption.
"It's just a dumb thing to do," Prof. Navarro said of further tax cuts. "The problem is that all people tend to do is either put the money under their mattress because they're freaked out about the economy or pay off their debt." Some economists support at least temporary cuts in sales taxes, because these would affect consumption directly. That's not an option in the United States, though, where several financially battered states are considering hiking sales taxes. There, Mr. Obama is placing all his bets on massive spending.
"Obama's a poker player," Prof. Navarro said. "Here we've got a new president coming in who is basically going to bet the entire administration on a fiscal stimulus hand that is at best two jacks." "
Nortel Seeks Legal Advice on Exploring Bankruptcy
Nortel Networks Corp. has sought legal counsel to explore bankruptcy-court protection from creditors in the event that its restructuring plan fails, according to people familiar with the situation. The move comes as the Toronto-based company grapples with plummeting sales for its wireless gear and as the credit crunch hobbles the sale of key assets. Ronald Alepian, a spokesman for Nortel, said that "no bankruptcy filing is imminent," but added that the company has engaged several advisers to help it chart a way forward. "We remain focused on carrying out the restructuring we outlined on Nov. 10 to cut costs," he said. Mr. Alepian said Standard & Poor's in November reaffirmed Nortel's ratings, saying the company "should be able to sustain adequate levels of liquidity in the next 12-18 months" despite difficult market conditions.
Nortel also has been exploring potential assistance from the Canadian government, according to a person familiar with the matter. But the disarray within the government is clouding those prospects. Last week, Prime Minister Stephen Harper shut down Parliament until late January to avoid attempts by opposition legislators to topple his Conservative government. The telecommunications-equipment maker was once Canada's largest company. Nortel's market value topped $250 billion in 2000 amid the telecom boom, but has since shriveled to $275 million. The company's stock has been trading below the $1 minimum on the New York Stock Exchange for a month. Chief Executive Mike Zafirovski joined Nortel three years ago after helping to revive the cellphone division of Motorola Inc. He swelled profits from selling Nortel's voice-only wireless equipment to U.S. carriers and used the money to fund new businesses. But a sudden drop in contracts by U.S. carriers, themselves seeking to rein in spending, choked off the company's cash engine. Nortel burned through $478 million in cash during the first nine months of this year, as sales of the company's CDMA technology atrophied.
In September, Mr. Zafirovski decided Nortel should sell assets to cut expenses and raise cash. On Sept. 17, the company said it would sell an unprofitable new business called Metro Ethernet, which makes gear to transmit Internet and video feeds. Until the announcement, many Wall Street analysts believed that Nortel still had time: It had an estimated $2.6 billion in cash and no payment on its $4.5 billion in debt until July 2011. But $500 million of Nortel's cash was tied up in overseas joint ventures and it needed $1 billion cash for daily working capital. Nearly a dozen companies and investment firms looked at the Metro Ethernet business, according to people familiar with the matter, and bankers encouraged suitors to consider buying the entire company. But no deal to sell the business has emerged because of a lack of "buyers at the right price," said a person familiar with the situation.
In hopes of finding better prices, Nortel recently began using J.P. Morgan Chase & Co. as well as Credit Suisse Group AG as investment bankers. Suitors for all of Nortel have been waiting on the sidelines, betting that its assets can be picked up without at least $6 billion in liabilities if the company seeks protection from creditors.
Uncertainty surrounding Nortel's finances has limited its ability to find new business, as its customers seek safety in contracts with better-financed rivals. The company won a bid to be the official telecom network provider for the 2010 Winter Olympics in Vancouver and 2012 Summer Games in London.
A tight Christmas
The government may be focused on jobs, banks and mortgages in its bid to halt the downward economic spiral, but charities dealing with the frontline fallout are bracing themselves for a tough Christmas - with many anticipating soaring demand for services such as homelessness support. Research earlier in the year by the Charity Commission and the Association of Chief Executives of Voluntary Organisations (Acevo) showed that up to three-quarters of voluntary organisations had seen demand for services rise, and provided an early portent of difficult times ahead. However, charities covering areas that traditionally see a spike in demand during the holiday season - such as drugs and alcohol addiction groups, domestic violence organisations and homelessness support - are feeling a renewed squeeze, and many believe that worse is to come.
Homelessness charities, accustomed to handling peaks in seasonal demand, are likely to face much worse problems, according to Leslie Morphy, chief executive of the charity Crisis. "We are seeing increased demand for some services already, but I really think going in to 2009 things will get particularly grim," she says. According to Morphy, the wider housing market crisis is hitting private tenants hard, forcing large numbers of single people in particular out of their homes. "We have seen a doubling of repossessions among buy-to-let landlords and a 49% rise in the number of buy-to-let mortgages in arrears in the three months to September," Morphy says. "In the event of their landlord being repossessed, private tenants can be thrown on to the streets without warning and literally left with nowhere to go."
The charity Homeless Link has surveyed its member organisations, which work with homeless people around the country, and a number of strains on services are emerging, according to its report published this week. One-third (34%) of the groups it canvassed have been affected "significantly or very significantly" by the fallout from the credit crisis, it concludes, while 31% report direct increases in demand for services. The survey found that day centres for the homeless are particularly strained. There is also evidence, according to both Homeless Link and Crisis, of threats to fundraising as donors tighten their belts. Crisis reports that while individual donors have been "particularly loyal", despite the wider financial crisis, there is evidence of corporate donors holding back. "At the moment, individual giving is holding up," a Crisis spokesman says. "Corporate giving, though, has been reduced." The charity's annual Christmas Card Challenge is a prime example, with donations down from £1m in 2007 to £645,000 this year.
Financial concerns are a key trigger for family breakdown in the run-up to Christmas every year, but organisations such as Relate, which supports families under stress, and Women's Aid, which helps victims of domestic violence, are concerned that the severity of the current crisis will place unprecedented strain on already stretched services. A spokeswoman for Relate says demand for its support line, Relate Response, has seen a rise in demand of 20% year-on-year. "There is no doubt that financial difficulties and job losses impact on families and relationships," she says. Further demands on the service, she adds, could come from "higher earners who may have lost jobs with the meltdown in the City". At the extreme end of relationship breakdown, Christmas is a notoriously difficult time, but widespread increases in financial hardship this year are likely to cause additional problems, suggests Teresa Parker, of Women's Aid. Financial concerns can directly exacerbate domestic violence, she says, and concludes that "there may therefore be increased pressures on support services as more victims seek help".
Another area predicted to see increasingly tough times is addiction services. The drugs and alcohol charity Addaction says government cuts in budgets for drug treatment will have a long-term impact, with the tougher spending round this year already slashing budgets by 10%. Extra demand on charitable trusts for funding is likely to mean overstretched services competing for a depleting pot of money. A spokesman for the charity says the recession may lead to a rise in white-collar workers with addiction problems coming forward, which could mean increased workloads for case workers. He says: "We also expect to see a rise in crimes such as burglary, so we may see more people coming through the criminal justice system."
Large organisations such as the social care charity Turning Point anticipate "new groups" of people asking for assistance, according to its chief executive, Lord Adebowale. He says that when it comes to organisations being able to deliver effective services in a climate of growing demand, government commitment to preventive services and ongoing support will be key. "Compared to other recessions in the past, we already have a political will to make connecting people's care work," he says. Government plans to tackle depression and anxiety, which he says is bound to increase in a recession, will be central to "stop people falling into crisis".
Charities say they are doing their best to manage any increase in demand for services, particularly if coupled with declining revenues. Citizens Advice, which saw a 52% rise in inquiries relating to redundancy between April and September this year, was given extra cash by the Treasury last month to keep offices open for longer in the run-up to Christmas, but other groups cannot expect similar help. If, as predicted, the recession turns out to be deep and prolonged, what happens as this year ends may just be the beginning of a more enduring crisis for the sector.
De Beers to cut gem output as credit crisis hits demand
De Beers, seller of four in ten of the world’s rough diamonds, plans to reduce output at its mines because the global credit freeze has damped demand from jewelers. The closely held company’s customers, who cut and polish gems before reselling them, are lowering inventories at the request of their lenders, De Beers executive director Stephen Lussier said in an interview in New York. Lussier said the size of De Beers’ production cuts has not been decided. While demand next year will be lower than in 2008, it is not expected to drop to “crisis” levels seen in other industries, he said. “It’s not a price issue, it’s a volume and liquidity challenge,” Lussier said. “Clients who buy rough are squeezed by the banks. They have a lot of debt.”
The Johannesburg-based company’s customers, who use loans to buy their stock of rough stones, have been hit by the global recession and a credit-freeze. Production from De Beers’ biggest open-pit mines in South Africa and Botswana, which had been running at full capacity, will be reduced until diamond demand recovers, he said. Lussier’s own discussions with the industry’s bankers indicate that they will stand by clients in the diamond-cutting and polishing business provided they reduce their inventories and don’t buy gems for speculative purposes, he said. Still, the total amount of credit available to that industry may decline, he said. “There will be a big focus on inventory reduction in the first half,” Lussier said. “We’ll gear production to the level of demand from our clients.”
The company’s own debt is “manageable,” provided costs come down, Lussier said. Exploration spending will be reduced in 2009 as work draws to an end on some of the company’s exploration concessions in the Democratic Republic of Congo. De Beers had net interest-bearing debt of $4 billion at the end of last year. De Beers sales last year slipped 3.7 percent to $5.9 billion as the company bought fewer stones for resale from Russia’s ZAO Alrosa. Anglo American Plc. owns 45 percent of De Beers, the Oppenheimer family owns 40 percent and the rest is held by the Botswana government.
The company’s mines had been producing around the clock to cope with higher demand, Lussier said. Some of those shifts will be reduced now, and more time will be spent on maintenance and stripping waste to expose diamond-bearing ore that can be mined later, he said. If staff cuts are needed, the company will discuss them with labor unions in affected areas to decide whether to eliminate jobs or give miners’ fewer shifts, he said. Production levels will be set once sales figures from Christmas and the Chinese New Year in January have been reported, he said. Retail-sales volumes of diamonds during the Thanksgiving holiday weekend in the US were “similar” to last year, Lussier said. While the rough-diamond market is “challenged” and some polished diamonds were sold at discounted levels, prices for finished stones remain higher than a year ago, he said.
Because diamonds are bought primarily to mark special occasions, like engagements, weddings and anniversaries, demand is less elastic than for many other luxury goods, he said. In Asia, De Beers sees a trend of consumers purchasing assets that increase in value, which will benefit diamonds because of their scarcity, he said. De Beers forecasts the world’s diamond production remaining at around current levels until about 2017 before volumes decline by about 20 percent, he said. As output drops, the company will further expand its worldwide network of retail stores, which is currently at 45 outlets, from 37 in the first half of 2008, Lussier said. No new shops will be added this year in the US, the world’s largest diamond-jewelry market, he said. Stores will be opened in China, the Middle East and possibly Singapore and Malaysia.
Russians trudge ahead as economy tanks once again
As financial turmoil spreads and storm clouds gather over the entire world, many middle-aged Russians are feeling a familiar chill. Unlike most Americans, any Russian over 40 has vivid memories of two previous national economic crashes that brought personal ruin to millions of people. Recent conversations with Russians offer glimpses of a middle class that's worried, but not yet afraid. They say their past brushes with disaster put iron into their souls and changed their values. "I think I can overcome anything; I've already been through every stage of hell," says Mikhail Sadskykh, a successful Moscow massage therapist who, like many of his compatriots, has been through three different professions in as many decades. "I'm not going to be stressed anymore over anything. I've changed. The most important thing for me now is my family, who stood by me through the hardest times. We'll get through whatever may be coming."
As the US was pulling out of a mild recession in the early '90s, post-Soviet Russia was plunging into a decade-long depression that saw the country's gross domestic product slump by over half. It began in 1992 with a hurricane of hyperinflation – in the course of a year 1,000 rubles went from paying for a two-week vacation on the Black Sea to barely covering the cost of a candy bar. The aftermath of the breakup of the USSR also brought widespread industrial closures, and a nearly total collapse of the social safety net. As Russia's fledgling middle class was just starting to find its feet, the financial system crashed in 1998, vaporizing the savings of millions – including Sadskykh – and sent the ruble into another free-fall.
A decade on, most Russians have recovered from the crisis of '98. They've acquired new careers, purchased cars, and built family homes. Some experts have even suggested that the first stable Western-style middle class in all of Russian history has arrived. Despite stringent official media filters on economic news, many people say they are now noticing signs of downturn, including a freeze in urban construction, tightening credit, widespread layoffs, and a steady slide in the value of the ruble. Economists say Russia is indeed slowing – oil prices are in the basement and nearly $200 billion in foreign investment has left the country following the recent war with Georgia. This week, for the first time since the 1998 crisis, Russia's long-term debt rating was lowered. For Russians, it's all more of the same.
"As a society, Russians have been traumatized repeatedly," says Martin Gilman, a former Russia-based official of the International Monetary Fund who now teaches at Moscow's Higher School of Economics. "There's a psychological component here, unlike with most people in the West, which has inured them to what's happening now. But there certainly is a lot of confusion out there." Sadskykh, a sturdily built construction worker with steel-blue eyes, was among the first Russians to start a private business when former Soviet leader Mikhail Gorbachev created the possibility in the late '80s. At the time of the USSR's collapse he had 30 employees in his small firm, which produced cinder blocks and was expanding rapidly. As the economy suddenly contracted and orders for cinder blocks plunged, he desperately borrowed large sums of money – in dollars, because the ruble had become worthless.
"In 1993 we finally went bankrupt, and I lost everything," he says. "It wasn't just me. Everyone around was going under; those were awfully hard times for most people. A few people managed to get rich, but not many of them were honest workers, if you know what I mean. I found myself owing a lot of money to people like that, with no way of paying it back." Sadskykh gradually pulled himself out of that hole. By the mid-'90s, he had a small shop in his native Volga city of Yelabuga, selling mainly foodstuffs and alcoholic drinks. "You could always sell vodka," he recalls. He had managed to buy a small flat and was paying down his debts when the 1998 crisis struck. "In a few days, my income in rubles became nothing, while my dollar debts ballooned," he says. "I closed down and went into hiding from my creditors. It all happened again: I'd been well off one day, a pauper the next."
The 1998 financial collapse derailed Maria Strizhevskaya's middle-class dream in a few dreadful days. Fresh out of university, she had gone to work as a marketing expert for the giant oil company Yukos, and thought she'd found her life's work. But the crisis hit, she lost her job as the company downsized, and her entire savings, around $1,000, evaporated along with the private bank she'd kept them in. Ms. Strizhevskaya has since built a new career as a successful freelance journalist, but she knows it's precarious. "Lots of people I know are losing their jobs, and it's all the people in middle-class professions, like publicity, insurance, and consulting," she says. "I'm very concerned, but I think as long as I'm healthy, I'll find what to do. You have to go forward."
Roza Primbretova, an energetic woman with a perpetual smile, was educated as an engineer but went to work in late Soviet times for the Ministry of the Interior, which oversees the police. Thanks to her official job, she escaped the worst effects of the first crisis, but left the police force, with the rank of major, just as the 1998 crash was hitting. "I'd had very high hopes that, with my education and experience, I'd land a great job [in the private sector]," she recalls. Instead, as the economy tanked, she wound up living with her sister in a crowded flat and taking on a series of menial jobs, including cleaner, dog-sitter, and vegetable packer in an agricultural depot. She became active in her church, a small Protestant group in Moscow, and says that gave her strength as she continued searching for a career. "One day my pastor said to me, 'Roza, if you don't know what to do, why don't you do what you like?' " she remembers. "Well, what I like to do is travel, though I never had any money for it."
About eight years ago, Ms. Primbretova went to work for a Moscow travel agency, booking tours for up-and-coming middle-class Russians to exotic destinations, like Thailand, Egypt, and Spain. "Because we lived behind closed borders in the Soviet Union for so long, Russians have this huge hunger to see the outside world," she says. "As life began improving in recent years for average Russians, one of the first things people wanted to spend cash on was travel." Last year, having saved up money and won many loyal customers, she started her own travel agency with a prestigious office in downtown Moscow. "Things were going very well, and we had a good summer this year," she says. "But it's suddenly fallen off, people just aren't booking all of a sudden. A lot of tour operators are on the brink of bankruptcy." But she adds: "I think the real crisis is in our heads. We just have to grow. I have faith that things will get better."
Life has also taken many twists since the last crisis for Sadskykh. Nearly a decade ago, he sold his flat, sent his family to live with relatives in the countryside, and set out to pay off his debts. He worked as a construction boss and a cleaner of oil storage tanks, and a couple years ago came to Moscow where he found work in a fitness club teaching a type of Tibetan yoga that he'd learned from books. He's been so successful that he's set up his own business teaching yoga, and has reunited with his family. "Finally I've been able to pull my head above the water; I feel well now," he says. But a shock-free life would have been preferable, he adds. "If only the country had been calm, and I'd been able to work normally since 1991, and build my business, that would have been the best," he says. "I'll bet I'd be a millionaire by now."
Where did all the money disappear? – Liquid Fantasies
by Satyajit Das
In recent years, money was cheap and other assets were expensive. As each of the global economy’s credit creation engines breaks down and systemic leverage reduces, money becomes scarce and expensive triggering adjustments in asset prices in a reversal of this process. In the current financial crisis, the quantum of available capital, the munificent resources of central banks and sovereign wealth funds and the globalisation of capital flows may be some of the accepted "facts" that are revealed to be grand illusions. As Mark Twain once advised: "Don't part with your illusions. When they are gone you may still exist, but you have ceased to live".
In recent years, there has been speculation about the amount of capital or liquidity available for investment globally. The substantial reserves of central banks and, their acolytes, sovereign wealth funds were frequently cited in support of the case for a large pool of "unleveraged" liquidity, that is "real" money. In reality, the available pool of money may be more modest than assumed. For example, China has close to $2 trillion in foreign exchange reserves. The reserves arise from dollars received from exports and foreign investment into China that are exchanged into Renminbi. The central bank generates Renminbi by printing money or borrowing through issuing bonds in the domestic market. On China’s "balance sheet", the reserves are essentially "leveraged" using domestic "liabilities".
In order to avoid increases in the value of the Renminbi that would affect the competitive position of its exporters, China undertakes "currency sterilisation" operations where it issues bonds to mop up the excess liquidity. China incurs costs – effectively a subsidy to its exporters - of around $60 billion per annum (the difference between the rate it pays on its Renminbi debt and the investment income on it reserves). The dollars acquired are invested in foreign currency assets, around 60% in dollar denominated US Treasury bonds, GSE paper (such as Freddie and Fannie Mae debt) and other high quality securities. China is exposed to price changes in these investments and currency risk because of the mismatch between foreign currency assets funded with local currency debt.
Deterioration in the US economy and the need to issue additional debt to support the financial sector may place increasing pressure on the US sovereign rating and the dollar. US Government support for financial institutions is already approaching 6% of GDP compared to less than 4% for the Savings and Loans crisis. Deterioration in the credit quality of the United States results in losses on investment through falls in the market value of the debt and a weaker dollar. The credit default swap ("CDS") market for sovereign debt is increasingly pricing in increased funding costs for the US. The fee for hedging against losses on $10 million of Treasuries was about 0.58% pa for 10 years (equivalent to $58,000 annually) in December 2008. This is an increase from 0.01% pa ($1,000) in 2007 and 0.40% pa ($40,000) in October 2008. It is also not easy to tap this liquidity pool. Given the size of the portfolios, it is difficult for large investors like China to rapidly mobilise a large portion of these funds by liquidating their investments and converting them into the home currency without substantial losses. This means that this money may not, in reality, be available, at least at short notice.
If the dollar assets lose value or cannot be accessed then China must still service its liabilities. It can print money but will suffer the economic consequences including inflation and higher funding costs. The position of emerging market sovereign investors with large portfolios of dollar assets is similar to that of a bank or leveraged hedge fund with poor quality assets. China’s Premier Wen Jiabao recently expressed concern: "If anything goes wrong in the U.S. financial sector, we are anxious about the safety and security of Chinese capital…" In December 2008, Wang Qishan, a Chinese vice-premier, noted: "We hope the US side will take the necessary measures to stabilise the economy and financial markets as well as guarantee the safety of China’s assets and investments in the US."
There are other factors affecting the availability of the reserves at central banks and sovereign wealth funds. In recent years, sovereign wealth funds have also suffered losses on some of their investments, most notably in US and European financial institutions. Some central banks have been forced to utilise some of the reserves to support the domestic economy and banking system. For example, South Korea has used a portion of its reserves to provide dollars to banks unable to re-finance short-term dollar borrowings in international money markets. Russia has similarly used a significant portion of its reserves to support financial institutions and also its domestic markets. Russia’s reserves, which rank third after China’s and Japan’s reserves in size, have fallen $122.7 billion, or 21 percent, since August 2008. The reserves, including oil funds that exclusively act as a safety cushion for the budget, stood at $475.4 billion on November 2008.
The substantial build-up of foreign reserves in central banks of emerging markets and developing countries, as identified by David Roche (see David Roche and Bob McKee (2007) New Monetarism; Independent Strategy Publications), is really a liquidity creation scheme that relies on the dollar's favoured position in trade and as a reserve currency. Many global currencies are pegged to the dollar at an artificially low rate, like the Chinese Renminbi to maintain export competitiveness. This creates an outflow of dollars (via the trade deficit that is driven by excess US demand for imports based on an overvalued dollar). Foreign central bankers are forced to purchase US debt with dollars to mitigate upward pressure on their domestic currency. Large, liquid markets in dollars and dollar investments capable of accommodating the very large investment requirements and the historically unimpeachable credit quality of the US sovereign assets facilitated the process. The recycled dollars flow back to the US to finance the spending.
This merry-go-round is a significant source of liquidity creation in financial markets. It also kept US interest rates and cost of capital low, encouraging further borrowing to finance consumption and imports to keep the cycle going. This process increased the velocity of money and exaggerated the level of global liquidity. The large build-up in reserves in oil exporters from higher oil prices and higher demand from strong world growth was also re-cycled into US dollar debt. The entire process was reminiscent of the "petro-dollar" recycling of the 1970s. The central banks holding reserves were lending the funds used to purchase goods from the country. In effect, the exporter never got paid at least until the loan to the buyer (the vendor finance) was paid off. As the debt crisis intensifies and global growth diminishes with increased defaults, it is increasingly likely that this debt will not be paid back in it entirety. This liquidity circulation process supported, in part, the growth in global trade. This too may have been an illusion as the underlying process is a gigantic vendor financing scheme.
An accepted article of economic faith is that failure of economic co-operation and resurgent nationalism in the form of trade protectionism (for example, the Smoot-Hawley Act) contributed to the global financial crisis of the 1930s. The stock market crash of 1929 and the subsequent banking crisis caused a collapse in financing and global demand resulting in a sharp of the US trade surplus. Smoot-Hawley was passed in 1930 to deal with the problem of over-capacity in the U.S. economy through higher tariffs designed to increase domestic firms’ market share. The higher US tariffs led to retaliation from trading partners affecting global trade. The slowdown in central bank reserve re-circulation affects global trade through the decrease in the availability of financing for purchasers to buy goods and services. This is apparent in the sharp slowdown in consumer consumption in the US, UK and other economies. The availability of cheap finance also helped drive up the prices which, in turn, allowed excessive borrowing against the inflated value of these assets that fuelled consumption.
Weakness in the global banking system (in particular, loan losses, the lack of capital and concerns about counterparty risk between large financial institutions) contributes to restricted availability of trade letters of credit, guarantees and trade finance generally. This exacerbates the problem. The restrictions, in turn, further impact on the level of trade flows and capital re-circulation resulting in a further decrease in trade activity that in turn further slows down international credit creation. It is not easy to fix the problem. Redirection of capital held in central banks and sovereign wealth funds to domestic economies affects the global capital flows needed to finance the debtor countries, such as the US and re-capitalise the banking system. Maintenance of the cross border capital flows to finance the debtor countries budget and trade deficits slows down growth in emerging countries and also perpetuates the imbalances.
Trade has become subordinate to and the handmaiden of capital flows. As capital flows slow down, global trade follows. Indirectly, the contraction of cross border capital flows and credit acts as a barrier to trade. In each case, de-leveraging is the end result. This opens the way to "capital protectionism". Foreign investors may change their focus and reduce their willingness to finance the US. Wen Jiabao, the Chinese Prime Minister, indicated that China’s "greatest contribution to the world" would be to keep it’s own economy running smoothly. This may signal a shift whereby China uses its savings to invest in the domestic economy rather than to finance US needs. China and other emerging countries with large reserves were motivated to build surpluses in response to the Asian crisis of 1997-98. Reserves were seen as protection against the destabilising volatility of short term capital flows. The strategy has proved to be flawed.
It promoted a global economy based on "vendor financing" by the exporting nations. The strategy also exposed the emerging countries to the currency and credit risk of the investments made with the reserves. Significant shifts in economic strategy are likely. Zhou Xiaochuan, governor of the Chinese central bank, commented: "Over-consumption and a high reliance on credit is the cause of the US financial crisis. As the largest and most important economy in the world, the US should take the initiative to adjust its policies, raise its savings ratio appropriately and reduce its trade and fiscal deficits." More ominously Chinese President Hu Jintao recently noted: "From a long-term perspective, it is necessary to change those models of economic growth that are not sustainable and to address the underlying problems in member economies."
There is also the risk of "traditional" trade protectionism. The end of the current liquidity cycle, like the one in the 1930s, may cause a sharp fall in exports. Exporting countries, seeking to maintain domestic growth may try to boost exports by devaluation of the currency or subsidies. Import tariffs are less effective unless there is a large domestic market. Recently the governor of the Chinese central bank, Zhou Xiaochuan, did not rule out China depreciating its currency.
The change in these credit engines also distorts currency values and the patterns of global trade and capital flows. The current strength in the dollar particularly against the Euro reflects repatriation of capital by investors and the shortage of dollars from the slowdown in the dollar liquidity re-circulation process. It is also driven by the reliance on short-term dollar financing of some banks and countries and the need for re-financing. This is evident in the persistence of high inter-bank dollar rates and dollar strength. The strength of the dollar is unhelpful in facilitating the required adjustment in the current account and also financing of the US budget deficit. The slowdown in the credit and liquidity processes outlined may have long-term effects on global trade flows. As Mark Twain also observed: "History not repeat but it rhymes."
Gillian Tett of the Financial Times coined the phrase (see "Should Atlas still shrug?" (15 January 2007) Financial Times) "candy floss money". New financial technology spun available "real" money into an exaggerated bubble that, like its fairground equivalent, collapses ultimately.
The global liquidity process was multi-faceted. There was traditional domestic credit creation system built on the fractional reserve system that underpins banking. The leverage in the system was pushed to extreme levels. Losses and renewed regulation are forcing this system of credit creation to shut down. The foreign exchange reserve system was another part of the global credit process. Dollar liquidity re-circulation has also slowed as a result of reduced trade flows (driven by falls in US consumption and imports), losses on dollar investments, domestic claims on reserves and the inability to readily mobilise large amount of reserves.
Another credit process - the export of Yen savings via the Yen carry trade and acquisition of foreign assets by Japanese investors) - has also slowed. The focus of the November 2008 G-20 meeting was firmly on financial sector reform. Stabilisation of global capital flows in the short term and addressing global imbalances over the medium to long term barely merited a mention. It may well come to be seen in coming weeks and months as a major missed opportunity to address these issues. Markets placed great faith in the volume of money available to support asset prices and assist in alleviating shortages of liquidity. The perceived abundance of liquidity was, in reality, merely an illusion created by high levels of debt and leverage as well as the structure of global capital flows. As the financial system de-leverages, it is becoming clear, unsurprisingly, that available capital is more limited than previously estimated.
As Sigmund Freud once observed: "Illusions commend themselves to us because they save us pain and allow us to enjoy pleasure instead. We must therefore accept it without complaint when they sometimes collide with a bit of reality against which they are dashed to pieces." There is an apocryphal story about a disgraced rock star who ended up in bankruptcy court. When asked what happened to his fortune of several million dollars, he responded: "Some went in drugs and alcohol, I gambled some of it away, some went on women and the rest I probably wasted!" Financial markets have "wasted" a staggering amount of money that ironically probably did not exist in the first place.
Bernanke-Greenspan’s Fed Failed Economy, Created Bubbles: Books
Ben Bernanke and Henry Paulson are flinging more than $8.5 trillion from their helicopters to rescue the economy. As dollar bills fall from the skies, this might be a good time to ask how we got into this mess in the first place and how we might prevent a future crisis. George Cooper offers a cogent answer in "The Origin of Financial Crises: Central Banks, Credit Bubbles and the Efficient Market Fallacy." Cooper, a veteran central-bank watcher and fixed-income analyst, is a principal of Alignment Investors, a unit of London hedge fund BlueCrest Capital Management Ltd. His argument is disarmingly easy to grasp.
The U.S. Federal Reserve and other central banks follow one economic theory during an expansion and another during a contraction, he says. When things are bubbling along, they are Friedmanites who leave the market to do its thing. When they get one whiff of a slowdown, though, they turn Keynesian, rushing to stimulate the economy with rate cuts. "As a rule we favor capitalism in an expansion and socialism in a contraction," Cooper observes. The upshot of this asymmetric response: Excess credit builds up, cycle after cycle, inflating asset prices into ever bigger bubbles that must, inevitably, burst. Cooper’s solution: Oblige central banks to prick bubbles early and often, before they morph into the kind of crisis now ravaging the global economy.
He’s hardly alone in arguing that central banks should take away the punchbowl just as the party gets going, as former Fed governor William McChesney Martin said. What sets Cooper apart is his succinct examination of why the Fed is happy to stimulate a sagging economy and unwilling to throw a giddy one into detox. His answer has more to do with flawed philosophy than with the foibles of Alan Greenspan. When the economy is growing and markets are rising, central banks hew to the Efficient Market Hypothesis, which posits that assets are "always and everywhere at the correct price," as he says. Yet when the economy contracts and markets drop, they revert to the pump-priming strategies of John Maynard Keynes. "Had Isaac Newton subjected himself to these same standards," writes Cooper, "he would have given us three laws of gravity: one telling us how an apple behaves when thrown up into the air; another quite different law telling us how it then falls back to earth; and a third law telling us the apple never moves at all."
The dangers in this muddled thinking should be clear as the U.S. struggles to avert its worst recession since World War II and the Fed’s interest-rate target approaches zero. As debt swells, it gets "progressively more difficult for the stimulus policies to offset future downturns," he says. Some data points tell the story: Total U.S. credit-market debt stood at $51 trillion at the end of the second quarter, making the ratio of debt to gross domestic product 357 percent. In 1929, of all years, debt was 185 percent of GDP, as Grant’s Interest Rate Observer noted the other day. Though Cooper knows his book will be read as a critique of the Fed, he says it’s wrong to blame "any one institution, much less any one individual." He has a point. Japanese monetary policy, after all, made the same blunder, turning a 1980s borrowing binge into 13 years of zero or near-zero rates. What’s a central banker to do? Start by re-reading Keynes’s 1936 classic, "The General Theory of Employment, Interest and Money," which in Cooper’s view refuted the idea of efficient markets and proposed stimulus as a cure for depression.
"Today Keynesian stimulus is used not to exit depression but rather to avoid going into recessions," he says. This "bastardizes" Keynes’s insight, he adds, and deprives borrowers of "the opportunity to learn that their excessive borrowing was indeed excessive." Central banks should also deliver occasional shocks to the system by suddenly withdrawing liquidity. Such "fire drills" would test the economy’s resilience and the sustainability of an expansion. First, though, we must tackle the current crisis, which leaves us with only one immediate alternative, Cooper says: Use the printing press to pay off outstanding debt. "Unleash the Inflation Monster," he says. This strategy is unpalatable and gives borrowers a "get- out-of-jail-free card, paid for at the expense of savers," he says. Yet it’s preferable in his view to the alternatives, including Andrew Mellon’s proposal to "purge the rottenness" from the system by letting credit contract and assets deflate. I suppose Cooper is right, though I’ll take purgation over hyperinflation any day.
Ilargi: Look, when Sharon Astyk of all people tells me to read a car review, I do. Simple as that.
Vauxhall Insignia 2.8 V6 - An adequate way to drive to hell
I was in Dublin last weekend, and had a very real sense I’d been invited to the last days of the Roman empire. As far as I could work out, everyone had a Rolls-Royce Phantom and a coat made from something that’s now extinct. And then there were the women. Wow. Not that long ago every girl on the Emerald Isle had a face the colour of straw and orange hair. Now it’s the other way around. Everyone appeared to be drunk on naked hedonism. I’ve never seen so much jus being drizzled onto so many improbable things, none of which was potted herring. It was like Barcelona but with beer. And as I careered from bar to bar all I could think was: “Jesus. Can’t they see what’s coming?” Ireland is tiny. Its population is smaller than New Zealand’s, so how could the Irish ever have generated the cash for so many trips to the hairdressers, so many lobsters and so many Rollers? And how, now, as they become the first country in Europe to go officially into recession, can they not see the financial meteorite coming? Why are they not all at home, singing mournful songs?
It’s the same story on this side of the Irish Sea, of course. We’re all still plunging hither and thither, guzzling wine and wondering what preposterously expensive electronic toys the children will want to smash on Christmas morning this year. We can’t see the meteorite coming either. I think mainly this is because the government is not telling us the truth. It’s painting Gordon Brown as a global economic messiah and fiddling about with Vat, pretending that the coming recession will be bad. But that it can deal with it. I don’t think it can. I have spoken to a couple of pretty senior bankers in the past couple of weeks and their story is rather different. They don’t refer to the looming problems as being like 1992 or even 1929. They talk about a total financial meltdown. They talk about the End of Days. Already we are seeing household names disappearing from the high street and with them will go the suppliers whose names have only ever been visible behind the grime on motorway vans. The job losses will mount. And mount. And mount. And as they climb, the bad debt will put even more pressure on the banks until every single one of them stutters and fails.
The European banks took one hell of a battering when things went wrong in America. Imagine, then, how life will be when the crisis arrives on this side of the Atlantic. Small wonder one City figure of my acquaintance ordered three safes for his London house just last week. Of course, you may imagine the government will simply step in and nationalise everything, but to do that, it will have to borrow. And when every government is doing the same thing, there simply won’t be enough cash in the global pot. You can forget Iceland. From what I gather, Spain has had it. Along with Italy, Ireland and very possibly the UK. It is impossible for someone who scored a U in his economics A-level to grapple with the consequences of all this but I’m told that in simple terms money will cease to function as a meaningful commodity. The binary dots and dashes that fuel the entire system will flicker and die. And without money there will be no business. No means of selling goods. No means of transporting them. No means of making them in the first place even. That’s why another friend of mine has recently sold his London house and bought somewhere in the country . . . with a kitchen garden.
These, as I see them, are the facts. Planet Earth thought it had £10. But it turns out we had only £2. Which means everyone must lose 80% of their wealth. And that’s going to be a problem if you were living on the breadline beforehand. Eventually, of course, the system will reboot itself, but for a while there will be absolute chaos: riots, lynchings, starvation. It’ll be a world without power or fuel, and with no fuel there’s no way the modern agricultural system can be maintained. Which means there will be no food either. You might like to stop and think about that for a while. I have, and as a result I can see the day when I will have to shoot some of my neighbours - maybe even David Cameron - as we fight for the last bar of Fry’s Turkish Delight in the smoking ruin that was Chipping Norton’s post office. I believe the government knows this is a distinct possibility and that it might happen next year, and there is absolutely nothing it can do to stop Cameron getting both barrels from my Beretta. But instead of telling us straight, it calls the crisis the “credit crunch” to make it sound like a breakfast cereal and asks Alistair Darling to smile and big up Gordon when he’s being interviewed.
I can’t say I blame it, really. If an enormous meteorite was heading our way and the authorities knew it couldn’t be stopped or diverted, why bother telling anyone? Best to let us soldier on in the dark until it all goes dark for real. On a more cheery note, Vauxhall has stopped making the Vectra, that dreary, designed-in-a-coffee-break Eurobox that no one wanted. In its place stands the new Insignia, which has been voted European car of the year for 2009. This award is made by motoring journalists across Europe, and, with the best will in the world, the Swedes do not want the same thing from a car as the Greeks. That’s why they almost always get it wrong. Past winners have been the Talbot Horizon and the Renault 9. They’ve got the Insignia even more wrong than usual because the absolutely last thing anyone wants right now, and I’m including in the list consumption, a severed artery and a massive shark bite, is a four-door saloon car with a bargain-basement badge.
Oh it’s not a bad car. It’s extremely good-looking, it appears to be very well made, it is spacious and the prices are reasonable. But set against that are seats that are far too hard, the visibility - you can’t see the corners of the car from the driver’s chair - and the solid, inescapable fact that the Ford Mondeo is a more joyful thing to drive. In the past, none of this would have mattered. Fleet managers would have bought 100 of whichever was the cheapest, and Jenkins from Pots, Pans and Pyrex would have had no say in the matter. Those days, however, are gone. The travelling salesman is now an internet address, and the mini MPV has bopped the traditional saloon on the head. I cannot think of the question in today’s climate to which the answer is “A Vauxhall Insignia”. And I’m surprised my colleagues on the car of the year jury didn’t notice this as well. Then I keep remembering the Renault 9 and I’m not surprised at all.
I feel, I really do, for the bosses at GM who’ve laboured so hard to make this car. It’s way better than the Vectra. It looks as though they were bothered. But asking their dealerships to sell such a thing in today’s world is a bit like asking men in the first world war trenches to charge the enemy’s machinegun nests with spears. Right now, there are two paths you can go down. You can either adopt the Irish attitude to the impending catastrophe and party like it’s 1999. In which case you are better off ignoring the Vauxhall and buying a 24ft Donzi speedboat instead. Or you can actually start to make some sensible preparations for the complete breakdown in society. In which case you don’t want a Vauxhall either. Better to spend the money on a pair of shotguns and an allotment.
Ilargi: I read Stiglitz, proud fake Nobel owner, and everybody talks about how great he is, and all I'm thinking is:
"Where were you Joe Stiglitz, when your nation turned its lonely eyes to you?"
Dumping Greenspan now is easy, but what did you do when it mattered?
by JOSEPH E. STIGLITZ
There will come a moment when the most urgent threats posed by the credit crisis have eased and the larger task before us will be to chart a direction for the economic steps ahead. This will be a dangerous moment. Behind the debates over future policy is a debate over history—a debate over the causes of our current situation. The battle for the past will determine the battle for the present. So it’s crucial to get the history straight. What were the critical decisions that led to the crisis? Mistakes were made at every fork in the road—we had what engineers call a “system failure,” when not a single decision but a cascade of decisions produce a tragic result. Let’s look at five key moments.
In 1987 the Reagan administration decided to remove Paul Volcker as chairman of the Federal Reserve Board and appoint Alan Greenspan in his place. Volcker had done what central bankers are supposed to do. On his watch, inflation had been brought down from more than 11 percent to under 4 percent. In the world of central banking, that should have earned him a grade of A+++ and assured his re-appointment. But Volcker also understood that financial markets need to be regulated. Reagan wanted someone who did not believe any such thing, and he found him in a devotee of the objectivist philosopher and free-market zealot Ayn Rand. Greenspan played a double role. The Fed controls the money spigot, and in the early years of this decade, he turned it on full force. But the Fed is also a regulator. If you appoint an anti-regulator as your enforcer, you know what kind of enforcement you’ll get. A flood of liquidity combined with the failed levees of regulation proved disastrous.
Greenspan presided over not one but two financial bubbles. After the high-tech bubble popped, in 2000–2001, he helped inflate the housing bubble. The first responsibility of a central bank should be to maintain the stability of the financial system. If banks lend on the basis of artificially high asset prices, the result can be a meltdown—as we are seeing now, and as Greenspan should have known. He had many of the tools he needed to cope with the situation. To deal with the high-tech bubble, he could have increased margin requirements (the amount of cash people need to put down to buy stock). To deflate the housing bubble, he could have curbed predatory lending to low-income households and prohibited other insidious practices (the no-documentation—or “liar”—loans, the interest-only loans, and so on). This would have gone a long way toward protecting us. If he didn’t have the tools, he could have gone to Congress and asked for them.
Of course, the current problems with our financial system are not solely the result of bad lending. The banks have made mega-bets with one another through complicated instruments such as derivatives, credit-default swaps, and so forth. With these, one party pays another if certain events happen—for instance, if Bear Stearns goes bankrupt, or if the dollar soars. These instruments were originally created to help manage risk—but they can also be used to gamble. Thus, if you felt confident that the dollar was going to fall, you could make a big bet accordingly, and if the dollar indeed fell, your profits would soar. The problem is that, with this complicated intertwining of bets of great magnitude, no one could be sure of the financial position of anyone else—or even of one’s own position. Not surprisingly, the credit markets froze. Here too Greenspan played a role. When I was chairman of the Council of Economic Advisers, during the Clinton administration, I served on a committee of all the major federal financial regulators, a group that included Greenspan and Treasury Secretary Robert Rubin. Even then, it was clear that derivatives posed a danger. We didn’t put it as memorably as Warren Buffett—who saw derivatives as “financial weapons of mass destruction”—but we took his point. And yet, for all the risk, the deregulators in charge of the financial system—at the Fed, at the Securities and Exchange Commission, and elsewhere—decided to do nothing, worried that any action might interfere with “innovation” in the financial system. But innovation, like “change,” has no inherent value. It can be bad (the “liar” loans are a good example) as well as good.
The deregulation philosophy would pay unwelcome dividends for years to come. In November 1999, Congress repealed the Glass-Steagall Act—the culmination of a $300 million lobbying effort by the banking and financial-services industries, and spearheaded in Congress by Senator Phil Gramm. Glass-Steagall had long separated commercial banks (which lend money) and investment banks (which organize the sale of bonds and equities); it had been enacted in the aftermath of the Great Depression and was meant to curb the excesses of that era, including grave conflicts of interest. For instance, without separation, if a company whose shares had been issued by an investment bank, with its strong endorsement, got into trouble, wouldn’t its commercial arm, if it had one, feel pressure to lend it money, perhaps unwisely? An ensuing spiral of bad judgment is not hard to foresee. I had opposed repeal of Glass-Steagall. The proponents said, in effect, Trust us: we will create Chinese walls to make sure that the problems of the past do not recur. As an economist, I certainly possessed a healthy degree of trust, trust in the power of economic incentives to bend human behavior toward self-interest—toward short-term self-interest, at any rate, rather than Tocqueville’s “self interest rightly understood.”
The most important consequence of the repeal of Glass-Steagall was indirect—it lay in the way repeal changed an entire culture. Commercial banks are not supposed to be high-risk ventures; they are supposed to manage other people’s money very conservatively. It is with this understanding that the government agrees to pick up the tab should they fail. Investment banks, on the other hand, have traditionally managed rich people’s money—people who can take bigger risks in order to get bigger returns. When repeal of Glass-Steagall brought investment and commercial banks together, the investment-bank culture came out on top. There was a demand for the kind of high returns that could be obtained only through high leverage and big risktaking.
There were other important steps down the deregulatory path. One was the decision in April 2004 by the Securities and Exchange Commission, at a meeting attended by virtually no one and largely overlooked at the time, to allow big investment banks to increase their debt-to-capital ratio (from 12:1 to 30:1, or higher) so that they could buy more mortgage-backed securities, inflating the housing bubble in the process. In agreeing to this measure, the S.E.C. argued for the virtues of self-regulation: the peculiar notion that banks can effectively police themselves. Self-regulation is preposterous, as even Alan Greenspan now concedes, and as a practical matter it can’t, in any case, identify systemic risks—the kinds of risks that arise when, for instance, the models used by each of the banks to manage their portfolios tell all the banks to sell some security all at once.
As we stripped back the old regulations, we did nothing to address the new challenges posed by 21st-century markets. The most important challenge was that posed by derivatives. In 1998 the head of the Commodity Futures Trading Commission, Brooksley Born, had called for such regulation—a concern that took on urgency after the Fed, in that same year, engineered the bailout of Long-Term Capital Management, a hedge fund whose trillion-dollar-plus failure threatened global financial markets. But Secretary of the Treasury Robert Rubin, his deputy, Larry Summers, and Greenspan were adamant—and successful—in their opposition. Nothing was done.
Then along came the Bush tax cuts, enacted first on June 7, 2001, with a follow-on installment two years later. The president and his advisers seemed to believe that tax cuts, especially for upper-income Americans and corporations, were a cure-all for any economic disease—the modern-day equivalent of leeches. The tax cuts played a pivotal role in shaping the background conditions of the current crisis. Because they did very little to stimulate the economy, real stimulation was left to the Fed, which took up the task with unprecedented low-interest rates and liquidity. The war in Iraq made matters worse, because it led to soaring oil prices. With America so dependent on oil imports, we had to spend several hundred billion more to purchase oil—money that otherwise would have been spent on American goods. Normally this would have led to an economic slowdown, as it had in the 1970s. But the Fed met the challenge in the most myopic way imaginable. The flood of liquidity made money readily available in mortgage markets, even to those who would normally not be able to borrow. And, yes, this succeeded in forestalling an economic downturn; America’s household saving rate plummeted to zero. But it should have been clear that we were living on borrowed money and borrowed time.
The cut in the tax rate on capital gains contributed to the crisis in another way. It was a decision that turned on values: those who speculated (read: gambled) and won were taxed more lightly than wage earners who simply worked hard. But more than that, the decision encouraged leveraging, because interest was tax-deductible. If, for instance, you borrowed a million to buy a home or took a $100,000 home-equity loan to buy stock, the interest would be fully deductible every year. Any capital gains you made were taxed lightly—and at some possibly remote day in the future. The Bush administration was providing an open invitation to excessive borrowing and lending—not that American consumers needed any more encouragement.
Meanwhile, on July 30, 2002, in the wake of a series of major scandals—notably the collapse of WorldCom and Enron—Congress passed the Sarbanes-Oxley Act. The scandals had involved every major American accounting firm, most of our banks, and some of our premier companies, and made it clear that we had serious problems with our accounting system. Accounting is a sleep-inducing topic for most people, but if you can’t have faith in a company’s numbers, then you can’t have faith in anything about a company at all. Unfortunately, in the negotiations over what became Sarbanes-Oxley a decision was made not to deal with what many, including the respected former head of the S.E.C. Arthur Levitt, believed to be a fundamental underlying problem: stock options. Stock options have been defended as providing healthy incentives toward good management, but in fact they are “incentive pay” in name only.
If a company does well, the C.E.O. gets great rewards in the form of stock options; if a company does poorly, the compensation is almost as substantial but is bestowed in other ways. This is bad enough. But a collateral problem with stock options is that they provide incentives for bad accounting: top management has every incentive to provide distorted information in order to pump up share prices. The incentive structure of the rating agencies also proved perverse. Agencies such as Moody’s and Standard & Poor’s are paid by the very people they are supposed to grade. As a result, they’ve had every reason to give companies high ratings, in a financial version of what college professors know as grade inflation.
The rating agencies, like the investment banks that were paying them, believed in financial alchemy—that F-rated toxic mortgages could be converted into products that were safe enough to be held by commercial banks and pension funds. We had seen this same failure of the rating agencies during the East Asia crisis of the 1990s: high ratings facilitated a rush of money into the region, and then a sudden reversal in the ratings brought devastation. But the financial overseers paid no attention. The final turning point came with the passage of a bailout package on October 3, 2008—that is, with the administration’s response to the crisis itself. We will be feeling the consequences for years to come. Both the administration and the Fed had long been driven by wishful thinking, hoping that the bad news was just a blip, and that a return to growth was just around the corner. As America’s banks faced collapse, the administration veered from one course of action to another. Some institutions (Bear Stearns, A.I.G., Fannie Mae, Freddie Mac) were bailed out. Lehman Brothers was not. Some shareholders got something back. Others did not.
The original proposal by Treasury Secretary Henry Paulson, a three-page document that would have provided $700 billion for the secretary to spend at his sole discretion, without oversight or judicial review, was an act of extraordinary arrogance. He sold the program as necessary to restore confidence. But it didn’t address the underlying reasons for the loss of confidence. The banks had made too many bad loans. There were big holes in their balance sheets. No one knew what was truth and what was fiction. The bailout package was like a massive transfusion to a patient suffering from internal bleeding—and nothing was being done about the source of the problem, namely all those foreclosures. Valuable time was wasted as Paulson pushed his own plan, “cash for trash,” buying up the bad assets and putting the risk onto American taxpayers. When he finally abandoned it, providing banks with money they needed, he did it in a way that not only cheated America’s taxpayers but failed to ensure that the banks would use the money to re-start lending. He even allowed the banks to pour out money to their shareholders as taxpayers were pouring money into the banks.
The other problem not addressed involved the looming weaknesses in the economy. The economy had been sustained by excessive borrowing. That game was up. As consumption contracted, exports kept the economy going, but with the dollar strengthening and Europe and the rest of the world declining, it was hard to see how that could continue. Meanwhile, states faced massive drop-offs in revenues—they would have to cut back on expenditures. Without quick action by government, the economy faced a downturn. And even if banks had lent wisely—which they hadn’t—the downturn was sure to mean an increase in bad debts, further weakening the struggling financial sector. The administration talked about confidence building, but what it delivered was actually a confidence trick. If the administration had really wanted to restore confidence in the financial system, it would have begun by addressing the underlying problems—the flawed incentive structures and the inadequate regulatory system.
Was there any single decision which, had it been reversed, would have changed the course of history? Every decision—including decisions not to do something, as many of our bad economic decisions have been—is a consequence of prior decisions, an interlinked web stretching from the distant past into the future. You’ll hear some on the right point to certain actions by the government itself—such as the Community Reinvestment Act, which requires banks to make mortgage money available in low-income neighborhoods. (Defaults on C.R.A. lending were actually much lower than on other lending.) There has been much finger-pointing at Fannie Mae and Freddie Mac, the two huge mortgage lenders, which were originally government-owned. But in fact they came late to the subprime game, and their problem was similar to that of the private sector: their C.E.O.’s had the same perverse incentive to indulge in gambling.
The truth is most of the individual mistakes boil down to just one: a belief that markets are self-adjusting and that the role of government should be minimal. Looking back at that belief during hearings this fall on Capitol Hill, Alan Greenspan said out loud, “I have found a flaw.” Congressman Henry Waxman pushed him, responding, “In other words, you found that your view of the world, your ideology, was not right; it was not working.” “Absolutely, precisely,” Greenspan said. The embrace by America—and much of the rest of the world—of this flawed economic philosophy made it inevitable that we would eventually arrive at the place we are today.