New York City, Children's Aid Society
Ilargi: We start off in Canada today, with a story written by friend Rumor, and a few articles on teh state of Canada’s real estate and automobile industries. For those of you who don't know, Canada has so far largely lived in a state of denial. Its politicians and media never tire of uttering empty phrases such as "energy superpower" when describing their land, and "there is no subprime here" has also been a longtime favorite.
Well, the energy claim, based on tarsands production, is dying off fast with oil at $45 per barrel while a barrel of tar oil costs $80 to produce. As for housigng and mortgages, the Globe and Mail has finally looked into a situation they should have been on top of at least a year go. It features TAE friend and ex-MP Garth Turner, who has focused on this in the past, but was hindered at every step.
What I find the most worrisome, though, is Canadian politics. Two months ago, Canada had a federal election which resulted in a minority Conservative cabinet. Two weeks ago, the Prime Minister suspended parliament. 6-7 weeks after that parliament was elected!! That same PM will now dole out billions of dollars to the car industry. On what authority, I'd like to know? Here's Rumor:
Rumor: Is Canada an island among a sea of nation-boats heaving through financial storms? As of yesterday, not even the Bank of Canada seems to think so, reversing its long-standing boosterism of the soundness of the Canadian economy. The Big 5 banks all took substantial hits to their expected profits this quarter and are issuing stock in a bid to reinforce their capital ratios. We must presume that they see a cliff coming. Canada is primarily a resource extracting nation. We dig things up or cut them down and sell them to the rest of the world.
As commodity prices soared in the early and middle part of this year, Canada certainly did look like an island, but now the winds have changed direction and that perception is starting fade. Despite this overall national picture, however, the Central Canada region is heavily dependent on manufacturing. As such, a key issue to Central Canada at the moment is the survival of the Big 3 automakers' plants in Ontario. As in the States, these auto companies have come hat-in-hand to various governments for money in order to keep their companies running.
A debate over the details of an auto bailout package currently rages in the US Congress. Although it seems now inevitable that a bailout will occur in one form or another, there are serious questions to be asked. Are these car companies viable? Will taxpayers see a return of their money? Is it even reasonable to expect that car companies can turn a profit, even if they weren't burdened under enormous liabilities, in a deflationary period? Is there a long term future for the individual automobile at all? Is a bailout the same as effectively putting thousands of individuals on the government payroll for producing nothing but unsaleable heaps of metal and plastic? If so, is that wise?
As the US moves closer to some form of bailout, Chrysler is notably playing a peculiar game of hardball, threatening to pull out of Canada unless they, too, hand over billions. This occurs at the same time that US Senators are suggesting that Chrysler is entirely incapable of producing a future profit. Expect to see more of this in the future. Just as the past three decades have been a race to the bottom for corporate tax rates as companies seek to play arbitrage at the international level, now the economic lives of blue and white collar workers are poker chips in a new stage of the same game. It's a race to the bottom, or in other words a race into government deficits.
What Chrysler is banking on is that the current Harper government lacks the will or is too ideologically blinkered to consider nationalizing Chrysler's Canadian subsidiary, installing its own chosen executives and doing whatever it wants with Chrysler's plants. Nationalizing the auto industry may not help the industry survive, but no one can seriously suggest that allowing a company to blackmail the national government does anything but harm. yet I think Chrysler is right that nationalization is not a risk. The current government won't take this route. Parliament, were it not prorogued, might force the government to do so.
In Canada, there is no debate to be reported precisely because Parliament is suspended until late January. It is suspended at the request of the Prime Minister, who faced losing control of the government to the opposition parties last month. The federal Minister of Finance has heard the bailout proposals from the Big 3 in Canada and has just this week deemed them "capable of being dealt with". And that's the end of it. No details. Nothing to see here.
The implications of a minority government suspending Parliament when Parliament's confidence in that government is questionable are fairly large - while the government can't authorize new spending, it can otherwise govern by way of order-in-council, which potentially means rewriting regulations, including those that apply to financial and manufacturing requirements of the Big 3 automakers and to the banks. In fact, Chrysler is already asking the government to install a "tax holiday" for purchasers of new vehicles. Such regulatory changes will go unchallenged and undebated. Since the Governor General did not refuse Prime Minister Harper's request to prorogue Parliament, she can't be expeced to refuse to sign orders-in-council even if they are farther-reaching than a government in this position should be making.
The Harper government can also try to convince the Bank of Canada to make certain loans or buy up certain assets, much like the US Federal Reserve, although that doesn't seem necessary. We found out earlier this week that the BoC has already been steadily replacing treasuries and bonds on its books with "other" assets of a dubious nature - undoubtedly high-risk mortgages purchased from the Big 5 banks. Our dollar is now far less secure than it was only a few months ago, as the assets behind it's value are now just as murky as the banks' books.
What it comes down to is: what will this government get up to in this 7 week period where it is essentially unrestrained? I can hope nothing serious, but no government should be unleashed like this regardless of whether you approve of it or not. Harper might be able to restrain himself from continuing to take potshots at the opposition now and when Parliament resumes, thus ensuring that there actually is a government around to respond to the growing crisis, but his track record in self-control is spotty. More importantly, even if he can work grudgingly with the opposition, can he maintain the confidence of Parliament as economic and financial conditions spin out of control through 2009? That's is the 64 billion dollar question.
So should I worry more about the state of Canada's economy or its democracy? It's getting hard to decide. If deflation becomes an accepted reality, if the toll really begins to take hold here in Canada (as is now happening), if a Great-er Depression becomes acknowledgeable, can we expect more or less transparency from our government? Can we expect more or less debate? The answer will depend on how Canadians react right now. If you're like me, you're writing letters already. Maybe you can get on the news. If you're like me, you're also building your own lifeboat. Trust me: you'd better start now. It's not going to get easier later.
Jim Rogers calls most big U.S. banks "bankrupt"
Jim Rogers, one of the world's most prominent international investors, on Thursday called most of the largest U.S. banks "totally bankrupt," and said government efforts to fix the sector are wrongheaded. Speaking by teleconference at the Reuters Investment Outlook 2009 Summit, the co-founder with George Soros of the Quantum Fund, said the government's $700 billion rescue package for the sector doesn't address how banks manage their balance sheets, and instead rewards weaker lenders with new capital. Dozens of banks have won infusions from the Troubled Asset Relief Program created in early October, just after the Sept 15 bankruptcy filing by Lehman Brothers Holdings Inc. Some of the funds are being used for acquisitions.
"Without giving specific names, most of the significant American banks, the larger banks, are bankrupt, totally bankrupt," said Rogers, who is now a private investor. "What is outrageous economically and is outrageous morally is that normally in times like this, people who are competent and who saw it coming and who kept their powder dry go and take over the assets from the incompetent," he said. "What's happening this time is that the government is taking the assets from the competent people and giving them to the incompetent people and saying, now you can compete with the competent people. It is horrible economics."
Rogers said he shorted shares of Fannie Mae and Freddie Mac before the government nationalized the mortgage financiers in September, a week before Lehman failed. Now a specialist in commodities, Rogers said he has used the recent rally in the U.S. dollar as an opportunity to exit dollar-denominated assets. While not saying how long the U.S. economic recession will last, he said conditions could ultimately mirror those of Japan in the 1990s. "The way things are going, we're going to have a lost decade too, just like the 1970s," he said. Goldman Sachs & Co analysts this week estimated that banks worldwide have suffered $850 billion of credit-related losses and writedowns since the global credit crisis began last year.
But Rogers said sound U.S. lenders remain. He said these could include banks that don't make or hold subprime mortgages, or which have high ratios of deposits to equity, "all the classic old ratios that most banks in America forgot or started ignoring because they were too old-fashioned." Many analysts cite Lehman's Sept 15 bankruptcy as a trigger for the recent cratering in the economy and stock markets. Rogers called that idea "laughable," noting that banks have been failing for hundreds of years. And yet, he said policymakers aren't doing enough to prevent another Lehman.
"Governments are making mistakes," he said. "They're saying to all the banks, you don't have to tell us your situation. You can continue to use your balance sheet that is phony.... All these guys are bankrupt, they're still worrying about their bonuses, they're still trying to pay their dividends, and the whole system is weakened." Rogers said is investing in growth areas in China and Taiwan, in such areas as water treatment and agriculture, and recently bought positions in energy and agriculture indexes.
How high-risk mortgages crept north
In the first half of this year, as the subprime mortgage crisis was exploding in the United States, a contagion of U.S.-style lending practices quietly crossed the border and infected Canada's previously prudent mortgage regime. New mortgage borrowers signed up for an estimated $56-billion of risky 40-year mortgages, more than half of the total new mortgages approved by banks, trust companies and other lenders during that time, according to banking and insurance sources. Those sources estimated that 10 per cent of the mortgages, worth about $10-billion, were taken out with no money down. The mushrooming of a Canadian version of subprime mortgages has gone largely unnoticed. The Conservative government finally banned the practice last summer, after repeated warnings from frustrated senior officials and bankers that the country's financial system was being exposed to far too much risk as the housing market weakened.
Just yesterday, Finance Minister Jim Flaherty repeated the mantra that the government acted early to get rid of risky mortgages. What he and Prime Minister Stephen Harper do not explain, however, is that the expansion of zero-down, 40-year mortgages began with measures contained in the first Conservative budget in May of 2006. At the time, Mr. Flaherty announced that the government was opening up the market to more private insurers. “These changes will result in greater choice and innovation in the market for mortgage insurance, benefiting consumers and promoting home ownership,” Mr. Flaherty said. The new rules encouraged the entry of such U.S. players as American International Group – the world's largest insurance company – and Triad Guarantee Inc. of Winston-Salem, N.C. Former Triad chief executive officer Mark Tonnesen, who spearheaded his company's aborted push into Canada, said the proliferation of high-risk mortgages could have been mitigated if Ottawa had been more watchful. “There was a lack of regulation around the expansion of increased risk,” he said.
Virtually unavailable in Canada two years ago, high-risk mortgages proliferated in 2007 and early 2008 and must now be shouldered by thousands of consumers at a time when the economy is sinking quickly and real-estate prices are swooning. Long-term mortgages – designed to help newcomers get into the housing market sooner – are the most expensive in terms of interest costs, and least flexible when mortgage-holders cannot meet their payments and need extensions. The Bank of Canada this week warned that the perilous economy could lead to a doubling of so-called “vulnerable households” – those unable to meet their debts – and perhaps cost thousands of Canadians their homes. The central bank, which is always cautious with its words, said in a report that there is the potential for “a substantial increase in default rates on household debt.”
The federal government waited until June of this year to slam the regulatory door on 40-year mortgages. In October, as the global financial crisis erupted, Mr. Harper lauded his government for its “early” response to the mortgage dangers. “In the U.S., they are still responding to the fallout of the subprime mortgage mess. In Canada, we acted early over the past year,” Mr. Harper said in a speech to the Empire Club in Toronto. He didn't say that, not only did his own government open the sheltered Canadian mortgage market to U.S. insurers, but it also doubled to $200-billion the pool of federal money it would commit to guarantee their business. The foreigners unleashed what one U.S. insurance executive described as a fierce “dogfight for market share” that prompted rivals, including the giant federal agency Canada Mortgage and Housing Corporation, to aggressively push such risky U.S.-style lending. An investigation by The Globe and Mail found:
- AIG's Greensboro, N.C., mortgage subsidiary launched a quiet lobbying campaign in 2004 with senior U.S. executives and a former CMHC official to push open the doors to Canada's mortgage insurance market, where some of the world's highest insurance rates are charged. Two years later, on May 1, 2006, AIG's mortgage insurance division registered with the lobbying commissioner's office. It was the day before the federal budget revealed new players would be allowed into Canada.
- Banking and insurance officials were so concerned about the alarming rush to 40-year mortgages at the beginning of 2008 that one bank executive warned the Bank of Canada's chief financial stability officer, Mark Zelmer, in a meeting that “the government has got to put an end to this.”
- Critics, including former Bank of Canada governor David Dodge, say the lax mortgage policies only further stoked soaring house prices. As for mortgage insurance premiums, industry officials say rates remain virtually unchanged and could potentially rise as troubled U.S. players begin to retreat from Canada.
The story of how the U.S. housing crisis spread to Canada is a tale of carefully orchestrated U.S. corporate lobbying, failed public-policy promises and government inaction to numerous private and public warnings about reckless mortgage practices. Few of these consequences appear to have been anticipated by either the government or the financial institutions pushing high-risk mortgages on the public. “Quite honestly I was surprised [the 40-year mortgage] was seized upon so eagerly by the Canadian banks and borrowers,” said a U.S. insurance executive who asked not to be named. “You hear all the usual excuses: ‘It's a cash-flow management tool, people will pay off their mortgage ahead of time.' But in reality it just becomes a mechanism for borrowing more than you probably should have.”
How did the staid world of mortgage insurance become the cradle of so much financial risk in the Canadian housing sector? It started almost by accident. For nearly 40 years after CMHC was founded in 1954, the business of mortgage insurance was about as exciting as an actuarial table. The agency was set up by the federal government as a kind of financial cushion to encourage the country's conservative financial institutions to open their vaults and lend more money to homeowners. If a home buyer couldn't pony up a 25-per-cent down payment on a house purchase, CMHC shouldered the risk of default by insuring the mortgage and charging the buyer an insurance premium. Backing CMHC's insurance policies was a 100-per-cent federal guarantee. In bad years, Ottawa piped money into CMHC; in good years, the agency added to the federal treasury by paying taxes.
The smooth working system hit a pothole in late 1988 when Canada's only other mortgage insurer at the time, Toronto-based MICC, was nearly wiped out by new international bank capital rules. The rules threatened to shutter MICC because they effectively made it cheaper for banks to use CMHC's government-guaranteed mortgage insurance. Faced with the imminent collapse of Canada's only private-sector mortgage insurer, the then Conservative government went to a place that few other industrialized countries have gone by agreeing to guarantee the policies of a non-government mortgage insurer. According to people involved in the crisis, Ottawa “hesitantly” agreed to “taking on an enormous liability” of guaranteeing 90 per cent of MICC's insurance policies.
The government's worst fears about a massive liability materialized in 1995, when MICC's risky insurance bets in the construction sector threatened to torpedo the company. As Ottawa wrestled with the grim prospect of losing the insurer for millions of dollars in mortgages, the world's largest non-bank financial company came knocking with a rescue proposal. The company was General Electric. The U.S. conglomerate was offering to take over MICC's mortgage insurance portfolio provided Ottawa met one condition: It would bless GE's planned new Canadian mortgage insurance subsidiary with a federal guarantee. “It was a bit of a slam dunk,” recalls one former Ottawa official. “GE was one of the strongest companies in the world.” Ottawa agreed to GE's offer, thereby shifting the federal government's 90-per- cent guarantee from a small Canadian mortgage insurer to a unit of a global giant with aggressive Canadian ambitions. GE's mortgage subsidiary, later spun off and renamed Genworth Mortgage Insurance Co., rapidly carved out a major presence in Canada, capturing about 30 per cent of the market and reporting $205-million of profits in 2005. Other U.S. insurers took notice.
The days of a CMHC-Genworth duopoly were numbered. In the fall of 2005, a tiny paragraph buried in a 280-page federal government estimate of expenditures signalled a new era of competition in the industry. The Finance Department's provision was considered so insignificant at the time that many staffers of the minister, Liberal MP Ralph Goodale, didn't recall it when contacted by The Globe. A current spokesman for the Saskatchewan MP insisted that the provision was not designed to open the market to riskier products. Another federal official who declined to be identified said the wording of the provision was eased because Genworth's name had changed and the government wanted to leave room for additional switches. Despite these explanations, executives and advisers to a number of U.S. insurers and Canadian players said the paragraph was widely interpreted as a signal that Ottawa was opening the country's mortgage insurance sector to outside competitors.
Intended or not, the shift followed years of mobilizing by U.S. insurance companies, all hungry for a piece of what is regarded as one of the most lucrative and the second-largest mortgage insurance market in the world. At the forefront of this movement was mammoth AIG, now in near ruins as a result of its role in the U.S. subprime crisis. U.S. competitors had envied premium rates on Canadian mortgage insurance policies for years. With only two players competing in the space, Triad's Mr. Tonnesen said CMHC and Genworth were so profitable that they were “basically printing money.” Eyeing the rich northern market, representatives from at least three U.S. insurers made regular trips to Ottawa for meetings with the Finance Department and Office of the Superintendent of Financial Institutions, the insurance regulator. But AIG created a strategic advantage by hiring Bill Mulvihill, a Canadian mortgage expert who had spent years as the chief financial officer at CMHC. Mr. Mulvihill, who is still a director of AIG's Canadian operation, declined to comment.
“The difference that Bill Mulvihill made was that he was able to connect into the policy folks with OSFI and at Finance and convince them that we were for real,” said a former AIG executive who asked not to be identified. Following in AIG's footsteps were such U.S. insurers as PMI Group Inc., Triad and the Milwaukee-based Mortgage Guaranty Insurance Company. Ultimately, Parliament did not vote on the Finance Department's proposal, thanks to the 2006 federal election and the Conservatives' rise to office. But the U.S. insurers' efforts weren't for naught; the new Harper government quickly embraced the idea of them coming north. On May 2, 2006, in his first budget, Mr. Flaherty announced that not only would Ottawa guarantee the business of U.S. insurers, it was doubling the guarantee to $200-billion. Twenty-four hours before Mr. Flaherty's announcement, AIG's mortgage subsidiary first registered with Canada's lobbyist commissioner, according to a federal registry. At the time, companies who spent more than 20 per cent of their time lobbying the government for changes in policy were required, by law, to register. It is not known how much time AIG spent promoting its cause to the government.
In a statement, AIG's Canadian chief executive officer, Andy Charles, said the company began a “preliminary investigation” of Canadian opportunities years ago. He said the company “did not engage in discussions with elected officials until we became aware that our market entry was being debated.” Until that point, he said, the companies' “interactions were with the Department of Finance and Office of the Superintendent of Financial Institutions.” The lobbyist AIG hired was John Capobianco, a former aide to various MPPs in the Ontario government of Mike Harris and a defeated candidate for the federal Tories in the 2006 election. Mr. Capobianco said in an interview he wasn't familiar with any of AIG's negotiations with the federal government before he was retained in May. He was brought aboard to promote AIG's argument that more competition was good for consumers and massage the proposed policy through the finance committees of the House of Commons and Senate. By the time he was hired, Mr. Capobianco said, “the rubber was on the road.”
Although new U.S. insurers didn't generate any press coverage or public concern from the opposition parties, there was at least one lawmaker who had misgivings. Garth Turner, the former financial journalist turned politician who has bounced between the Conservative and Liberal parties, urged the finance committee to hold a day of hearings on the new U.S. insurers. He was a Conservative MP at the time, but was wary of his party's proposal. “We had a fairly stable market at a time when the American market was already starting to go to hell,” Mr. Turner said in an interview. “I was quite concerned that mucking around with our mortgage fundamentals would have the potential for chaos.” During a day of hearings, executives from the new U.S. insurers all pledged to make home ownership more affordable for people on the cusp of being approved by a traditional lender. AIG's new Canadian mortgage insurance chief, Mr. Charles, promised to service the neediest – immigrants, the self-employed and those with blemishes on their credit scores – who were mostly ignored by CMHC and Genworth.
Peter Vukanovich, Genworth's Canadian chief, fought to protect his profitable turf during the hearings and warned the government that it hadn't conducted any studies about the threat of disruption posed by new competitors. Shortly after the hearing, Mr. Turner said he was approached by Mr. Flaherty's parliamentary secretary, Diane Ablonczy, in the House of Commons. “She came to my desk where I was computing away on my laptop,” Mr. Turner said, recalling that she told him to “get onside.” In the end, no one raised a single question about the prospect of 40-year or zero-down mortgages. The bill sailed through the committee – including a vote of support from Mr. Turner. “At the end of the day I sadly acquiesced,” he said, adding that he regrets voting the way he did. “At the time it was politically difficult.” (He has since written and published a book, The Greater Fool, predicting a Canadian real-estate market crash similar to the one in the United States.) The provision later passed through the Senate committee, but not without one ominous exchange.
Senator Terry Stratton, a Conservative, had a prophetic inquiry about the potential that AIG might engage “higher risk” mortgage insurance practices, “thereby increasing the potential for forfeiture, which would place an additional burden on the federal government.” Mr. Charles, AIG's top executive in Canada, waved off the concerns. “In terms of exposure to the government, the practical likelihood of AIG, an organization with $800-billion in assets, ever coming to the government for anything as it relates to a claim is not nil, but it is as close to nil as it possibly could be.” Two years later, Washington has had to pump $150-billion into AIG after its business was shattered by reckless financial gambles. In February, 2006, as AIG was still trying to establish itself in Canada, CMHC moved to protect its coveted spot and announced a pilot project to insure 30-year mortgages. For the industry, it was a declaration of war. Two weeks later, Genworth announced it would do the Crown corporation one better, saying it would insure 35-year mortgages. CMHC matched that with its own 35-year product and raised the stakes by announcing it would insure interest-only loans that effectively required no down payment.
The aggressive new mortgage products alarmed Mr. Dodge, the Bank of Canada governor, who scolded the president of CMHC, Karen Kinsley, in a letter for “very unhelpful” mortgages that he said would inflate prices and ultimately make homes less affordable. In October, Genworth struck again, announcing Canada's first 40-year mortgage insurance policy. AIG and CMHC later added their own 40-year insurance products. Industry officials repeatedly said in interviews that they were shocked at the frenzied escalation of risk. “It was fast and furious,” said one AIG executive. Mr. Vukanovich, the head of Genworth, declined repeated interview requests. In a statement, Genworth said it introduced 40-year mortgage insurance policies “as a continuation of global lending practices and trends at that time.” The company added the policies were “prudently underwritten and not used to bring unqualified borrowers into the housing market.”
In an interview yesterday, CMHC vice-president Pierre Serré repeatedly pointed to the behaviour of his competitors when asked about the agency's riskier products, explaining that CMHC's rivals were the first to introduce the 40-year products. Asked if he thought that the new U.S. insurers pushed CMHC into riskier policies, Mr. Serré paused. “It' s a tough one for me to answer. In retrospect you can look at all the individual things happening and you can link them together, but it's a hard one to tell.” “We think we've done a prudent job of introducing these products and managing these products,” he added, declining to explain how many 40-year and zero-down mortgages the public agency now has on its books. Unlike in the United States, such figures are not made publicly available in Canada. Two-and-a-half years after Ottawa launched its mortgage insurance initiative, the promise of increased competition has all but died. Three of the entrants, PMI, Triad and Mortgage Guaranty Insurance Co., have retreated. Genworth and AIG are still operating, but, as financial woes mount for their U.S. parents, their future in Canada remains uncertain.
Industry sources said most banks have become so cautious in the wake of global financial crisis that they have sharply reduced their use of private insurance in Canada. The retreat by international insurers means that CMHC's dominant grip on the mortgage insurance market is expanding again, possibly beyond the 70-per-cent market share it enjoyed prior to the arrival of the bigger U.S. competitors. An adviser to one of the U.S. insurers, who declined to be identified, summed it up this way: “It's a failed experiment.”
Canada to Aid Carmakers If U.S. Provides Its Own Support
General Motors Corp., Chrysler LLC and Ford Motor Co. will get aid from Canada and the province of Ontario if the U.S. government provides its own support for the struggling carmakers, Industry Minister Tony Clement said. "The federal and Ontario governments are ready to move quickly if and when the Americans approve a support package," Clement told reporters in Toronto late yesterday. Clement declined to say how much aid Canada will provide, saying it will be "proportional" to the size of the industry’s domestic operations relative to North America. Canada accounts for about 20 percent of production, he said.
The U.S. Senate on Dec. 11 rejected a $14 billion bailout, though the Treasury Department said it might step in to help "until Congress reconvenes." If Canada were to provide support equal to a fifth of that package, it would amount to about $2.8 billion. The Bush administration dropped its opposition to using a $700 billion bank bailout to provide financing for U.S. automakers in order to "prevent an imminent failure," according to a statement. GM has asked for C$800 million ($641 million) in aid from Canada by month’s end and an additional C$1.6 billion line of credit through the second quarter. Ford’s Canadian unit has asked for access to as much as C$2 billion in "stand-by" credit, to be used if the current economic crisis worsens. Chrysler LLC hasn’t said how much it’s seeking.
"This is a great move of leadership and is hugely appreciated," David Paterson, vice president of corporate and environmental affairs for GM’s Canadian unit, said in an interview after the announcement. "Now we need to see what Washington will do." "This is a great step forward in helping the Canadian automotive industry to weather this unprecedented downturn brought on by the global financial crisis," Reid Bigland, president of Chrysler Canada, said in an e-mailed statement. "These funds will also help to solidify Canada’s significant automotive footprint." Clement said any aid from Canada would come with "conditions and expectations that the U.S. is part of the solution." Calling the current crisis "an existential moment" for the auto industry, Clement said he expects aid to be announced by the U.S. government "very soon."
Bankruptcy for any of the Detroit Three would exacerbate Ontario’s economic slowdown in carmaking towns such as Oshawa, east of Toronto, and Windsor, across the Detroit River from Michigan. Ontario, Canada’s most populous province, produced more cars last year than the U.S. state of Michigan. "We’re satisfied they sent out a signal that they’re ready to intervene," said Ken Lewenza, president of the Canadian Auto Workers union, which represents 27,800 Chrysler, Ford and GM employees in Canada. "What we’re looking for now from the companies is a sign that the aid will secure our facilities here and that our jobs will not go to the U.S. if they offer more money," he said.
The number of people claiming unemployment benefits in Oshawa almost doubled in September from a year earlier, according to Statistics Canada. Jobless claims in Windsor climbed 30 percent in the same month. Job losses are spreading beyond Ontario’s auto factories to parts suppliers, cutting the industry’s total employment to 181,000 people last year, down 18 percent from 2002, according to the Conference Board of Canada. GM has 12,574 active workers in Canada, Chrysler 7,865 and Ford 7,402. Those figures exclude laid-off union employees who have recall rights.
US, Canada auto bailout to top $17 billion
U.S. and Canadian governments say they will ride to the rescue of the beleaguered Detroit auto makers, hoping to head off a catastrophic collapse of Chrysler LLC or General Motors Corp. that would cascade throughout the North American economy. Ottawa and Ontario will provide an estimated $3.4-billion to the Canadian units of the Detroit Three, while U.S. President George W. Bush will throw a $14-billion (U.S.) lifeline to their parent companies. Federal Industry Minister Tony Clement called a hastily arranged news conference Friday night to announce the Canadian aid package. “The seriousness of the situation dictates that we be here this evening,” Mr. Clement said.
The dire situation auto makers face was underlined Friday when GM announced massive cuts in production in January. Honda Motor Co. Ltd. also said it will trim output, but by a smaller amount than GM. Mr. Clement would not provide a specific figure, but he said the amount of money in the Canadian bailout represents this country's one-fifth share of the Detroit Three's North American vehicle production and on Canada maintaining that percentage. “Clearly, this amount of money is meant to be, as the U.S. is finding out, a way to keep the doors open for the domestic auto sector while they continue their long-term planning,” he said. However, he stressed that the support package would reflect the interests of taxpayers and is contingent upon the auto makers working with their unions and parts suppliers on a long-term solution for the sector. It's also conditional on a U.S. deal coming together.
“This is an existential moment for the auto industry,” Mr. Clement added. “Is this industry going to exist in any capacity two years from now, five years from now?” Prime Minister Stephen Harper and Ontario Premier Dalton McGuinty ironed out the details of the Canadian plan during a one-hour meeting Friday afternoon in Mr. Harper's office in traffic-choked downtown Ottawa. Ontario will contribute a portion of the funding, one source said. A senior Ottawa source noted the U.S. government must change the $700-billion (U.S.) Troubled Assets Relief Program to make it apply to auto makers. Ottawa expects the Americans to take several days to finalize a deal. Just hours after Senate Republicans killed a $14-billion (U.S.) bailout late Thursday, Mr. Bush made it clear he considers GM, Chrysler and Ford Motor Co. too big and too vital to the economy, to be allowed to fail.
“The current weakened state of the economy is such that it could not withstand a body blow like a disorderly bankruptcy in the auto industry,” White House spokeswoman Dana Perino said. Chrysler and GM are in the most serious straits, warning that they could run out of sufficient cash to operate their businesses by the end of this month or early in January. A bankruptcy by one or both of them would create an auto industry cataclysm, likely taking down the healthiest Detroit company – Ford – and sending hundreds of suppliers into bankruptcy as well. One think tank estimated 3 million jobs in the United States alone would be vaporized. About 110,000 Canadians, mainly in Ontario, work for the Canadian units of the Detroit Three and for parts companies. Mr. McGuinty has expressed concerns that the sector is facing further job losses because, as he said, no amount of aid to the companies can make up for the fact that Americans are buying fewer cars.
The Detroit companies have warned that protection under Chapter 11 of the U.S. bankruptcy code can't be a solution for them because consumers won't buy vehicles from companies they think are bankrupt. The auto makers argue that they would be forced to liquidate their operations. Canadian dealers said Friday that some consumers are already balking. Parts suppliers are also getting skittish, with some starting to demand that Chrysler and GM pay them in cash immediately, instead of waiting for the usual 45- to 60-day payment period. The move by the Bush administration came after the Senate rejected a compromise bridge loan package that would carry the industry through to the new administration of Barack Obama in January.
Mr. Bush is exploring several options, including tapping cash from the $700-billion TARP fund – which was originally designed to bail out banks – something he had previously insisted he would not do.
He is just 40 days from handing over the keys to the White House to Mr. Obama while the country grapples with its worst economic crisis since the Great Depression. Mr. Obama, backed by a larger Democratic majority in the Senate, will likely have the votes to push through a more expansive rescue package when he takes office. But time isn't on the side of the auto makers. The precarious state of the Detroit Three, particularly Chrysler and GM, means they will almost certainly need a substantial amount of cash well before Mr. Obama's inauguration. Friday's GM and Honda production cuts offered fresh evidence of how the credit crisis has frozen auto sales and affected all companies. All GM passenger car plants in North America will be shut in January, as will some plants that make sport utility vehicles.
A Chrysler plant in Windsor, Ont., that makes minivans will also close for the entire month and one of the company's passenger-car factories in Brampton, Ont., will shut for the first two weeks of the new year. One government source said Canadian parts suppliers and dealers will get some help when the official agreement is announced. Mr. Clement said the government will also insist that the auto makers use the aid to keep paying their parts suppliers. Different parts of the sector have asked for different types of assistance and the needs of parts makers are distinct from those of the three vehicle manufacturers. For parts makers, Ottawa is likely to expand the ability of Export Development Corp. to insure accounts receivable, which is a major headache for suppliers in an economy where credit and financing are tight.
Calling Foreign Debt 'Immoral,' Leader Allows Ecuador to Default
Ecuador's President Rafael Correa said yesterday that his nation is defaulting on its foreign debt, fulfilling his longtime populist pledge to leave international creditors in the lurch. The default, Ecuador's second in 10 years, could rattle already jittery investors who have pulled billions of dollars out of emerging markets in recent months as the global financial crisis has spread. It could also set back U.S. interests in Latin America, as Correa now seeks to deepen financial ties with allies like Iran, which this week granted the South American nation a new $40 million credit line.
Yet some analysts say the impact of Ecuador's default may be relatively contained. They note the size of Ecuador's $3.9 billion worth of global bonds -- though four times larger than those held by the Seychelles, the only other country to default this year -- is still relatively small. By comparison, Argentina in 2002 defaulted on a whopping $100 billion in foreign debt. And while developing world economies have taken a sharp turn for the worse in recent months, Ecuador is ceasing payments not because the oil-rich country cannot afford to pay but because it has made a political decision not to.
Correa has been threatening default and demonizing foreign investors since his presidential campaign in 2006. Most recently, he has cited a presidential commission report that found evidence of criminal violations by previous governments that sold debt to pension funds, hedge funds and other overseas investors. Last month, Correa, an economist with a degree from the University of Illinois, said Ecuador would hold off on a $31 million interest payment, triggering a 30-day grace period that runs out Monday. He had hinted since then that Ecuador might make the payment. But speaking to reporters in the commercial center of Guayaquil yesterday, Correa said it would not be made and declared the country in default.
"We are ready to accept the consequences," Correa said, according to a transcript of his comments. He described the debt as "immoral," saying the government would take its findings that past debt sales were tainted by graft and bribes to international courts. Ecuadorian officials have been making their case in capitals across the hemisphere this week, including during a visit by Correa's top cabinet members to Washington and New York. But that may not prevent investors, who Correa said would receive a restructuring proposal in coming days, from suing Ecuador and possibly seeking the attachment of foreign assets.
Bondholders could be in for a steep haircut, though perhaps no worse than current market value for Ecuador's debt. As expectations of a default grew since September, the value of Ecuador's bonds fell more than 65 percent, to 30 cents on the dollar before Correa's announcement at 2 p.m. yesterday. They sank below 24 cents on the dollar shortly after his announcement. It is exceedingly rare in global finance for a nation not to honor its debt because it doesn't want to, as opposed to not being able to make payments because of a financial crunch. Some analysts fear it may set a precedent, emboldening other leaders who share Correa's ideology -- such as Venezuela's Hugo Chávez -- to make similar pronouncements.
"That is the real concern," said Alessandra Alecci, senior analyst for Moody's Investors Service in New York. "At some point, do you see Argentina and Venezuela saying, 'Well, Ecuador did it, why can't we?' " Oil represents about 60 percent of Ecuador's exports, and speculation has surged that crude's steep drop since this summer was making it more difficult for Ecuador to pay its debt. In a telephone interview yesterday Ecuador's homeland security minister, Fernando Bustamante, strongly refuted that. "I want to dispel the notion that this has any connection with any potential troubles related to our finances," he said.
Critics say the government may be playing a high-stakes game of chicken with investors. On Thursday, the Quito-based newspaper El Comercio reported that the government had quietly bought back $680 million in debt from foreign creditors in recent weeks. It has raised the possibility that Ecuador may have purposely been trying to drive down the value of its bonds on international markets, allowing the government to step in and buy them back for a fraction of the cost of honoring them and making a renegotiation of the debt easier now.
US auto crisis roils state budgets nationwide
The Big Three automakers' troubles are wreaking havoc on state and local budgets far beyond the Rust Belt. And a collapse of even one of Detroit's car manufacturers would hit governments while they are down. States and cities around the nation are already slashing budgets and services as the deepening economic downturn shrinks their coffers. To close their budget gaps, governments are cutting public health programs, reducing aid to public school and universities, and laying off workers.
Problems in the auto industry are only exacerbating this turmoil. Not only have nearly 800,000 people lost car-related jobs this year, accounting for 40% of the increase in unemployment, but auto sales are at a 26-year low and at least 660 dealerships have closed their doors. This means state and local governments are collecting less in personal income taxes, corporate business taxes and sales taxes -- all critical to funding their operations. State tax revenue fell 2.6%, when adjusted for inflation, in the third quarter, according to preliminary figures from the Rockefeller Institute of Government. "If we see a significant falloff in employment and a continued decline in auto sales, the states are really going to see it and feel it," said Scott Pattison, executive director of the National Association of State Budget Officers. "It just hits so many sources of revenue."
Any additional weakening of the auto industry would further reduce government revenues, while increasing the amount the public sector has to lay out for unemployment benefits, welfare and Medicaid, experts said. A 50% reduction in the Big Three's domestic operations, for instance, would result in 2.5 million people losing their jobs, according to the Center for Automotive Research. That would drain $20.5 billion in personal income taxes at the federal, state and local levels in 2009, while forcing the public sector to spend an additional $11.9 billion in benefits. Every state would feel the impact. Even if only GM, the most troubled of the automakers, shut down, 914,000 jobs would be lost nationwide, according to the Economic Policy Institute. This includes people who work in the plants, in auto suppliers and in businesses that support the industry, such as nearby restaurants and shops.
Of course, Michigan, Indiana and Ohio would be among the hardest hit, losing 2.5%, 1.4% and 1.1% of each state's total employment, respectively, the institute found. But all would see some decline in jobs, with Alabama losing 1.1% of its state workforce and New Hampshire shedding 0.6%. "When people lose their jobs, it has a disproportionate effect on the tax base because these are good jobs with good wages," said Robert E. Scott, senior international economist at the Economic Policy Institute. "The demand for services goes up, while tax revenue goes down. It's a real recipe for disaster for state and local governments." The slowdown in consumer demand for cars is also putting a crimp in state budgets. Americans bought 37% fewer cars in November than they did a year earlier, government figures show.
Though precise figures are difficult to come by, this big-ticket item accounts for about 12% to 15% of sales tax revenues in many states, estimates the Center on Budget and Policy Priorities. Alabama, for one, has seen a 10.6% decline in sales taxes from car purchases for fiscal year 2008, which ended Sept. 30, according to state officials. Gov. Bob Riley is expected next week to announce how he will close a looming budget deficit, which the Center for Budget and Policy Priorities estimates is at $458 million, or 5.5% of the general fund. Many states are already on the edge, experts say. At least 43 states are contending with budget shortfalls this year or next, according to the Center on Budget and Policy Priorities. They are the largest seen since the 2001 recession.
Soaring joblessness is also causing states to run out of money in their unemployment trust funds. The trust funds of five states are insolvent - meaning they have reserves of three months or less - while another eight state funds are nearly insolvent with reserves of four to six months, according to an October report from the National Employment Law Project. Six other states don't have enough money to cover a year of payments. That's why governors, mayor and other state and local officials have been pressuring President-elect Barack Obama to quickly pass a stimulus package once he takes office in January. They are looking for money for infrastructure projects, Medicaid and food stamp programs, among other items.
More than half the states have already cut spending, drained reserves or raised taxes and fees to balance their budget. But at least 37 states, plus the District of Columbia, have seen new gaps open that total $31.2 billion, or 7.2% of their budgets, the Center on Budget and Policy Priorities said. The cuts often come from public services, according to the center. Rhode Island, for instance, has eliminated health coverage for 1,000 low-income parents, while New Jersey has trimmed funds for charity care in hospitals. Florida has frozen reimbursements to nursing homes and relaxes staffing standards, while Massachusetts is reducing funding for some early care programs. Kentucky is eliminating 10% of its public defender positions, while Colorado has instituted hiring freezes.
Michigan, of course, has suffered greatly from the troubles in the auto industry. Just this week, the state budget director announced that general fund revenues are expected to fall $540 million below May estimates. "It's a very dire situation for local governments in Michigan," said Donald Grimes, senior research specialist at the University of Michigan. Michigan Gov. Jennifer Granholm plans to shave $134 million from the budget, which would involve slashing policy and program funding by $40 million and making $10 million in administrative cuts.
Suppliers demand cash from troubled Chrysler
A major oil company and a utility are demanding cash up front from ailing Chrysler LLC, offering a glimpse of the threat posed by a collapse of the North American auto supply chain. Executives at Chrysler, which is considered the most vulnerable of the Detroit Three, refused yesterday to identify the two suppliers. “The biggest risk we have is our suppliers coming and saying ‘I want to be paid on delivery,'“ Chrysler chief financial officer Ron Kolka explained. “We can't do that. The math just doesn't work.”
It's the classic Catch-22: The Detroit Three can't survive without their suppliers and parts companies need the auto makers to live. If Washington balks at a rescue of cash-starved General Motors Corp. and Chrysler, the companies won't have the cash they need to pay their vast network of suppliers, triggering a cascading series of bankruptcies throughout North America. The two companies are facing bills totalling $9-billion (U.S.) for already delivered parts. In turn, if suppliers start slipping into bankruptcy first, assembly plants would be starved of the parts they need to produce cars and generate cash.
Ford Motor Co., which is better off financially, could also be dragged to the brink if its suppliers follow GM and Chrysler into bankruptcy. In a sign of the deepening financial woes in the auto supply chain, metal stamping company PPI Holdings of Rochester Hill, Mich., filed for Chapter 11 bankruptcy protection yesterday. “The Big Three's precipitous loss of market share has devastated the automotive supply chain,” lawyers for the company said in a court filing. And earlier this week, Canadian parts maker Burlington Technologies Inc. was granted protection under the Companies' Creditors Arrangement Act – Canada's equivalent of Chapter 11. “Although the vast majority of [Burlington's] contracts are profitable, the severe slowdown in the automotive industry as a whole has resulted in a substantially reduced volume of sales,” the Oakville, Ont., based company said in court documents.
“We need to satisfy suppliers that there is going to be a tomorrow,” United Auto Workers president Ron Gettelfinger told reporters in Detroit. “If suppliers believe they can't operate, what are they going to do? They aren't going to deliver the goods. If they don't deliver the goods, the plants go down.” Chrysler's Mr. Kolka said the company would face imminent collapse if it had to pay its suppliers before taking delivery of parts. “If I had to pay $7-billion tomorrow before I get all my parts, there is no Chrysler,” he said. “Same thing with GM and Ford. You just don't have enough money to pay it.” Persisting in such demands for cash up front could cause a scenario in which the cash-strapped auto makers have to file for protection, setting off a cascading collapse of suppliers that could ripple throughout the industry because most parts makers supply several auto companies.
Chrysler acknowledged the problem in a meeting with suppliers yesterday. “It's important that the [auto makers] and supply network work together with a sense of calm and discipline. The situation in Washington has created tension in the supply network that threatens the delicate interconnected relationships this industry needs,” Chrysler said in a memo to suppliers. A massive January shutdown announced by GM yesterday will be another blow to Canadian parts makers that are already struggling and increases the need for government assistance for that section of the auto industry, said Gerry Fedchun, president of the Automotive Parts Manufacturers Association of Canada. Parts makers said they, too, should be included in any bailout offered to the Detroit Three. “That cascade effect, it's real,” said Craig Fitzgerald, an auto analyst with Plante & Moran in Southfield, Mich.
GM, Chrysler Bankruptcies Would Cause Turmoil for U.S. Economy
A bankruptcy filing by General Motors Corp. or Chrysler LLC might send the U.S. economy into chaos within weeks if it led to a shutdown at the companies. Industry experts and economists say the automakers would close plants, fire tens of thousands of workers and cut production. That would cause many of their suppliers to collapse, triggering more job losses, straining the cities and states where the car and parts companies operate, as well as federal safety-net programs. It would also deliver another psychological blow to consumers and a major shock to Main Street following the crises on Wall Street.
"The auto industry is a key element in the economy," said Bob Schnorbus, chief economist at J.D. Power & Associates in Troy, Michigan. "Anything that disrupts it is going to slow the economy down more than we have already seen." Economists say it’s difficult to estimate the full impact, given the large number of possible scenarios. The outcome hinges on which companies filed for bankruptcy and when, and whether they would be able to continue building cars and trucks while in reorganization -- assuming they don’t go into liquidation. "It would be unprecedented," says Stephen Stanley, chief economist at RBS Greenwich Capital in Greenwich, Connecticut. "So it’s hard to say exactly what would happen."
Still, a GM or Chrysler bankruptcy "would be the start of a cascade of failures," says Dennis Virag, president of Automotive Consulting Group in Ann Arbor, Michigan. "The economy will be in chaos within weeks." The Bush administration said yesterday it will consider using money from the $700 billion bank-bailout fund to prevent GM and Chrysler from "collapsing." On Dec. 11, the Senate rejected a short-term aid package for the two automakers. The effect of a bankruptcy on growth would be significant, although economists say it won’t be as great as in decades past. Gross domestic product fell at a 4.2 percent annual pace in the fourth quarter of 1970 -- when, like today, the U.S. was in a recession -- following a 67-day nationwide strike against GM. Now, auto production accounts for only about 3 percent of GDP, Stanley says. "It would obviously be a sizeable jolt to the economy," he says. "But the sector is not as important as it was."
Even so, statistics from the Center for Automotive Research in Ann Arbor show 239,000 people work in the U.S. for GM, Chrysler and Ford Motor Co. The center, which does research for the auto companies, estimates total job losses would reach 2.5 million if GM failed and 3.5 million if all three auto companies went out of business in 2009. That includes 1.4 million people in industries such as retailing that aren’t directly tied to manufacturing. Economists say each manufacturing job is responsible for an additional six outside the industry. While many analysts say the Center for Automotive Research totals are exaggerated, the number of jobs eliminated would still be staggering.
"I don’t know that we’d lose all of those folks," said Mark Zandi, chief economist at Moody’s Corp.’s Economy.com. "But over a million in the first quarter of ‘09, I think, would be reasonable to expect." The total would depend on whether Americans keep buying cars and trucks. While a Chapter 11 bankruptcy would allow the automakers to continue making vehicles while they restructure, GM, Ford and Chrysler have argued that deliveries would drop precipitously. Customers would baulk at buying anything from a company that might not be around to fix it, they say. U.S. auto sales plunged 37 percent in November to a seasonally adjusted annual rate of 10.2 million -- the lowest level in 26 years, according to Autodata Corp. in Woodcliff Lake, New Jersey -- compared with 16.1 million a year earlier and 10.6 million in October.
Dealerships are already feeling the pinch. The National Automobile Dealers Association, a trade group based in McLean, Virginia, estimates that even without an automaker bankruptcy, 900 dealers will close this year and 1,100 next year, most of them GM, Ford and Chrysler franchises. The association says the three companies have more than 13,000 dealers nationwide, employing more than 700,000 workers. The ripples of failure would also spread quickly to auto- parts makers. "There’s a fairly large number of suppliers out there very squeezed on cash right now," says Jim Gillette, director of supplier analysis for CSM Worldwide, an automotive consulting firm in Northville, Michigan. "Vehicle volumes are so low, regardless of a bailout, that suppliers are still in trouble."
Because many of these business work for all three companies, widespread closures would lead to production problems at Ford, even if it didn’t file for bankruptcy protection, officials at the No. 2 U.S. car company have said. Parts makers including American Axle & Manufacturing Holdings Inc. and brake and powertrain-system makers ArvinMeritor Inc. and Hayes Lemmerz International Inc. employ 526,000 workers, according to U.S. Labor Department statistics, down more than 300,000 since 2000. Gillette predicts another fifth of them will lose their jobs in the coming year even if the automakers get bridge loans. That will mean higher unemployment costs for states, which pay an average of $279 a week for benefits for 26 weeks, according to Jennifer Kaplan, a Labor Department economist. The payments can last as long as 39 weeks in some states, including Ohio, where GM has more than 11,000 employees, according to the company’s Web site. The jobless rate there was 7.2 percent in September.
Hundreds of thousands of auto retirees who depend on the companies for pensions and health insurance would also be affected. Bankruptcy could throw them into federal government programs -- including the Pension Benefit Guaranty Corporation and Medicare -- just when rescue packages and government market actions are ballooning the federal budget. The effect would be multiplied by an estimated decline in tax revenue for federal, state and local governments of $108.1 billion over three years if U.S. automakers’ operations were cut by 50 percent, the Center for Automotive Research says. A collapse would quickly spread to financial markets, said Eric Selle, an automotive-credit analyst at JPMorgan Chase & Co. in a research report last month.
GM, Ford, Chrysler and their credit operations comprise 10 percent of the high-yield bond market, he said, and any failure would have major implications for credit-default swaps, asset- backed securities and commercial paper. It would be "the credit crisis, part II," he said. Federal Reserve Chairman Ben S. Bernanke signaled less concern about the potential impact for the bond market in a Dec. 5 letter to Senate Banking Committee Chairman Christopher Dodd. The automakers’ bonds "already trade at 20 to 40 percent of par value, suggesting that many of the losses that would be associated with a default have probably already been recognized," he said.
Even if the automakers get loans to continue operations, the economy is going to take a hit. All three companies have promised to cut workers and close plants as a condition of receiving aid. And yesterday, General Motors said it will close 30 plants for at least part of the first quarter, cutting production by 250,000 vehicles. Honda Motor Co. said it will eliminate 119,000 vehicles from its North American production plan. That means "suppliers are going to go under in the next few months, even if a bridge loan comes in," Gillette says. "The only solution is to sell more cars."
G.M. to Idle Most Plants for About a Month
The General Motors Corporation said Friday that it would idle all of its assembly plants in the United States and Canada for at least part of the first quarter and build 250,000 fewer cars and trucks than it had planned. Meanwhile, Honda announced that it would reduce North American production from January through March by 119,000 vehicles. Honda now plans to build 1.29 million vehicles in its fiscal year ending March 31, down from earlier projections of 1.47 million, as the recession and tight credit markets send sales plummeting to their lowest level in 25 years.
At G.M., many plants will close for about a month in one of the broadest shutdowns in the automaker’s history. The closures will occur at various times during the quarter, though some will extend the annual Christmas holiday through January. G.M. now expects to build about 60 percent fewer vehicles in the first quarter, compared with the 885,000 it made in the same period of 2008. "Every plant in North America has some type of action related to it," a G.M. spokesman, Tony Sapienza, said. "This is an utter collapse of the market, and it’s not specific to G.M. or to U.S. automakers. People just aren’t buying cars right now."
But G.M., which has warned that it may run out of money unless it can borrow about $10 billion from the federal government this month, has suffered more than most of its rivals. G.M.’s sales were down 43 percent in October and November, compared with a 34 percent decline for the industry over all. The only major automaker that has performed worse is Chrysler. A message posted Friday on the Web site of United Automobile Workers union Local 276 in Arlington, Tex., told members that they would be off work from Dec. 23 until Jan. 20, and again during one week in March. The message from the local’s president, Enrique Flores Jr., expressed disappointment that the Senate rejected legislation Thursday to lend the Detroit automakers money, but urged the workers in Arlington, who build full-size sport utility vehicles, to remain hopeful.
"Each of you knows that you have no control over the purchasing decisions of the public," Mr. Flores wrote. "Each of you knows that you have no control over the banks and whether or not they will loan customers money to buy the products we produce." The only G.M. plant in the United States or Canada not affected by Friday’s announcement is in Lordstown, Ohio. Mr. Sapienza said Lordstown already had two weeks of down time scheduled in January. Three plants in Mexico will also be idled.
Detroit Gets Access to Bailout Funds
Throwing a lifeline to Detroit's ailing automakers, the White House reversed course Friday and said it would consider using the $700 billion financial-rescue plan to avert a bankruptcy of the Big Three that could deepen the U.S. recession. The announcement came hours after negotiations collapsed in Congress over a compromise bailout plan fiercely opposed by Senate Republicans. That package would have set up $14 billion in loans to the companies and a government-run restructuring process. The loans to be offered could be more limited than the $14 billion that Congress was contemplating -- perhaps closer to $8 billion, one person familiar with the situation said. General Motors Corp. would be a recipient, this person said. GM is hoping President George W. Bush will come through with about $10 billion to keep the company going. It warned Congress it needed at least $4 billion by the end of the month.
It wasn't clear whether loans would be made available to Chrysler LLC, which is controlled by private equity firm Cerberus Capital Management. Cerberus came in for heavy criticism during the recent debate for not bailing out its own company. Ford Motor Co. has said all along it doesn't need a short-term lifeline, but could need help if one of its peers keeled over. The White House's intervention showed how heavily the question of the president's legacy is weighing over his last few weeks in office. White House officials worried that the collapse of one or more domestic auto company, perhaps the last crisis Mr. Bush will confront as president, could cause a surge in job losses, worsening the current recession.
As early as Wednesday, during a private meeting with senators, Vice President Dick Cheney told lawmakers the Republicans didn't want to be remembered as the party of Herbert Hoover for allowing a company such as GM to collapse, according to people familiar with the matter. By signaling that Treasury bailout funds could be an option, the White House made it easier for Republicans to walk away from negotiations, creating an environment in which they could push for deep concessions from the United Auto Workers union. That license contributed to the seesawing negotiations of the past week as Congress veered from agreement to disunity, with union concessions a major point of disagreement.
For now, the biggest question for the White House is whether it will be able to extract any of the cost-saving concessions it had been seeking from the car companies, their unions and other interested parties. The Bush administration is beginning the process of examining the companies' books to figure out how much money is needed and intends to obtain protections for taxpayers. The Big Three directly employ almost 250,000, according to an administration estimate, and also support about one million retirees and their spouses, not counting the vast network of suppliers and dealers whose businesses are intertwined. In all, administration officials estimate that the failure of the U.S. auto makers would cost the economy more than one million jobs and would reduce economic output by more than 1%, significantly prolonging the downturn.
"We think that the current weakened state of the economy is such that it could not withstand a body blow like a disorderly bankruptcy in the auto industry," White House spokeswoman Dana Perino told reporters aboard Air Force One Friday. "We'll have to take another look at what they [the companies] might need and how we might be able to provide that as a short-term mechanism to help prevent a disorderly bankruptcy that we think could devastate further an already very weak economy." GM recently started working with bankruptcy specialists to make contingency plans in case a Chapter 11 filing becomes necessary. It is also trying to cut costs. On Friday, GM said it will temporarily close 20 North American factories in reaction to declining auto sales. It now expects to make 250,000 fewer vehicles in the first quarter compared to the first three months of last year.
On Friday, Chrysler Chief Executive Bob Nardelli implored employees to do all they can to save money to keep the company afloat while it lobbies the Bush administration for emergency loans. In an email to workers, Mr. Nardelli hinted Chrysler is hoping for a better reception when President-elect Barack Obama is in office. "Key members of the incoming administration are aware of the importance of addressing the short-term and long-term viability of our industry and our company," he wrote. The failure of Congress to act creates a mess for the administration. The White House must now wade into the muddy task of structuring an auto bailout, which will drain the Treasury's fast-dwindling supply of funds, while figuring out whether to ask Congress for the second half of the promised financial rescue money. Congress has doled out the rescue funds in installments and would likely return to Washington to debate the matter.
The Treasury wants to avoid a messy political battle with an increasingly hostile Congress. Even the spectacle of a failed effort to block the next $350 billion could spook already fragile financial markets. The administration said that in the wake of the legislation's collapse, it would consider "other options" for helping Detroit, including use of the Troubled Asset Relief Program as well as other unspecified possibilities. The White House decision reverses Treasury Secretary Henry Paulson's longstanding position that the funds be used to help only financial institutions. Treasury officials -- and others in the administration -- worry about opening TARP to an array of other non-financial companies seeking cash. The line of industries seeking federal funds is growing as state governments, transit agencies, insurers and others clamor for a piece of the pie.
Mr. Paulson could potentially circumvent the need to ask for the second installment by diverting some of the $250 billion slated for capital injections, of which Treasury has committed just $161 billion to 53 banks. Treasury has completed 80% of the loan applications it's received from the banks' primary regulators. While additional applications are likely still pending at the regulators, those are unlikely to eat up a significant portion of the remaining $89 billion. Democratic congressional leaders had suggested for weeks the White House use TARP money to aid the auto industry. Administration officials instead settled on a strategy that required Congress amend a $25 billion program originally intended to help car makers build environmentally friendly vehicles. One advantage of that strategy was that the retooling program required the companies to be financially viable in order to qualify for the loans, a provision that helped wring concessions from the UAW.
From the beginning, the auto rescue was weighed down by the $700 billion fund that might now save it. Winning additional funds for Detroit was never going to be easy, said Sen. John Thune (R., S.D.), because many lawmakers felt they "got hammered pretty hard" over the $700 billion fund, by constituents who viewed it as a giveaway to the banking industry. The push for a rescue package gained steam a week ago, when top Democrats and the White House agreed on a compromise. The House approved the plan Wednesday, but the package faltered in the Senate the next day amid strong objections lodged by Republicans. They used the opportunity to demand deep concessions from labor unions, including a commitment to bring wages in line with those at U.S. operations for foreign-based producers such as Toyota Motor Corp. and Nissan Motor Co. The dispute broke apart the talks and spilled onto the Senate floor, where leaders of both parties declared the effort dead Thursday.
Auto bailout's death seen as a Republican blow at unions
The congressional push to help U.S. automakers was generally cast in terms of protecting the reeling national economy from another body blow -- the collapse of one or more of Detroit's Big Three. But in killing the stopgap rescue plan worked out by President Bush and congressional Democrats, conservative Republicans -- many from right-to-work states across the South -- struck at an old enemy: organized labor. "If the [United Auto Workers], which is perceived as one of the strongest unions in the country, can be put under control, that may send a message across the whole country," said Michigan State University professor Richard Block, a labor relations expert.
Such antipathy to unions was an undercurrent through the weeks of negotiations leading up to Thursday's Senate vote rejecting the plan. Handing a defeat to labor and its Democratic allies in Congress was also seen as a preemptive strike in what is expected to be a major battle for the new Congress in January: the unions' bid for a so-called card check law that would make it easier for them to organize workers, potentially reversing decades of declining power. The measure is strongly opposed by business groups. "This is the Democrats' first opportunity to pay off organized labor after the election," read an e-mail circulated Wednesday among Senate Republicans. "This is a precursor to card check and other items. Republicans should stand firm and take their first shot against organized labor, instead of taking their first blow from it."
One of the leading opponents of the auto bailout, Sen. Jim DeMint (R-S.C.), said: "Year after year, union bosses have put their interests ahead of the workers they claim to represent. Congress never should have given these unions this much power, and now is the time to fix it." Of course, for Democrats' part, they were fighting for one of their most loyal supporters in backing the $14-billion bailout. The UAW, which represents about 150,000 employees of the Big Three, delivered campaign contributions and foot soldiers to help elect Barack Obama president, especially in crucial states such as Michigan and Ohio.
What lent a bipartisan gloss to Senate Democrats' effort was the fact that party leaders had negotiated for days with the White House and made a string of concessions that toughened the bill and won active support from the Bush White House. Sen. George V. Voinovich (R-Ohio), a strong auto industry supporter, acknowledged that some of his colleagues simply did not want to help the UAW. "We have many senators from right-to-work states, and I quite frankly think they have no use for labor," he said. "Labor usually supports very heavily Democrats and I think that some of the lack of enthusiasm for this [bailout] was that some of them didn't want to do anything for the United Auto Workers."
One major car dealer said conservatives let political ideology get in the way of protecting the country's interests. "Being a Republican myself, I feel very betrayed by the Republican Party right now," said Beau Boeckmann, vice president of Galpin Motors Inc. in North Hills. Galpin has the nation's largest Ford dealership as well as lots where it sells eight other foreign and domestic brands. The anti-union sentiment rose to the surface in the final desperate hours of negotiations. Republicans insisted that the UAW agree to cut its wages to be competitive with foreign companies such as Honda, Toyota and BMW by a set date. UAW officials and their Democratic allies balked, saying the autoworkers were being told to make sacrifices that had not been demanded of other industries receiving government bailouts.
"We could not accept the effort by the Senate GOP caucus to single out workers and retirees for different treatment and to make them shoulder the entire burden of any restructuring," UAW President Ron Gettelfinger said, arguing the union had gone further than any other stakeholder in making concessions to help the companies avoid bankruptcy. But DeMint argued that the unions had helped create Detroit's plight. "It is no coincidence that the healthy automakers in the United States are located in 'right-to-work' states and are not unionized by the UAW," he said. "Right-to-work" states bar agreements between trade unions and employers making membership or payment of union dues or "fees" a condition of employment, either before or after hiring.
Rep. John D. Dingell (D-Mich.), a labor ally, said Friday that Republican senators who opposed the bailout might have "wanted to crush a longtime political rival, the United Auto Workers," without concern for the economic consequences. Democrats lauded the UAW as a hero in the bailout process for agreeing to new concessions on top of major ones given in 2005 and 2007. House Speaker Nancy Pelosi (D-San Francisco) called the union "courageous" just before the House approved the bailout Wednesday. But some Republicans framed the UAW as the villain, criticizing what they called lavish wages and benefits that they said had driven General Motors, Chrysler and, to a lesser extent, Ford to their knees. "I'm sure that I'm going to be asked, 'Congressman, I work at Honda' or 'I work at Mercedes. I get $40 an hour. Why are you going to take my tax dollars and pay it to a company that's paying their employees $75 an hour?' " Rep. Spencer Bachus (R-Ala.) said last month.
That wage figure -- widely used by opponents of the auto industry bailout -- is not in fact the wage paid to current workers. It is an approximation of the costs of salaries and benefits for current and retired workers. After wage concessions in recent contracts, the UAW says its workers at GM, Ford and Chrysler plants range from $33 an hour for skilled trades to $14 an hour for new hires. Precise wages and extrapolated benefits costs for U.S. workers at nonunionized foreign companies, such as Honda and Toyota, are difficult to ascertain, but Block estimated salaries for current workers are approximately the same. The Big Three automakers have higher labor costs primarily because they have operated factories in the U.S. much longer than their foreign counterparts, so have many more retirees receiving pension and healthcare payments, Block said.
Even if UAW workers at GM took a 20% pay cut, it would only save the company about $1.1 billion annually because the company's unionized workforce in the United States has decreased dramatically in recent years, to 55,000, he said. Sen. Sherrod Brown (D-Ohio) characterized the GOP opposition as "class-warfare assault by the Republicans." "They never ask about banker salaries. . . . They never asked they give money back," he said. When Congress convenes in January, the expanded Democratic majorities are expected to push for an Employee Free Choice Act, also known as the "card check," under which companies would recognize unions if a majority of workers signed cards saying they favored a union. That would replace the traditional method of a secret ballot among workers.
Block and other analysts believe the looming fight added to the political maneuvering over the bailout. "The opposition might be as strong, but it might not be as urgent," Block said. "If the public could be convinced the problem with the auto industry is the UAW . . . then it will be easier than otherwise to marshal public support against unions and their legislative agenda."
Meatier Stimulus Plan in Works
President-elect Barack Obama's economic team is considering an economic-stimulus program that will be far larger than the two-year, half-trillion-dollar plan under consideration two weeks ago, according to people familiar with the team's thinking. The president-elect is expected to be briefed on the broad parameters of the plan next week, with aides still hoping for Congress to pass a bill by the time Mr. Obama takes office Jan. 20. With the unemployment rate now expected to hit 9% without aggressive intervention, Obama aides and advisers have set $600 billion over two years as "a very low-end estimate," one person familiar with the matter said. The final number is expected to be significantly higher, possibly between $700 billion and $1 trillion over two years.
Transition spokeswoman Stephanie Cutter denied any decisions have been made on the scope of the plan. "Any speculation on size or scope is premature at this time," she said. On the upper bounds, liberal economists in the team have staked out $600 billion in the first year and $300 billion to $600 billion in the second, depending on economic conditions in 2010. Incoming Obama White House Chief of Staff Rahm Emanuel said early this week he had tasked National Economic Council Director Lawrence Summers to sound out conservative and liberal economists on their views. The general sense among economists being canvassed by the Obama team is that "every day there's a new bad number," one of the people familiar with the matter said. "And people's sense of what the appropriate stimulus is rises" with the news.
Christina Romer, who will lead Mr. Obama's Council of Economic Advisers, is also surveying economists, trying to build political consensus around a larger number before it is presented to Congress in early January. People familiar with the discussion say Lawrence Lindsey, President George W. Bush's first NEC director, has counseled $800 billion to $1 trillion in stimulus over two years. Harvard University economist Martin Feldstein, a Reagan White House economic adviser, has raised his initial, one-year, $300 billion figure to at least $400 billion. Neither Messrs. Lindsey nor Feldstein returned calls requesting comment.
As economic conditions worsen, Obama economists now say the package will have to be larger than expected to ensure the needed stimulus actually reaches the economy. Households will save some percentage of the initial tax cut. And some amount of spending, especially on infrastructure, won't reach the economy in the expected time frame of the package, since contracts and projects may be delayed. "How much do you have to spend to give $100 billion of stimulus? One hundred billion is the wrong answer. It's more," a person familiar with the deliberations said.
The process of putting together the package is now far enough along to bring the president-elect into the mix. The economic team will brief Mr. Obama next week, largely about the size of the package. Discussions are still under way about content. Mr. Obama has said the package will include an initial tax cut and a massive infusion of funds for roads, bridges, water systems, school repair, spreading broadband access, promoting health-care information technology, improving energy efficiency in buildings, renewable-energy projects, and assisting struggling state and local governments. But the balance of those projects is still under debate.
Sen. Dodd: Congress Would Vote Against Release Of 2nd TARP Tranche
Congress would vote against releasing the second tranche of $350 billion of funds under the financial rescue package if Treasury Secretary Henry Paulson requested them, a leading Democratic senator said Friday. Sen. Christopher Dodd, D-Conn., the chairman of the Senate Banking Committee, and the Democrats' chief negotiator on the financial rescue package, said that decision would be due to anger over the handling of the first tranche of funds by the Treasury. The Troubled Asset Relief Program created by the White House and Congress allocated $700 billion to the Treasury to use to stabilize the financial markets.
The goal of the program was that the federal government would strengthen bank and other financial institutions balance sheets and they would in turn start lending more to each other, businesses and individuals to unglue seized-up credit markets. But under with nearly half the money spent, many lawmakers have complained that there is little evidence that many of the banks that have received taxpayer financial assistance have used the money to increase lending levels. The legislation creating the TARP stated that lawmakers could prevent the second tranche of money being released by passing a resolution of disapproval.
Last week, Dodd said that he would personally oppose the release of the funds to the Treasury. Friday, he went further, saying he now believed that Congress would vote against the release. Paulson has so far not formally requested the release of the funds. Even if Congress approved a resolution of disapproval, President George W. Bush would be able to veto it, so lawmakers would realistically have to vote for the resolution by a two-thirds veto-proof majority.
GMAC: Bank Holding Company Status or Else...
GMAC LLC, the lender to customers and dealers of General Motors Corp., sweetened terms on a debt swap designed to save the firm from bankruptcy and extended the deadline for a fourth time to lure more investors. Holders of a "substantial portion" of $38 billion in GMAC debt agreed in principle to new terms including an improved interest rate and a capital contribution by its owners, Detroit- based GMAC said in a statement. The deadline was extended from yesterday to Dec. 16 for early delivery, with final expiration set on Dec. 26.
The swap would pave the way for GMAC to convert to a bank holding company and gain access to U.S. rescue programs. Even with the new accord, GMAC remains short of the 75 percent participation needed for its recovery plan to work. So far, only a quarter of the affected debt has been tendered. Without the swap, GMAC has said its application to become a bank will fail, and analysts have said bankruptcy would likely follow. The agreement "represents substantial progress toward attaining the estimated overall participation that would be required," GMAC’s statement said. "However, significant additional participation will also be required."
The debt swap includes notes issued by GMAC and its Residential Capital LLC mortgage unit. Amended terms include increasing the annual dividend to 9 percent, according to the statement, which didn’t specify the original level. The rate drops to 7 percent after GMAC raises at least $2 billion of new capital, with $750 million contributed by GMAC’s existing shareholders. The accord also restricts liens, subsidiary guarantees and asset sales.
The proposal previously asked holders to swap for as little as 55 cents in cash or a combination of new notes and preferred stock. Before today’s announcement, GMAC had extended the deadline for debt holders three times.
GM, which sold 51 percent of GMAC in 2006 to a group led by private equity firm Cerberus Capital Management LP, is also seeking a federal bailout to avert bankruptcy. GMAC has been crippled by losses over the past five periods that total $7.9 billion, driven by slumping sales at GM and defaults on subprime home loans at ResCap. With auto sales at their lowest since World War II and the U.S. in its worst housing crisis since the Great Depression, GMAC and ResCap have little means to revive sales and have been shut out of credit markets.
GMAC has $540 million of bonds due this month and another $11.6 billion that mature in 2009. Without gaining bank status, GMAC would lose its "last lifeline," said Mirko Mikelic, senior portfolio manager at Fifth Third Asset Management in Grand Rapids, Michigan, in a Dec. 10 Bloomberg Television interview.
Deflation has become inevitable
For a while now I have been on the fence on the inflation/deflation issue – whether the massive monetisation of bad debts by central banks and governments will lead to rapidly escalating inflation as currencies are debased or, alternatively, lead to deflation as bad debts and illiquidity undermine all commercial and financial activity in the economy. I’m now coming down on the side of deflation for a very simple reason: there is no longer any incentive to save or invest, and so debt and investment cannot increase much beyond current bloated levels.
In Lombard Street, Bagehot’s seminal tome on fractional reserve central banking, Bagehot advises any central bank facing a simultaneous credit crisis and currency crisis to raise interest rates. By raising rates they will ensure that foreign creditors remain incentivised to maintain the general level of credit available while the central bank resolves the local liquidity crisis through liquidation of failed banks and temporary liquidity support of stressed banks.
The very opposite policies have been pursued by central banks in the US, Europe and UK since the beginning of the sub-prime crisis in August 2007. They have cut policy rates drastically, and as the crisis escalated and spread, the yield on government debt has dropped to negative territory. Meanwhile they have shielded those responsible for the creation of record levels of bad debt from any regulatory accountability, relaxed transparency of accounts, and provided massive taxpayer-funded financial infusions to prevent failure and liquidation.
While in the short term these policies have expediency and the maintenance of market "confidence" on their side, in the longer term these policies must undermine any confidence a rational and objective saver or investor might have that savings or investment in the US, EU or UK will be fairly remunerated at an above-inflation rate, or that savings and investments will be protected by effective oversight and regulation from the sorts of executive debasement and outright misappropriation and fraud that are beginning to colour our perceptions of the past decade.
Anyone sitting on a pile of cash now is unlikely to want to either (a) place it in a bank, or (b) invest it in the stock market. As a result, the implosion of the financial and real economy must continue no matter how big the central bank’s aspirations for its balance sheet or the treasury’s aspirations for its deficit. If US, EU and UK had substantial domestic savings to fund their banks (as in Japan in 1990), then perhaps the consequences would not be so imminently disastrous. Lacking sufficient domestic savings, however, their actions will likely make foreign creditors in Japan, China, the Gulf and elsewhere question whether it is worthwhile to keep pumping scarce savings into such flawed and reckless economies.
During the reckless boom years, savings collapsed in bubble economies as retail and commercial and financial actors alike chased speculative yields with greater and greater leverage. During the reckless bust years, savings will collapse further as retail and commercial and financial actors chase safety by hoarding their meagre remaining assets from further erosion by refusing to lend at negative returns and refusing to finance failed corporate and investment models that only enrich poltically-connected management and intermediaries.
The determination to avoid any accountability for failed banks, failed business models, failed regulatory systems and failed academic rationales for all the above invites anyone with spare cash – an increasingly select crowd – to withhold it from further depredations. It is this instinct, more than confidence in the government, which is driving so many to seek the temporary safety of short-dated government securities.
The result of discouraging domestic and foreign creditors and investors must be inevitable deflation as debt levels become increasingly hard to finance and ultimately contract. Irresponsible central banks and governments can try to bail out the failed banks, businesses and municipalities at the centre of every popped bubble, but the bubble economies are ever more certain to deflate with each bailout. Each bailout further undermines the market discipline which is bedrock to a saver or investor’s decision to part with hard-earned cash by trusting it to the intermediation of the management of a bank or business.
It’s this simple: I won’t invest in a country that bails out failure and punishes savers. I won’t invest in the US or UK until they change course and protect savers and investors, ensuring a reasonably predictable positive return. In the EU, I will be very selective, preferring those conservative states like Germany that never embraced the worst excesses, although sadly still have fall out from individual banks' stupidity in buying into foreign excess. I will know when it is safe to reinvest when policy interest rates, bank/intermediary oversight and accounting standards give me confidence I am better protected than the corporate or financial elite.
While it may take the Asian and the Gulf State investors longer to embrace my analysis, I have no doubt that they too will eventually conclude that parting with their savings under the terms now on offer will only deepen their losses. They would be better off keeping the money at home, investing locally under local laws and vigilance, and letting the US and UK implode.
The argument against this has always been that with trillions already invested in the US during the deficit years, the Chinese and Gulf States would suffer even more horrible losses from a collapse of the western economies. This is accurate, but not complete, as it ignores the relative value of cash investment at the top and bottom of a bursting bubble. Once the collapse has bottomed out, so long as a globalised economy survives, there will be even better opportunities for those with savings to invest selectively in businesses with clearer prospects and more certain profitability under regulatory frameworks which have been restored to a proper balance of investor protection and intermediary oversight.
Right now survival of businesses in the West depends largely on political pull and access to regulatory forbearance and central bank or treasury finance. The market has failed, and officialdom is collaborating in perpetuating that failure. Should the western economies implode in deflation, however, there will be new opportunities to return to market-based policies that reward effective, efficient management and punish corrupt, debased management. Until that happens, those that invest will continue to lose money. Once deflation is exhausted, then those that invest can expect to make and retain profits again.
I think it took me so long to feel confident about predicting deflation because the floating currency system under dollar hegemony and Bretton Woods II distorts the workings of both inflation and deflation. Despite the US being the epicentre of all the failed debts, failed securitisations, failed credit derivatives, failed rating agencies, failed banking businesses, failed corporate governance, failed accounting standards, failed capital adequacy models, and failed regulatory forbearance, the US dollar has recently strengthened as deflation globalised. The US exported inflation in the boom years, and now exports deflation in the bust years.
Since spring 2008, as US investment banks sold off assets, imposed margin calls, and used access to unsegregated wholesale assets in custody in the rest of the world to upstream liquidity to their US-based parents and affiliates, the dollar has strengthened relative to other currencies. The media reports this as a "flight to quality", but it is more like a last looting of the surrounding countryside before dangerous brigands hole up in their hilltop fortress. The brigands appear temporarily wealthy compared to the peons left stripped and penniless and facing winter. When the brigands have eaten all the stolen grain and livestock, however, they will have no means to replenish except to use force to raid the countryside again. The peons can always hunt, forage, farm and carefully husband a surplus to gradually increase their wealth. If the brigands raid too thoroughly or too regularly, the peons have no incentive to grow crops or keep herds (negative savings returns) and everyone starves (deflation).
In the meanwhile, the peons just might wise up, hide any surplus more securely and organise mutual defense against further attacks to ensure that their peon children prosper and the brigands die off. That would be the end of Bretton Woods II, and the rise of China, India, the Gulf and other productive and/or resource rich states which invest surplus in domestic productivity and regional growth. I reread my piece on Fisher’s Theory of Debt Deflation in Great Depressions the other day. One of the more confusing aspects is his assertion that the dollar "swells" as debt deflation takes hold. What he meant, of course, is that deflation increases the quantity of assets and the likely investment return each dollar purchases as deflation wrings debt and misallocation of capital out of the economy.
It is now clear to me that policy makers in the West are determined to apply every available resource to underpinning failure, misallocation and executive excess. As this discourages the honest saver from parting with cash, policy makers are ensuring that deflation will wreak its havoc on the financial and real economies of the world. Only when that deflation has played out and rational policies that reward market-based management and returns are restored will it be worthwhile to invest again. In the meanwhile, any wealth saved securely from state seizure will "swell" to buy more assets in future - a key aspect of deflation and a key means of restoring the control of the economy into the hands of more farsighted savers and investors.
I have quoted Mr John Mill before, but it bears repeating: "Panics do not destroy capital; they merely reveal the extent to which it has been destroyed by its betrayal into hopelessly unproductive works." The extent to which capital has been betrayed in the past quarter century under Bretton Woods II, bank deregulation and the Basle Capital Adequacy Accords is unrivalled in the history of fiat banking. The bankers, lawmakers, regulators and academics who collaborated in the betrayal still hold power, like the well-armed brigands in the fortress, and their continued collaboration to prevent accountability must inevitably discourage honest savers from risking further loss. Even so, it is the savers/peons who hold the ultimate power as they can starve the brigands.
Some day soon savers will revolt at financing further depredations. They will refuse to buy even government securities, gagging at the quantities of issue forced upon them under terms of only negative return. When that final massive bubble bursts, deflation will follow its harsh corrective course and clean out deficit-financed "unproductive works". When that happens, if reason is restored in markets with effective oversight, I might consider investing again, very selectively, in whatever productive works might then be on offer and only when secure in realising - and retaining - a positive yield.
Japan, China, South Korea Meet to Address Global Crisis
The leaders of Japan, China and South Korea meet Saturday in a summit that will test whether the rivals can put aside old animosities to collectively address the global economic crisis. A response to the crisis will be at the top of the agenda at the one-day meeting, which was originally planned in an effort to build relations.
The summit in Fukuoka, Japan -- the first trilateral gathering for the three countries -- is likely to yield only vague promises to bolster their export-reliant economies, which are all hurting from a slowdown in overseas markets. The nations' leaders -- Japanese Prime Minister Taro Aso, Chinese Premier Wen Jiabao and South Korean President Lee Myung-bak -- are expected to issue a declaration promising action. Japan said it will prod China to put some of its vast foreign-currency reserves toward propping up the International Monetary Fund. Tokyo last month pledged a $100 billion loan to the IMF to support needy nations.
In a sign of how cooperation among the three nations is already under way, South Korea signed bilateral currency-swap agreements Friday with China and Japan, moves that it hopes will keep the Korean won from weakening further and lighten the pressure on the central bank's foreign-currency reserves. A spokesman at China's Ministry of Foreign Affairs said he hopes the three countries can "jointly respond to this financial crisis" but offered no details on how they can cooperate. Relations have improved after years of friction under former Japanese Prime Minister Junichiro Koizumi, who angered Beijing and Seoul by praying at a war shrine that honors Japan's war dead.
Georgia, Texas Banks Seized as Foreclosures Push Failures to 25
Georgia and Texas banks with $544 million in deposits were closed by state regulators today, pushing the toll of failures to 25 as mortgage delinquencies and home foreclosures surge to records during a deepening recession. Haven Trust Bank of Duluth, Georgia, was seized and sold by the Federal Deposit Insurance Corp. to BB&T Corp. of Winston- Salem, North Carolina, which will reopen four offices northeast of Atlanta on Dec. 15 as branches, the FDIC said. Sanderson State Bank was shut by Texas regulators and its assets were sold to Pecos County State Bank of Fort Stockton, which will open Sanderson’s southwest Texas office as a branch on Dec. 15. Acquisitions by BB&T, the fifth-best performing stock in the KBW Bank Index this year, and Pecos County were "the ‘least costly’ resolution for the FDIC’s deposit insurance fund," the Washington-based FDIC said in a statement.
Regulators have closed the most banks in 15 years, and the annual total now exceeds the combined toll for the previous six years, with the collapses of Washington Mutual, Inc. and IndyMac Bancorp Inc. among the biggest in history. The U.S. entered a recession a year ago and President-elect Barack Obama on Dec. 7 said the slump will worsen before a recovery begins. BB&T will buy about $55 million of Haven’s $572 million in assets and pay $112,000 for the failed bank’s $515 million in deposits, the FDIC said. The agency will retain the remaining assets "for later disposition." The deposit insurance fund, supported by fees on insured banks, will pay an estimated $200 million, the agency said. Pecos will buy $3.8 million of about $37 million in Sanderson’s assets and pay a premium of 0.55 percent to assume the failed bank’s $27.9 million in deposits, the FDIC said. The deposit insurance fund will pay $12.5 million, the agency said.
The U.S. is seeking to avert failures by using $250 billion from a bank-rescue fund to boost lender capital after tighter credit contributed to a freeze in markets. The FDIC and Office of the Comptroller of the Currency in November allowed private- equity firms and other investors to buy assets and deposits of failing lenders, expanding the pool of bidders. The FDIC on Nov. 25 classified 171 banks as "problem" in the third quarter, a 46 percent jump from the second quarter, and said industry earnings fell 94 percent to $1.73 billion from a the prevision year. The agency doesn’t name "problem" banks. "We’ve had profound problems in our financial markets that are taking a rising toll on the real economy," FDIC Chairman Sheila Bair said at a Washington news conference after releasing the report. U.S. foreclosure filings climbed 28 percent in November from a year earlier and a looming "storm" of new defaults and job losses may force 1 million homeowners from their properties next year, RealtyTrac Inc. said yesterday.
The FDIC oversees 8,384 institutions with $13.6 trillion in assets, and insures deposits of as much as $250,000 per depositor per bank and the same amount for retirement accounts. The agency has proposed doubling premiums charged to banks for coverage to replenish its reserves amid agency forecasts that bank failures through 2013 will cost almost $40 billion. Washington Mutual, the biggest savings and loan, sold its assets to JPMorgan Chase & Co. Sept. 25 after customers drained $16.7 billion in deposits in less than two weeks. Wachovia Corp., the sixth-biggest bank, was pushed by regulators to sell itself to Wells Fargo & Co. for $11.7 billion or face collapse. The Treasury as part of its bank-rescue effort has bought preferred shares in nine banks: Wells Fargo & Co., JPMorgan, Citigroup Inc., Bank of America Corp., Merrill Lynch & Co., Morgan Stanley, Goldman Sachs Group Inc., Bank of New York Mellon Corp. and State Street Corp.
US retail sales keep plunging as wholesale prices follow
Consumers reduced their spending at retail stores again in November while the costs of goods before they reach store shelves also continued to drop, more bad signs in a recession that appears to be deepening. Businesses also cut their inventories by the largest amount in five years, the government said Friday, a sign the recession will force further cuts in production. The numbers came as White House spokeswoman Dana Perino said the Bush administration is considering using the Wall Street rescue fund to prevent U.S. automakers from failing.
The Senate late Thursday rejected the $14 billion auto-industry bailout bill after the United Auto Workers refused to accept Republican demands for swift wage cuts. General Motors and Chrysler executives have said they could run out of cash within weeks without government help. Ford, which would also be eligible for federal aid under the bill, has said it has enough cash to make it through 2009. Meanwhile, the Commerce Department reported Friday that retail sales dropped by 1.8 percent in November. The decline, which was slightly below the 1.9 percent dip that had been expected, was the fifth straight monthly drop, a record stretch of weakness.
The downturn was led by a 2.8 percent fall in auto sales, which had been expected since automakers had reported that November was their worst sales month in more than 26 years. The Producer Price Index, which tracks costs of goods before they reach consumers, fell 2.2 percent last month as gasoline and other energy prices retreated, according to the Labor Department. That followed a record 2.8 percent plunge in wholesale prices in October, and November’s price drop was larger than the 2 percent decline economists expected. Falling prices might sound good for buyers, but a prolonged, widespread decline would do serious economic damage, dragging down incomes, clobbering home prices even more and shrinking corporate profits.
The Commerce Department also said businesses slashed the inventories they hold on shelves and back lots by 0.6 percent in October, three times the 0.2 percent decline economists expected. It was the biggest cut in inventories since August of 2003. Inventories are closely watched signals of business confidence. When companies are reducing their stockpiles because they are worried about future sales, it can further depress overall economic growth. The reports come a day after the Labor Department said initial jobless claims rose to the highest level in 26 years, though the work force has grown by about half over that time. Most Americans expect the jobs situation to get even worse, according to a poll released Thursday by the Pew Research Center for the People & the Press. More than 60 percent believe unemployment will increase next year, and 73 percent plan to cut back on holiday gifts this year.
Questions Are Raised in Trader’s $50 Billion Fraud
For years, investors, rivals and regulators all wondered how Bernard L. Madoff worked his magic. But on Friday, less than 24 hours after this prominent Wall Street figure was arrested on charges connected with what authorities portrayed as the biggest Ponzi scheme in financial history, hard questions began to be raised about whether Mr. Madoff acted alone and why his suspected con game was not uncovered sooner. As investors from Palm Beach to New York to London counted their losses on Friday in what Mr. Madoff himself described as a $50 billion fraud, federal authorities took control of what remained of his firm and began to pore over its books. But some investors said they had questioned Mr. Madoff’s supposed investment prowess years ago, pointing to his unnaturally steady returns, his vague investment strategy and the obscure accounting firm that audited his books.
Despite these and other red flags, hedge fund companies kept promoting Mr. Madoff’s funds to other funds and individuals. More recently, banks like Nomura, the Japanese firm, began soliciting investors for Mr. Madoff internationally. The Securities and Exchange Commission, which investigated Mr. Madoff in 1992 but cleared him of wrongdoing, appears to have been completely surprised by the charges of fraud. Now thousands, possibly tens of thousands, of investors confront losses that range from serious to devastating. Some families said on Friday that they believed they had lost all their savings. A charity in Massachusetts said it had lost essentially its entire endowment and would have to close. According to an affidavit sworn out by federal agents, Mr. Madoff himself said the fraud had totaled approximately $50 billion, a figure that would dwarf any previous financial fraud.
At first, the figure seemed impossibly large. But as the reports of losses mounted on Friday, the $50 billion figure looked increasingly plausible. One hedge fund advisory firm alone, Fairfield Greenwich Group, said on Friday that its clients had invested $7.5 billion with Mr. Madoff. The collapse of Mr. Madoff’s firm is yet another blow in a devastating year for Wall Street and investors. While Mr. Madoff’s firm was not a hedge fund, the scope of the fraud is likely to increase pressure on hedge funds to accept greater regulation and transparency and protect their investors. On Thursday, the Federal Bureau of Investigation and S.E.C. said that Mr. Madoff’s firm, Bernard L. Madoff Investment Securities, ran a giant Ponzi scheme, a type of fraud in which earlier investors are paid off with money raised from later victims — until no money can be raised and the scheme collapses.
Most Ponzi schemes collapse relatively quickly, but there is fragmentary evidence that Mr. Madoff’s scheme may have lasted for years or even decades. A Boston whistle-blower has claimed that he tried to alert the S.E.C. to the scheme as early as 1999, and the weekly newspaper Barron’s raised questions about Mr. Madoff’s returns and strategy in 2001, although it did not accuse him of wrongdoing. Investors may have been duped because Mr. Madoff sent detailed brokerage statements to investors whose money he managed, sometimes reporting hundreds of individual stock trades per month. Investors who asked for their money back could have it returned within days. And while typical Ponzi schemes promise very high returns, Mr. Madoff’s promised returns were relatively realistic — about 10 percent a year — though they were unrealistically steady.
Mr. Madoff was not running an actual hedge fund, but instead managing accounts for investors inside his own securities firm. The difference, though seemingly minor, is crucial. Hedge funds typically hold their portfolios at banks and brokerage firms like JPMorgan Chase and Goldman Sachs. Outside auditors can check with those banks and brokerage firms to make sure the funds exist. But because he had his own securities firm, Mr. Madoff kept custody over his clients’ accounts and processed all their stock trades himself. His only check appears to have been Friehling & Horowitz, a tiny auditing firm based in New City, N.Y. Wealthy individuals and other money managers entrusted billions of dollars to funds that in turn invested in his firm, based on his reputation and reported returns. Victims of the scam included gray-haired grandmothers in Florida, investment companies in London, and charities and universities across the United States.
The Wilpon family, the main owners of the New York Mets, and Yeshiva University both confirmed that they had invested with Mr. Madoff, and a Jewish charity in Massachusetts said it would lay off its five employees and close after losing nearly all of its $7 million endowment. Other investors included prominent Jewish families in New York and Florida. On Friday afternoon, investors and lawyers for investors with Mr. Madoff packed Judge Louis L. Stanton’s courtroom at federal court in Manhattan, hoping to question lawyers for Mr. Madoff and the S.E.C. But a deputy for Judge Stanton canceled the hearing, leaving investors with few answers. Several investors said they were planning to file lawsuits against the firm in the hope of recovering some money. Based on the vagueness of the complaints against Mr. Madoff, his confession, as detailed in court filings, seems to have taken the F.B.I. and S.E.C. by surprise. Investigators have not explained when they believe the fraud began, how much money was ultimately lost and whether Mr. Madoff lost investors’ money in the markets, spent it, or both. It is not even clear whether Mr. Madoff actually made any of the trades he reported to investors.
The F.B.I. and S.E.C. have also not said whether they believe Mr. Madoff acted alone. According to the authorities, Mr. Madoff told F.B.I. agents that the scheme was his alone. He worked closely with his brother, sons and other family members, many of whom have retained lawyers. Also likely to face very difficult questions are the hedge funds, investment advisers and banks that raised money for Mr. Madoff. At least some big investment advisers steered clients away from putting money with Mr. Madoff, believing the returns could not be real. Robert Rosenkranz, principal of Acorn Partners, which helps wealthy clients choose money managers, said the steadiness of the returns that Mr. Madoff reported did not make sense, and the size of his auditor raised further concerns. "Our due diligence, which got into both account statements of his customers, and the audited statements of Madoff Securities, which he filed with the S.E.C., made it seem highly likely that the account statements themselves were just pieces of paper that were generated in connection with some sort of fraudulent activity," Mr. Rosenkranz said.
Simon Fludgate, head of operational due diligence for Aksia, another advisory firm that told clients not to invest with Mr. Madoff, said the secrecy of his strategy also raised red flags. And Mr. Madoff’s stock holdings, which he disclosed each quarter with the Securities and Exchange Commission, appeared to be too small to support the size of the fund he claimed. Mr. Madoff’s promoters sometimes tried to explain the discrepancy by explaining that he sold all his shares at the end of each quarter and put his holdings in cash. "There were no smoking guns, but too many things that didn’t add up," Mr. Fludgate said. However, the S.E.C. had already investigated Mr. Madoff and two accountants who raised money for him in 1992, believing they might have found a Ponzi scheme. "We went into this thing just thinking it might be a huge catastrophe," an S.E.C. official told The Wall Street Journal in December 1992. Instead, Mr. Madoff turned out to have delivered the returns that the investment advisers had promised their clients. It is not clear whether the results of the 1992 inquiry discouraged the S.E.C. from examining Mr. Madoff again, even when new red flags surfaced.
Meanwhile, Fairfield Greenwich Group, whose clients have $7.5 billion invested with the Madoff firm, said it was "shocked and appalled by this news." "We had no indication that we and many other firms and private investors were the victims of such a highly sophisticated, massive fraudulent scheme." At the court hearing, an individual investor, who declined to give his name to avoid embarrassment, expressed a similar sentiment. "Nobody knows where their money is and whether it is protected," the investor said. "The returns were just amazing and we trusted this guy for decades — if you wanted to take money out, you always got your check in a few days. That’s why we were all so stunned."
Spain may have $4 billion exposure to Madoff fraud
Spanish investors could have up to 3 billion euros ($3.98 billion) of exposure to funds managed by Wall Street trader Bernard Madoff, accused of masterminding a fraud of up to $50 billion, Expansion said on Saturday. 'The first estimates suggest both groups (large fortunes and Spanish funds) could have invested more than 3 billion euros in vehicles managed by Madoff,' the financial daily said without naming its sources.
Investors in hedge fund Optimal, run by Spain's largest bank Santander, Santander's private banking subsidiary Banif, M&B Advisers Gestion (M&B Capital Advisers) and Spain's second largest bank BBVA were among those affected, the same sources told the paper. A spokesman for BBVA said BBVA customers in Spain were not exposed to the fraud. 'BBVA has not commercialised in its network of retail clients or private banking in Spain products managed or deposited in Madoff Investment Securities,' he said.
A spokesman for Santander declined to comment on whether it had exposure. Santander's Optimal has commercialised more than $3 billion dollars of Madoff funds, the newspaper ABC said, citing data from Bloomberg. Two funds of M&B Capital Advisers have $578 million invested in a Madoff hedge fund, ABC said, citing Bloomberg data. No one was available to comment at M&B Capital Advisers.
Executive Accused of Mortgage-Securities Scheme
A financial executive used little more than a pen to alter credit scores and reclassify mobile homes as single-family houses, inflating the value of thousands of mortgages that were repackaged and sold to investors, prosecutors allege. Federal prosecutors in Miami on Thursday charged Steven Gordon, 49 years old, a former partner at Bayview Financial LP, with one count of wire fraud, in one of the first cases highlighting investigators' efforts to move beyond low-level mortgage schemes and delve into suspected fraud in the mortgage-securities business involving bigger financial firms.
Mr. Gordon, a former director of residential acquisitions at Bayview, made more than $2.8 million in additional commissions by altering the value of 2,800 loans from 2001 to 2006, according to documents filed by prosecutors in U.S. District Court in Miami. Bayview said in a securities filing that after it discovered the fraud, it bought out or substituted potentially fraudulent loans valued at $66 million. It said there were no investor losses. Mr. Gordon plans to plead guilty to the wire-fraud count, according to his lawyer. Prosecutors said Mr. Gordon is expected to turn himself in to federal authorities Monday.
Mr. Gordon no longer works at Bayview, but his lawyer said he continues to work in the mortgage industry. "I am appalled at how easy it was for him to do this," U.S. Attorney R. Alexander Acosta said. "You would think there would be more due diligence." The case comes as Justice Department and Federal Bureau of Investigation officials push to determine the role fraud may have played in the inflation and subsequent collapse of sophisticated mortgage-backed securities, which have deepened the turmoil facing Wall Street firms.
The case against Mr. Gordon offers a snapshot of the ease with which some mortgage-backed securities became tainted. Federal investigators say Mr. Gordon reviewed portfolios of Bayview loans and plucked out certain mortgages that he wanted to make more valuable before securitization. On some, he simply used a pen to increase the credit scores of borrowers, making the loans appear less risky and more valuable to investors, according to investigators. On others, he changed internal codes used to classify mobile homes or vacant land and reclassified them as single-family homes, investigators said. Marty Steinberg, the lawyer for Mr. Gordon, said the conduct was "aberrant behavior" for his client. "When it occurred, Steve admitted he made a mistake in judgment. He has made full restitution," Mr. Steinberg said.
Bayview, of Coral Gables, Fla., is one of thousands of players in the mortgage-securitization business, buying portfolios of loans from banks and pooling those mortgages into "special-purpose entities" that it uses to issue securities sold to institutional and other investors. Bayview officials said in a conference call with investors in 2006 that it repurchased or substituted new loans to replace mortgages on which data had been altered. Out of a total of $3.3 billion in securitized residential mortgages outstanding at the time, the data alteration affected 2% of the loans, according to a transcript filed with securities regulators.
It isn't known which financial firms bought the securities backed by the altered loans. Brian Bomstein, Bayview general counsel, said that "no investor suffered a loss" from Mr. Gordon's alleged scheme. Securities and Exchange Commission investigators conducted an informal inquiry into Mr. Gordon's conduct in 2006 and concluded it without taking any enforcement action, the firm said in a securities filing.
Why home values may take decades to recover
Rick Wallick moved into a new, three-bedroom $200,000 home in Maricopa, Ariz., in October 2005. Today, the home is worth $80,000. The disabled software engineer stopped making mortgage payments this month. His $70,000 down payment is now worthless. His dream house will be foreclosed on next year. "We're so far underwater it's not funny," says Wallick, 57, who had to return to his original home in Oregon to care for a sick family member and tend to his own medical problems. Wallick, one of the hardest-hit victims in one of the states hit hardest by the housing crisis, lost 60% of his home's value in three years. His story is an extreme example, but home values have fallen so sharply since hitting a historic peak in the spring of 2006 that many Americans are wondering how much more prices can sink.
As painful as the decline has been, history suggests home values still may have a long way to drop and may take decades to return to the heights of 2? years ago. "We will never see these prices again in our lifetime, when you adjust for inflation," says Peter Schiff, president of investment firm Euro Pacific Capital of Darien, Conn. "These were lifetime peaks." The boom in home prices — fueled by heavily leveraged loans built on low or even no down payments — made it easy to forget that housing values had been remarkably stable for a half-century after World War II, rising at roughly the same pace as income and inflation. Prices soared in most of the country — especially in Arizona, California, Florida and Nevada and metro areas of Washington, D.C., and New York — during a brief period of easy lending, especially from 2002 to 2006. That era's over. So far, home values nationally have tumbled an average of 19% from their peak. As bad as that is, prices would need to fall as least 17% more to reach their traditional relationship to household income, according to a USA TODAY analysis of home prices since 1950. In that scenario, a $300,000 house in 2006 could be worth about $200,000 when real estate prices hit bottom.
The price plunge has wiped out trillions of dollars in home equity and caused the worst financial crisis since the Great Depression. Susan Wachter, professor of real estate at the University of Pennsylvania, fears that foreclosures and tight credit could send home prices falling to the point that millions of families and thousands of banks are thrust into insolvency. "Homes are different than other goods and services," she says. "The fragility of our banking system is tied to the value of homes." Home values have fallen before — during the Great Depression and in Texas after a 1980s oil boom, for example — but those drops were a response to other economic forces. This time, the housing price collapse is the cause of the nation's broad economic troubles, not just an effect. "If we have another 20% decline in prices, we'll need another bailout of banks similar to what we just did," Wachter says. Other economists see a brighter picture in the long term. Wachovia economist Adam York expects home values to keep falling until 2010 but is optimistic they will recover. "The one saving grace is the population is growing by 3 million people a year," he says. "They need to live somewhere. That means more roofs."
Until recently, homes were stable, unspectacular investments, not get-rich-quick schemes. Nationally, the typical existing home was worth roughly the same in 2000 as it was in 1950, after adjusting for inflation, according to Yale University economist Robert Shiller. Newly built homes generally were bigger and more expensive than older houses. As time passed, that meant Americans lived in larger, more valuable homes overall. But a house, once constructed, grew slowly in value. California in the 1970s, Texas in the 1980s and Florida on-and-off for a century were conspicuous exceptions to the rule. Despite only modest increases in value, homes were smart investments. Owners lived in a house, then got their money back when they sold. That's a better deal than renting. Borrowers got tax breaks, too, and built equity that could be leveraged into bigger houses as their incomes grew.
From 2002 to 2006, houses went from being a tortoise to a hare in the investment world. Home sale profits and relaxed lending standards such as lower down payment requirements and adjustable-rate mortgages (ARMs) made it possible for buyers of all income levels to pay more for houses. When the housing bubble began to deflate in 2006, history had a sobering lesson to teach. Home values had closely tracked three common-sense measures for many years:
- Income - Home values floated at about three times average household income from 1950 to 2000. In 2006, the average household income was $66,500. Under the traditional model, home prices should have been about $200,000. Instead, the typical home sold for $301,000.
- Rent - Homes traditionally have sold for about 20 times what it would cost to rent them for a year. In 2006, houses were selling for 32 times annual rent.
- Appreciation - Existing homes grew in value by less than 0.5% per year, after adjusting for inflation, from 1950 to 2000. From 2000 to 2006, home prices rose at an average annualized rate of 8.2% above inflation and peaked with a 12.3% jump in 2005. Housing prices began to fall in the second quarter of 2006.
Inflation could help homes recapture their old prices, if not their value. But when inflation is factored in, home prices might not return to their 2006 peak for many years. Housing prices are meaningless if you don't adjust for inflation, says Schiff, the investment manager. He points out that gold peaked in 1980 at $850 an ounce in response to inflation and the Iranian hostage crisis. It never recovered. Today, it sells for about $750 an ounce and would have to top $2,000 an ounce when adjusted for inflation to match its value in 1980. "That's the nature of bubbles," Schiff says. "The price never comes back."
An extreme relaxation of lending standards inflated the housing bubble. "Shoddy underwriting on mortgages" is the primary cause of the housing crisis, says York, the Wachovia economist. "People got caught off-guard by how bad it was." Millions of home buyers — poor, rich and middle class — were approved to buy homes at prices that had been out-of-reach just a few years earlier. Lenders offered low introductory "teaser" rates on adjustable rate mortgages and approved borrowers based on artificially low mortgage payments, not the higher ones that took effect later.
What else changed:
- Optional payments on principal - In 2005, 29% of new mortgages allowed borrowers to pay interest only — not principal — or pay less than the interest due and add the cost to the principal. That was up from 1% in 2001, according to Credit Suisse, an investment bank.
- No verification of income - Half of mortgages generated in 2006 required no or minimal documentation of household income, reports Credit Suisse.
- Tiny down payments - In 1989, the average down payment for first-time home buyers was 10%, reports the National Association of Realtors. In 2007, it was 2%. Low down payments and ARMs gave homeowners enormous financial leverage to pay high home prices. Leverage boosts buying power through debt, the same way a 100-pound woman uses a lever to jack up a 3,000-pound car.
Consider a couple with $20,000 cash. In 2006, they easily could get a 5% down mortgage to buy a $400,000 house. Today, a 10% down payment would limit the couple to a $200,000 house. "Leverage matters a lot when you buy a house," says University of Wisconsin economist Morris Davis, an expert on housing prices and rents. "We're not going to go back to the days of only 20% (down payment) mortgages, but the days of putting nothing down are long gone." Easy access to borrowed money reset all housing prices, even those paid by cautious borrowers. People of all income classes moved up a notch, Census Bureau housing data show.
The sale of new homes costing $750,000 or more quadrupled from 2002 to 2006. The construction of inexpensive homes costing $125,000 or less fell by two-thirds. The biggest boom was in the middle. Homes costing $200,000 to $300,000 became affordable to millions of families. The failed titans of home lending — Countrywide Financial, IndyMac Bank and Washington Mutual — specialized in high-risk, highly leveraged loans. "The price correction has been severe, rapid and probably permanent because lending standards have changed," says mortgage credit analyst Suzanne Mistretta, a senior director at Fitch Ratings, a bond rating company. "We are not going to see 2006 peak levels for a very, very long time."
The Great Depression of the 1930s was preceded by a real estate bubble, also fueled by loose lending standards and shrinking down payment requirements. Those real estate problems — and solutions — echo today's. Florida real estate was the epicenter of speculation in the mid-1920s. Developers ran up prices by selling to borrowers who put as little as 10% down. Those were shockingly risky loans at a time when the standard mortgage lasted five years and required a 50% down payment. The risky loans went bad first, but it was the spread of credit problems to the supposedly safe loans — five years and 50% down — that caused the housing market to collapse. The five-year loans required no payments to reduce principal. Homeowners expected to refinance mortgages when the loans expired, usually with the same lender. The stock market crash led to a "liquidity crisis" — no money to borrow — that dried up mortgage refinancing. Millions of families lost their homes to foreclosure. Falling prices on nearly everything — homes, farm crops, wages — made consumers reluctant to buy and banks afraid to lend.
As part of the New Deal, the government took control of millions of loans and restructured them into something new: the modern mortgage, with 20% down and principal that is repaid over the life of the loan. The government extended the mortgages to 15 years, then 25 and finally 30. When World War II ended in 1945 and the Baby Boom began the following year, the 30-year, fixed-rate mortgage became a cornerstone of society and led to unprecedented levels of homeownership. This resilient home finance system should recover in a few years, some analysts say. National Association of Realtors chief economist Lawrence Yun predicts home prices will keep falling in 2009 but could return to their 2006 peak in three years, not counting inflation. He says the bubble largely was confined to four states — California, Nevada, Florida and Arizona. "People who bought at the peak in those states will need time for prices to recover, even up to five years," he says. Yun says people who buy now "have much less risk of price declines and a great possibility of price gains."
The danger of rapidly falling home prices is that — similar to the Depression — potential buyers and lenders will stay away, fueling even sharper price declines. During the housing boom, buyers expected prices to rise, so they were quick to buy, borrow and pay a premium. As prices drop, home buyers wait for better deals. says economist Dean Baker of the liberal Center for Economic Policy Research in Washington, D.C. Lenders want bigger down payments to protect against the falling value of collateral. Homeowners lose equity, so they can't buy other houses. "Price declines can be a self-reinforcing mechanism," Wachter says. An out-of-control price collapse would have dire consequences, Baker says. Even the most conservative banks would find themselves carrying portfolios of toxic mortgage loans. If housing prices don't stabilize at traditional levels, financial troubles could spread everywhere — to credit cards, car loans and commercial mortgages, Baker says. "The waves of bad debt will just keep coming," he says.
Baker and Wachter want the U.S. government to take aggressive steps to help homeowners, not just financial institutions. They support expanding programs that restructure troubled mortgages to prevent a flood of foreclosed homes from coming on the market and driving prices below their traditional level. Rick Wallick is an example of how even cautious borrowers can be hurt by a price collapse. He made a 35% down payment on his house and got a 15-year, fixed-rate mortgage at 5.75%. Arizona's real estate mess wiped him out anyway. Now that he's in Oregon, he's renting out his Arizona house at a loss and can't afford to keep two homes. Wallick's Arizona house is surrounded by countless foreclosed homes and empty lots. He told his mortgage company that his December payment will be his last. "It may ruin my credit rating, but I can still buy food," he says.
Shelley McComb used a no-money-down, interest-only ARM to pay $199,000 in December 2006 for a new three-bedroom home near Birmingham, Ala. The house's assessed value briefly rose to $225,000. Now, she needs to move to Atlanta where her husband got a promotion. The McCombs put their home up for sale in March. After getting no offers, they dropped their price to $179,000. They'd settle for $160,000. Shelley McComb, 30, who manages a doggie day care center, says, "I wish we'd rented."
Freight Haulers Slam on the Brakes
In a normal year, Gordon Trucking Inc. might replace 20 percent of its fleet of 1,500 big rigs with new trucks. But given the bleak outlook for the freight business, the Pacific, Wash., hauler doesn’t intend to buy a single new truck next year. "We’re settling in for nuclear winter in the first half of 2009," said Steve Gordon, operating chief for the company, which hauls everything from paper products to electronics. He’s not alone. Some industry executives and analysts predict that 2009 could be the worst year for freight-transportation volume in three decades or more. As a result, companies in industries ranging from trucking to railroads to ocean shipping are scaling back sharply.
Ocean freighters are docking vessels and putting off delivery of new ships. Rail-car production is expected to plummet as railroads put box cars in storage rather than buy new ones. And U.S. trucking companies are projected to buy just 101,000 tractor-trailers next year, down an estimated 22 percent from this year and 64 percent from two years ago, according to freight-transportation forecaster FTR Associates. Next year "is going to be the worst year for transportation demand in 30 years," FTR economist Noel Perry said in an industry conference call last month.
The drop comes as weak consumer spending has prompted retailers and other businesses to delay or reduce orders. As the carriers have responded, their retrenchment already has reverberated across various industries that heavily rely on haulers to transport supplies and raw materials, including U.S. auto makers and homebuilders teetering on the brink of collapse. Business is so bad that FedEx Corp. and United Parcel Service Inc. canceled their annual predictions of how many packages they would handle in the peak shipping days before Christmas. The couriers, the world’s largest cargo airline and the world’s biggest ground courier, respectively, are looked to by economists and other analysts as barometers because they carry a combined average of 22 million packages a day. "The economy is so unpredictable that we’re just not comfortable making a prediction," said UPS spokesman Norman Black.
UPS, which reported a 9.9 percent decline in third-quarter profit, expects U.S. package volume in the current quarter to fall 4 percent from a year ago. FedEx on Monday substantially cut its earnings outlook for the fiscal year ending May 31 and said it would announce additional cost-curbing plans when it reports quarterly results on Dec. 18. FedEx declined to comment further. Trucking company Con-Way Inc. this week announced an 8 percent work force reduction in its freight division, eliminating about 1,450 positions. Across the trucking industry, volume fell 6.3 percent from July through October, when volume usually begins to grow as retailers restock their inventories ahead of the holiday season, according the American Trucking Associations. But not this year. November remained weak. "It doesn’t look like December’s any better," said Stifel Nicolaus & Co. analyst John Larkin. "It could actually be worse."
Several truck manufacturers, such as Daimler Trucks North America and Kenworth Trucking Co., are closing facilities, severely cutting back production or laying off employees. At a Kenworth plant in Renton, Wash., more than 400 employees will lose their jobs when the company, a subsidiary of Paccar Inc., suspends making heavy-duty highway trucks at the plant next year, according to Don Hursey of the machinists union, who said he has been briefed on the plans. Just a few years ago, the plant produced 50 big rigs a day, he said. A Kenworth spokesman declined to specify how many workers will lose their jobs. "This is the tip of the iceberg," Mr. Hursey said. "It’s going to be a disaster next year for the entire industry. I’m scared to death."
The picture is similar on the rails. Delivery of new railcars could drop below 40,000 next year from a projected 58,000 this year, according to analyst Paul Bodnar of Longbow Research in Cleveland. U.S. railroad car-load volume dropped 10 percent last month from a year earlier, the biggest drop since the Association of American Railroads began tracking such data in 1997. Norfolk Southern Corp. plans to cut costs by reducing the number of trains it operates, laying off workers and parking some rail cars, said Chief Executive Charles W. Moorman, citing the industry’s weakness last month. For ocean shipping lines, the global downturn is particularly brutal. The lines have been slashing prices in the face of plummeting demand. The industry also is plagued by overcapacity, as some carriers are taking delivery of new ships that were ordered several years ago, when the global economy was booming. Greek ocean shipper DryShips Inc. on Wednesday announced it was canceling $400 million in orders for four new dry-bulk vessels.
Maersk Line, the world’s largest ocean shipper by volume, plans to lay up eight vessels because of declining freight volume. Parent A.P. Moller-Maersk A/S reported a third-quarter drop of 3 percent. Should economic conditions fail to improve next year, the possibility of mothballing even more ships "is obviously something we have to look into," said Michel Deleuran, group senior vice president. "I have not experienced anything that is quite as severe as this." Not everyone in the freight-hauling industry is quite so gloomy, however. Ray Kuntz, the chief executive of Watkins Shepard Trucking Inc., said he expects business to improve in the second half of 2009 for stronger trucking firms that will pick up business as weaker competitors shut down. Still, the Missoula, Mont., company, which has 700 trucks and 1,100 employees, trimmed its work force by 5 percent in the fall and has no plans to buy new trucks next year.
British consumers adopt Depression-era mentality
Sales of home hair-dye kits and frozen food are surging as a Depression-era mentality sets in across Britain, the head of Asda said Thursday. Andy Bond, chief executive of the supermarket chain, said the group’s customers were also cutting back on ready meals and haircuts, and eating food past its use-by date in an attempt to save money. He warned that, as in the 1930s, the severity of the downturn would change consumer behaviour for a generation.
"This won’t be a recession where it’s a blip and then people return to how they were," he said. "Anyone waiting for things to get back to normal is mad." This Christmas, he said, toys were still being bought for children but sales of "gimmicky, throwaway gifts" for adults had collapsed. The most popular grown-up gift this winter, Asda says, will be a jumper. "We are moving into an area of the frivolous being unacceptable and the frugal being cool," Mr Bond said. "A whole new consumer generation will come out of this."
Sales of ready meals have dropped by up to 40 per cent year-on-year at Asda as people choose instead to buy ingredients and cook from scratch. Other supermarkets have seen similar trends. At Tesco, sales of coffee makers and Thermos flasks are up 75 per cent as people opt for home-made drinks instead of shop-bought lattes. Across the grocery sector, sales of bottled water and smoothies are falling as people opt to drink from the tap and eat fruit. Tesco says a quarter of its customers are buying products from is new Discounter range, while Sainsbury has seen a 25 per cent jump in sales of its Basics products, and says almost a third of shoppers say they would never switch back to big brands.
A survey of 2,500 Asda customers showed more than half were going out less, and almost 40 per cent had reduced their visits to the hairdresser, a service usually seen as recession-proof. Sales of do-it-yourself hair-dye have jumped by almost a third. The Wal-Mart-owned chain, the UK’s biggest grocer after Tesco, has used its reputation as the country’s cheapest large supermarket group to outperform many of its rivals as consumer spending shrinks. It says it has attracted 1m new customers this year, a 6 per cent rise on last year, including wealthier people trying to cut their weekly bills.
Shell's Dutch pension fund tumbles by 40%
Plunging equity markets have seen the total assets of Royal Dutch Shell's Dutch Pension Fund fall below the level required by Holland's central bank, although the company's UK pension scheme remains fully funded. The Dutch pension fund said that its coverage ratio had fallen to 85pc at the end of November. This followed a 40pc plunge in the value of the scheme's investments over the course of 2008.
The coverage ratio is the proportion of assets held by the fund compared with its future liabilities. A coverage ratio of 100pc means the fund has sufficient assets to meet all of its future obligations. A Shell spokesman noted that the company's contributory pension fund in the UK was managed separately and that it was fully funded, with the UK scheme benefiting from a move away from equities and into bonds in 2007.
Last month the Dutch Central Bank postponed the deadline for pension funds with a coverage ratio that had fallen below 105pc to draw up plans on how they were to make up the difference because of the global turmoil. The funds now have until April 1, 2009, to table a recovery plan.
If the Dutch pension scheme's coverage ratio drops below 105pc on a regular basis over a six-month period, Shell will have to make up the shortfall until the ratio again rises above the 105pc level.
German bank bail-out has failed, say MPs
Germany’s banking sector rescue has failed and should be modified urgently if lasting damage to the economy is to be avoided, the MPs who oversee the €500bn ($668bn, £449bn) of funds warned on Friday. In a letter to Peer Steinbrück, the finance minister, obtained by the Financial Times, the MPs said a €400bn fund set up by the government to guarantee bank debt had not led to a resumption of inter-bank lending and that German banks were not providing companies with sufficient credit. In addition to the €400bn fund, the bail-out also includes €80bn for capital injections and €20bn for the purchase of so-called "toxic assets".
The MPs’ appeal will add to pressure on Angela Merkel, chancellor, to reconsider her government’s financial markets stabilisation fund. The appeal may also add to international doubts about Germany’s handling of the financial crisis in the week that Mr Steinbrück harshly criticised the British economic strategy. "Although . . . we can expect that [the €400bn in guarantees] will have been used up in the near future, there is serious concern that the expected revival of the inter-bank lending market will not take place," Albert Rupprecht, chairman of the parliament’s financial markets committee, wrote to the finance minister. Speaking to the FT in a telephone interview, Mr Rupprecht said: "The expectation that stabilising a few financial institutions would kickstart interbank lending has not materialised. I fear the debt guarantees could soon be exhausted without this having happened."
Soffin, the body set up to run the financial sector rescue fund, said on Friday that it had approved €90bn of guarantees to Commerzbank, BayernLB, HSH Nordbank and Hypo Real Estate, and was considering requests from 11 other banks. It said it believed it had enough margin to cover all requests. Ms Merkel is known to be concerned about the availability of credit after receiving alarming reports that long-term investment in sectors ranging from shipbuilding to renewable energy was being being put on hold due to the absence of funding. Although small and mid-sized companies are still obtaining day-to-day financing from savings and co-operative banks, lending for larger projects has dried up.
The issue is likely to come up at a meeting at the chancellery on Sunday where Ms Merkel will discuss the state of the economy with cabinet ministers, economists, banking representatives, and business and union leaders. Mr Rupprecht urged Mr Steinbrück to consider setting up a central clearing house for interbank lending, whereby banks would lend to a government-managed body that would in turn provide short-term financing to other banks. The Bundesbank, which co-manages the stabilisation fund with the finance ministry, is known to be considering creating such a clearing-house.
Saving Volvo and Saab
One in every five cars sold in Sweden last year was a Volvo and Saab is the exclusive supplier to King Carl XVI Gustaf. So Sweden was never likely to abandon its two famous marques entirely to the mercies of parent companies Ford and General Motors. But while Thursday's promise of a 28 billion Swedish kronor ($3.44 billion) aid package offers Sweden's car-makers a lifeline, it may not be enough to ensure their long term survival. With the U.S. rescue plan for GM and Ford stalling in the Senate and more than 150,000 Swedish car industry jobs on the line amid falling sales and mounting losses, the Swedish car industry needs all the help it can get.
Of the total package, SEK20 billion is in credit guarantees for loans to help fund environmentally-friendly research. And SEK3 billion is for a government-run company to conduct research and strengthen competitiveness. That's good for the long-term viability of the companies, especially when added to the billions already spent by Ford and GM on new models and green technologies, such as biofuel. At the same time, the government has provided a further SEK5 billion in rescue loans to help the companies stay afloat long enough to restructure or liquidate. But if Ford and General Motors are forced to sell, this aid package will not be enough to allow Saab and Volvo to survive as standalone businesses and may not be enough to attract bidders.
All the European manufacturers have more or less ruled themselves out. The best hope is an Asian buyer, most likely an Indian or Chinese car-maker, although this too looks like a long shot. Volvo's unique selling point used to be its safety, but as standards have risen across the industry, this advantage has eroded. The brand now falls between stools: its record 458,323 cars sold worldwide in 2007 was well below that of a true volume producer such as Volkswagen which sold 3.66 million cars in the same period, but too few to be considered a specialist player. Saab, which sold just 125,000 cars in 2007, could just about qualify as a niche player but lacks Volvo's attractive large US dealer network.
Volvo and Saab's best chance may lie in a GM and Ford firesale. As every car dealer knows, the best way to shift stock is to knock a few zeroes off the price.
Citadel Halts Withdrawals From Two Hedge Funds After 50% Drop
Citadel Investment Group LLC, enduring its biggest losses since starting in 1990, halted year- end withdrawals from its two biggest funds after investors sought to take out $1.2 billion, or 12 percent of assets. Withdrawals may resume as early as March 31 for the Kensington and Wellington funds, the Chicago-based firm said in a letter yesterday to clients. The funds, which together manage about $10 billion, have lost 49.5 percent of their value this year through Dec. 5. "We have not made this decision lightly," Citadel founder Kenneth Griffin, 40, wrote. "We recognize how a suspension impacts our investors, especially those with current financial obligations of their own to meet."
Firms including Fortress Investment Group LLC and Tudor Investment Corp. also have limited redemptions to avoid dumping securities to raise cash. As of October, 18 percent of the industry’s assets, or about $300 billion, were subject to withdrawal restrictions, according to Peter Douglas, principal of Singapore-based hedge-fund consulting firm GFIA Pte. The limits have been imposed by about 5 percent of managers. Hedge funds declined 18 percent on average through Nov. 30, according to data compiled by Chicago-based Hedge Fund Research Inc. That’s the most in a year since the firm began tracking the data in 1990.
Citadel has among the strictest redemption rules. It normally allows clients to take out up to 1/16th of their money quarterly. If redemptions in any quarter exceed 3 percent of fund assets, investors incur a fee ranging from 5 percent to 9 percent. Withdrawals have never before surpassed the limit. The firm will also absorb "a substantial portion" of the funds’ expenses this year, the letter said. Citadel clients usually pay these charges, which have traditionally amounted to about 3 percent to 4 percent of assets. The fund is holding between 25 percent and 30 percent of its assets in cash.
Before 2008, Citadel had posted just one losing year, dropping 4 percent in 1994. Three Citadel funds, whose returns are tied to the firm’s market-making business, have climbed about 40 percent this year. Those funds manage about $3 billion. Hedge funds are private, largely unregulated pools of capital whose managers can buy or sell any assets, bet on falling as well as rising asset prices and participate substantially in profits from money invested.
For the Jet Set, a Newfound Austerity
Vilified for their role in the auto-industry meltdown, executives at Detroit's "Big Three" haven't done the corporate-jet business any favors either. Their unfortunate decision to take private planes to Washington for their first senatorial drubbing was a gift to critics of corporate excess. Negative publicity makes this downturn different from the last. In the slump following the Sept. 11, 2001 attacks, disruptions due to tougher airport security provided some justification for investing in a set of wings. In 2007, three-quarters of Fortune 100 companies disclosed personal use of corporate jets by chief executives, up from 59% in 2004, according to Equilar, an executive-compensation research firm.
"Now, any display of wealth is negatively perceived," says David Strauss, an analyst at UBS. Worse than this apparent revival of understatement is the sense that this is one more bubble that has gone pop. Globally, almost 1,000 business jets were delivered in the first nine months of 2008, according to the General Aviation Manufacturers Association, up 30% from a year earlier. But the second quarter almost certainly marked the cyclical peak. Falling asset prices are making even the richest tycoons feel poorer. U.S. corporate profits are sliding. Spreading economic weakness and a strengthening dollar crimp foreign aircraft buyers' purchasing power.
A UBS index that tracks business-jet industry conditions has plummeted to 13, an all-time low and well below the 50 mark indicating stability. U.S. takeoffs and landings fell an estimated 19% year-on-year in October. That is particularly grim for servicing firms -- grounded planes don't need much maintenance -- and airstrip operators. Stocks of manufacturers such as Bombardier and General Dynamics have dropped by between 30% and 40% this year, broadly in line with the S&P 500-stock index. But while investors have clearly recognized that the peak is past, they may still be too optimistic on the depth and duration of the downturn.
The critical factor is backlogs. Even if new orders slow, the preceding boom means plane makers have hundreds of deliveries scheduled over the next few years. But backlogs aren't money in the bank. In UBS's latest industry survey, 36% of respondents said financing had dried up, compared with just 6% in September. Business jets are typically purchased in installments, with much of the money paid in the 18 months leading up to delivery. Within a year of delivery, the buyer is more or less committed by the amount already invested. Further out, however, cash-strapped buyers might prefer to delay or simply walk, especially as expectations take hold that the price of planes will fall. The number of "delivery slots" -- or planes on order -- up for sale in the secondary market has surged since February.
If financing remains closed for an extended period, order backlogs will begin to evaporate and more used planes are likely to enter the market, pressuring prices. In UBS's worst-case scenario, deliveries fall 41% to 650 planes, excluding very light jets, by 2011 (its base case forecasts a 25% drop). Manufacturers' stock prices, already trading down to single-digit price/earnings estimates, could fall further. Longer-term, the hope is that underpenetrated markets such as Europe and Asia provide salvation. How much the current backlash against executive perks affects that is anyone's guess. One money-saving compromise could involve more bosses opting to participate in fractional-ownership schemes. That is a mitigating benefit for the likes of NetJets, while another worry for manufacturers. For shareholders of many of the companies that currently indulge top managers with a jet-propelled runaround, though, it is probably no bad thing.
DIP loan freeze may cause preemptive bankruptcies
The bankruptcy of newspaper publisher Tribune Co and potential filing by Nortel Networks Corp reflect the increasing difficulty of accessing loans in bankruptcy, which may cause companies to preemptively file for protection, Morgan Stanley said. Tribune filed for Chapter 11 bankruptcy protection on Monday, less than a year after the company was taken private in a deal led by real estate mogul Sam Zell. Instead of securing a debtor-in-possession (DIP) loan, which has traditionally been made to fund a company as it reorganizes in bankruptcy, the company reached an alternative financing deal with Barclays Capital.
This includes a $50 million letter of credit and continued use of a $300 million trade receivables facility it had made with Barclays in July. It has a $225 million balance on the facility. "Tribune's filing is telling, and what concerns us is that constraints on DIP financing will only worsen as the cycle wears on," Morgan Stanley analysts said on Friday in a report. The dramatic pullback in lending by banks and other lenders amid the global credit crisis has dried up access to DIP loans, in turn increasing the likelihood a company will need to liquidate if it fails. "The most telling evidence of the challenging DIP financing environment is that companies with significant cash levels are contemplating preemptive bankruptcy (Nortel is an example) as a means to continue to function in a DIP-less bankruptcy backdrop," Morgan Stanley added.
The Wall Street Journal reported on Wednesday that Nortel has sought legal advice on a bankruptcy protection scenario in the event that its restructuring plan fails. The popularity in recent years of companies taking out loans that were secured against their assets also complicates securing a DIP loan, as the companies are left with fewer unencumbered assets to pledge against the loan, Morgan Stanley said. "This is yet another example of the unintended consequences of the proliferation in leveraged loans and securitization over the past few years," the bank said.
Bankruptcy proceedings may also be more contentious than previously as corporate lenders have shifted away from banks to hedge funds and other investors. "The holders of paper heading into bankruptcy are very different in this cycle relative to history," Morgan Stanley said. "The involvement of hedge funds and Collateralised Loan Obligations (CLOs) shapes our expectation that the bankruptcy process will be contentious relative to the clubby democratic-type negotiations involving commercial banks' workout groups of the past," the bank added. CLOs are structured vehicles that repackage loans into portfolios that are sold on to generate higher returns.
Bombing in Woodburn, Oregon bank
Last evening, there was a bombing at a bank in the town of Woodburn, Oregon. I'm still trying to make sense of that fact, let alone that the small town's police chief was on the table before me. I won't go into detail, because every patient and their family has the right to privacy. I've never actively sought to break that solid creed. When I saw him, he'd already lost a leg and the other one was very badly damaged. When I took a break after five hours of surgery, I went with one of surgeons to meet the family and discuss our progress. The emotion in that room, from dozens of family and friends, was an entity unto itself. Vocal. Impassioned. Present. What I'm writing may seem graphic, probably unorganized, definitely to be respected as the family and friends of those effected by this incident are to be considered first and foremost.
But I respect everyone too much not to write about my experience; and perhaps I just need to let this one out a little because something happened to me during this case that hasn't happened during the thousands of other cases I've scrubbed in my past nine years. Whenever I enter a trauma room (an operating room that's prepared with specialty instruments and machinery designed specifically for acute trauma) I immediately take in the activities. It's not like television. It's not like anything else really. I'll see people talking on the phone, wide eyes, a lot of clear tubing with various colored fluid passing through them, some laughter at times, random styles of music might be playing in the background, pagers beeping. It's a sensory whiplash with a peppermint shock. It's a first kiss feeling. A cheyne stoke on a cigarette. It's a feeling you get when you know what's coming isn't just something that hasn't really happened before, but it has and you know to start expecting anything to come next.
What I've learned in over twenty years of direct patient care is that this anticipation of anything happens all the time. A lot of "front-liners" might be ex-military, trained or exposed to combat wounds that American civilian facilities aren't accustomed to see. I've seen some bad wounds, perpetrated for various reasons. Self-inflicted gunshot wounds, homicidal stabbings, pipebomb and fireworks accidents, deglovings from car crashes and even the mutilations that result from vengeful gang violence. All of these categories of injuries rouse the senses that I described above. They fill you with a n urgency that's tempered from doing a lot of them, but allowed to show just enough to express confidence and comfort in the unbiased messiness of it all. What happened to me tonight was new: It wasn't there.
I was confident to scrub the case. That hadn't changed. My understanding of the needs and procedures were present. That hadn't changed. I know these surgeons. I trust them. They're First Class. That hadn't changed. I treat every patient like they have a family member hanging on every move I make to do everything I can to help. That hadn't changed. But I had changed. I didn't feel anything tonight. It's gone. That spark that makes my direct involvement in trauma feel like a horse's kick to the heart -- gone. And it probably left long ago, but like a gunshot fired from miles away, the bullet hit me long before I ever heard the discharge. Tonight I realized that sensation really had left me, and now I'm left to wonder why.
This diary isn't exactly about the tragedy that took place in Woodburn; but it does have to do with how people react to trauma. It's not exactly about terrorism or it perpetuation on civilians; but it cannot exclude that setting off a bomb in a bank is just nothing short of wicked. I'm thinking about all of those family members, the dozens of them; and the dozens of local, city and state police officers that came here to the hospital tonight to show their support for the family and victims of this cowardly act. I'm thinking of you, reading this, wondering if I'm alright -- and I am. I am because I know that tomorrow this could happen again and it might not. But I know that when it does happen, I'll meet that need (like I have for decades now) but something will have changed in me: I won't feel as present as I used to feel.
Think well of the victims and families tonight. Thank the local, city and State police and emergency medical professionals that offer their services around the clock. Be thankful, and cherish what you have.
How private equity deals will deepen the recession
The once booming business of private equity faces an uncertain future. What’s not uncertain, however, is that many private equity deals are imploding from the weight of leveraged debt and greed. Inevitable bankruptcies will result in higher unemployment and a deeper recession. Private equity is an asset class consisting of equity securities in operating companies that are not publicly traded. The name "private equity" is the rechristened, kinder, and gentler, label for what used to be known as leveraged buyouts, or LBOs. But make no mistake about it, while leverage may not be part of the name any more, it remains a big part of every private equity deal.
LBO firms, or "franchises," as Henry Kravis, co-founder of Kohlberg Kravis Roberts & Co. (KKR), likes to call his shop, acquire publicly-traded operating companies. Then they streamline management and operations to increase profitability and hope to cash out through a merger, an outright sale of the company, or by taking the company public again through an initial public offering, or IPO. Private equity firms are the debutante sisters of hedge funds. They raise huge pools of capital from pension funds, endowment funds, sovereign wealth funds, institutional investors and wealthy entrepreneurs. But while hedge funds buy and sell the stocks of companies they hope to profit from, private equity shops buy whole companies. Generally, once a target is identified, an offer is made to buy a majority, or all of the stock of the company. The trick of the deal is to pay for the target by using as little equity capital as possible, and raising the remainder by actually having the target company borrow the required funds. Except for the private equity firm’s initial equity investment, the target company is essentially buying itself.
And if that isn’t enough of a trick, very often when the target is privatized, their new masters have the company borrow even more money so they can then pay themselves a dividend as a bonus for the good job they did in leveraging the company to the hilt so they can streamline it. The leveraged buyout business has been around for a long time and it has worked very well for investors and the private investment bankers who make an extravagant living with other people’s money. In fact, the business was so successful it eventually led to its now very problematic fork in the road. The problem facing private equity is that their leveraged deals were at one time in such great demand that it became too easy to borrow too much money. The result was that they chased too many deals, paid too much for targets, paid themselves too many dividends and fees, and now their portfolio companies are straining and collapsing under the weight of too much debt.
Act I: Two big mistakes that made leveraging possible
There are two elements that made massive borrowing possible. The first was a ready supply of capital courtesy of the U.S. Federal Reserve’s easy money policy and low interest rates. The second was the ability of banks that lend money to acquired companies to pool those loans into securities called collateralized loan obligations, or CLOs, and sell them off to investors. Banks and investors refer to this asset class as "leveraged loans." Since banks were able to sell off their leverage loans to investors, they had plenty of recycled money to lend out again and again. Competition to lend out all that money put borrowers in an advantageous position, which they exploited.
Banks and non-bank lenders attach covenants to the loans they make. Typically, covenants dictate to borrowers what specific balance sheet requirements must be met and include debt-to-cash flow leverage ratios, limitations on the total amount of debt a company can carry, minimum equity provisions and other dictates that serve to secure collateral that is relied upon by lenders. But, banks were so flush with money and so eager to lend that privately-acquired companies, driven by their new private equity masters, proposed that the money they borrowed should not be encumbered by the protective covenants lenders are use to demanding, hence the birth of "covenant-lite" loans. Covenant-lite loans included insane "reverse covenants" that benefited the borrowers not the lenders.
Among other things, some borrowers demanded and got rights to:
• Increase debt-to-EBITDA (Earnings Before Interest, Tax, Depreciation, and Amortization) levels to 10:1.
• Freely substitute collateral.
• Have collateral "released" outright.
• Issue unsecured debt equal to the total amount of existing debt (if they hedged or effected swaps.
• Employ PIK (payment-in-kind) options, where instead of paying interest in cash they could substitute more debt.
• Employ PIK toggles, sometimes called "extendibles."
PIK toggles (think of a toggle switch that is used to turn something on or off) let the borrower can roll interest payments into principal and extend the maturity, instead of making twice yearly cash payments. If that sounds like an option ARM mortgage, where borrowers can choose whether to pay the interest due, some part of it, or none of it, and rolls unpaid interest into principal, it’s because it is the exact same borrower covenant. It’s like déjà vu all over again.
Act II: With no leverage, private equity deals fall apart
Junk, junk, and more junk. When the music stopped and the credit crisis began last August, money and credit evaporated. Only then did it bother leveraged loan investors that the private equity guys were leveraging their private companies to pay themselves huge dividends – enough in many cases to repay the entire initial cash equity investment used to underpin the leveraged buyout of their targets. And only then did they realize that all the debt heaped onto these companies was going to drag many of them into bankruptcy. At that point, investors simply stopped buying leveraged loans. And the net result is that banks may be sitting on over $150 billion of junk leveraged loans that they can’t place. They are taking hits to their balance sheets as they have to mark down these loans that were securitized and subject to mark-to-market accounting. And they are terrified that the recession will drive more of these leveraged companies into bankruptcy.
Thomson Reuters recently reported that 40 private equity companies have sought bankruptcy this year. According to Standard & Poor’s, of 86 S&P rated companies that defaulted this year, 53 of them were private equity related transactions. Linens ‘n Things which was taken private by Apollo Group Inc. went bankrupt. Sharper Image, Wickes Furniture and catalogue company Lillian Vernon, were all taken private by Sun Capital Partners Inc., all of them are bankrupt. Mervyn’s, which was taken private by Sun Capital and Cerberus Capital Management LP., is bankrupt.
Also in the clutches of the three-headed-dog from Hades, Cerberus, is Chrysler LLC; Chrysler Financial, GMAC LLC (General Motors Acceptance Corporation) (GMA) – 51% owned by Cerberus – and Residential Capital LLC, a GMAC company. By most accounting standards, all of these companies are, if not already, close to insolvent.
GateHouse Media Inc. (GHS), 40% owned by Fortress Investment Group LLC (FIG), is at risk of debt default and may likely be headed for bankruptcy. Former Lazard Ltd. (LAZ) deputy chairman and media honcho Steve Rattner’s Quadrangle Capital Partners may lose control of American Media Inc., publisher of The National Enquirer and Star magazine, as he battles with bondholders and may also lose portfolio company Alpha Media Group Inc., publisher of Maxim magazine. These few examples of failures are just the tip of the iceberg. Then, of course, there’s the pure genius of PE firms coming to the rescue of troubled banks. But, TPG Capital (formerly Texas Pacific Group) doesn’t look so genius with its $7 billion investment in Washington Mutual Inc. (OTO: WAMUQ), which was wiped out in a matter of five months.
It’s understandable that bankrupt target companies are suing. Mervyn’s, for example, filed a 57-page suit against its lead dog master Cerberus, alleging fraud among other charges. But what is not as easily understandable is that some other lawsuits have the potential to turn the game viciously against the private equity firms and all the major bank lenders. I’m not talking about the deals that got done; I’m talking about the deals that didn’t get done because private equity firms walked away or otherwise tried to dissolve pending deals. Apollo Management asked a Delaware Court of Chancery to kill a transaction it had entered into to have one of its portfolio companies, Hexion Specialty Chemicals Inc., buy NYSE listed Huntsman Corp.(HUN) for $6.5 billion. Huntsman sued and won. The judge issued a ruling that Hexion "knowingly and intentionally" breached parts of the merger agreement and ordered the company to complete the deal. Not only is Apollo being forced to go through with the deal, the ruling allows Huntsman to seek damages from Apollo. Apollo is now suing the banks it had lined up to provide debt financing for the deal.
There are hundreds of billions of dollars of abandoned deals that may now be re-visited in courts around the country. The implication for private equity firms and banks is potentially staggering. Here are a few of the larger failed deals that resulted from a lack of debt investor interest:
• Cerberus’ failed deal for United Rentals Inc. (URI).
• The Blackstone Group LP’s (BX) failed deal for Alliance Data Systems Corp. (ADS).
• J.C. Flowers’ failed deal for SLM Corp. (SLM), also known as Sallie Mae.
• And Appaloosa Management in conjunction with Harbinger Capital Partners, Merrill Lynch & Co. Inc. (MER), Goldman Sachs Group Inc. (GS), and UBS Securities LLC’s failed financing of Delphi Corp. (OTC: DPHIQ) to take it out of bankruptcy, for which they are being sued for fraud and conspiracy to "derail" the bankruptcy plan; a serious situation because interfering with a bankruptcy is a federal crime. The amount of leverage involved in private equity deals is a problem if banks aren’t eager, or able, to supply needed loans. But that alone isn’t scary. What is scary is the effort private equity firms are making to actually get into the banking business themselves.
Act III: Private equity seeks to corrupt banking system
There’s a lot of pressure on banks to raise capital and there’s a lot of pressure being exerted by the private equity guys to lean on the Fed and U.S. Treasury to bend the rules to let them play in that sandbox. Pushing hard from the private equity camp are Randall Quarles, Managing Director of Carlyle Group Ltd. and a former senior Treasury official and none other than the former Treasury Secretary himself, Chairman of Cerberus Capital Management, John Snow. What the private equity guys want is the ability to buy into banks and control them. If they get their hands on the low cost deposit-based capital at commercial banks, they’ll be unstoppable. How about having the piggy-bank, backed by taxpayers to leverage at will? The prospect is frightening.
Right now there’s a limitation imposed on investors in Federal Deposit Insurance Company insured commercial banks. Once an investment exceeds 9.9% there must be an agreement with regulators to not "control or influence" management. If an investment exceeds 24.9%, the investing entity must register as a Bank Holding Company, and subject itself to all necessary transparencies called for by regulators and the Fed. In addition, the holding company is forced to serve as a "source of strength," meaning its capital will be called upon to support its bank. Private equity guys do not want any part of either of those restrictions. They don’t want their business looked through nor do they want their capital encumbered. The private equity firms are sitting on hundreds of billions of dollars of fresh money raised recently. While it may seem reasonable and expedient to allow private equity capital to be infused into ailing banks, any compromise of existing regulations would result in the creation of the mother of all moral hazard enablers.
There’s no doubt that if the recession is as deep and as long as feared, the continuing failure and bankruptcy of leveraged private equity portfolio companies will result in far greater unemployment, and in and of itself, has the potential to deepen the recession on an inordinate scale. There’s too much greed and far too much power in the form of private equity firms. Their greed has encumbered American banks with significant CLO and leveraged loan exposure and encumbered American companies with too much debt. Now, they threaten to undermine sound banking (wait a minute, that’s already been done by the banks themselves) by investing capital into them in order to control them. Until concrete underpinnings replace the glue and duct tape that’s holding together the banking system, and until leverage is wrung out of companies, investment vehicles and households, banks and private equity firms will both be on a slippery slope.
Too late? Why scientists say we should expect the worst
At a high-level academic conference on global warming at Exeter University this summer, climate scientist Kevin Anderson stood before his expert audience and contemplated a strange feeling. He wanted to be wrong. Many of those in the room who knew what he was about to say felt the same. His conclusions had already caused a stir in scientific and political circles. Even committed green campaigners said the implications left them terrified. Anderson, an expert at the Tyndall Centre for Climate Change Research at Manchester University, was about to send the gloomiest dispatch yet from the frontline of the war against climate change.
Despite the political rhetoric, the scientific warnings, the media headlines and the corporate promises, he would say, carbon emissions were soaring way out of control - far above even the bleak scenarios considered by last year's report from the Intergovernmental Panel on Climate Change (IPCC) and the Stern review. The battle against dangerous climate change had been lost, and the world needed to prepare for things to get very, very bad. "As an academic I wanted to be told that it was a very good piece of work and that the conclusions were sound," Anderson said. "But as a human being I desperately wanted someone to point out a mistake, and to tell me we had got it completely wrong."
Nobody did. The cream of the UK climate science community sat in stunned silence as Anderson pointed out that carbon emissions since 2000 have risen much faster than anyone thought possible, driven mainly by the coal-fuelled economic boom in the developing world. So much extra pollution is being pumped out, he said, that most of the climate targets debated by politicians and campaigners are fanciful at best, and "dangerously misguided" at worst. In the jargon used to count the steady accumulation of carbon dioxide in the Earth's thin layer of atmosphere, he said it was "improbable" that levels could now be restricted to 650 parts per million (ppm). The CO2 level is currently over 380ppm, up from 280ppm at the time of the industrial revolution, and it rises by more than 2ppm each year. The government's official position is that the world should aim to cap this rise at 450ppm.
The science is fuzzy, but experts say that could offer an even-money chance of limiting the eventual temperature rise above pre-industrial times to 2C, which the EU defines as dangerous. (We have had 0.7C of that already and an estimated extra 0.5C is guaranteed because of emissions to date.) The graphs on the large screens behind Anderson's head at Exeter told a different story. Line after line, representing the fumes that belch from chimneys, exhausts and jet engines, that should have bent in a rapid curve towards the ground, were heading for the ceiling instead. At 650ppm, the same fuzzy science says the world would face a catastrophic 4C average rise. And even that bleak future, Anderson said, could only be achieved if rich countries adopted "draconian emission reductions within a decade". Only an unprecedented "planned economic recession" might be enough. The current financial woes would not come close.
Anderson is not the only expert to voice concerns that current targets are hopelessly optimistic. Many scientists, politicians and campaigners privately admit that 2C is a lost cause. Ask for projections around the dinner table after a few bottles of wine and more vote for 650ppm than 450ppm as the more likely outcome. Bob Watson, chief scientist at the Environment Department and a former head of the IPCC, warned this year that the world needed to prepare for a 4C rise, which would wipe out hundreds of species, bring extreme food and water shortages in vulnerable countries and cause floods that would displace hundreds of millions of people. Warming would be much more severe towards the poles, which could accelerate melting of the Greenland and West Antarctic ice sheets. Watson said: "We must alert everybody that at the moment we're at the very top end of the worst case [emissions] scenario. I think we should be striving for 450 [ppm] but I think we should be prepared that 550 [ppm] is a more likely outcome." Hitting the 450ppm target, he said, would be "unbelievably difficult".
A report for the Australian government this autumn suggested that the 450ppm goal is so ambitious that it could wreck attempts to agree a new global deal on global warming at Copenhagen next year. The report, from economist Ross Garnaut and dubbed the Australian Stern review, says nations must accept that a greater amount of warming is inevitable, or risk a failure to agree that "would haunt humanity until the end of time". It says developed nations including Britain, the US and Australia, would have to slash carbon dioxide emissions by 5% each year over the next decade to hit the 450ppm target. Britain's Climate Change Act 2008, the most ambitious legislation of its kind in the world, calls for reductions of about 3% each year to 2050.
Garnaut, a professorial fellow in economics at Melbourne University, said: "Achieving the objective of 450ppm would require tighter constraints on emissions than now seem likely in the period to 2020 ... The only alternative would be to impose even tighter constraints on developing countries from 2013, and that does not appear to be realistic at this time." The report adds: "The awful arithmetic means that exclusively focusing on a 450ppm outcome, at this moment, could end up providing another reason for not reaching an international agreement to reduce emissions. In the meantime, the cost of excessive focus on an unlikely goal could consign to history any opportunity to lock in an agreement for stabilising at 550ppm - a more modest, but still difficult, international outcome. An effective agreement around 550ppm would be vastly superior to continuation of business as usual."
Henry Derwent, former head of the UK's international climate negotiating team and now president of the International Emissions Trading Association, said a new climate treaty was unlikely to include a stabilisation goal - either 450ppm or 550ppm. "You've got to avoid talking and thinking in those terms because otherwise the politics reaches a dead end," he said. Many small island states are predicted to be swamped by rising seas with global warming triggered by carbon levels as low as 400ppm. "It's really difficult for countries to sign up to something that loses them half their territory. It's not going to work." A new agreement in Copenhagen should concentrate instead on shorter term targets, such as firm emission reductions by 2020, he said.
The escalating scale of human emissions could not have come at a worst time, as scientists have discovered that the Earth's forests and oceans could be losing their ability to soak up carbon pollution. Most climate projections assume that about half of all carbon emissions are reabsorbed in these natural sinks. Computer models predict that this effect will weaken as the world warms, and a string of recent studies suggests this is happening already. The Southern Ocean's ability to absorb carbon dioxide has weakened by about 15% a decade since 1981, while in the North Atlantic, scientists at the University of East Anglia also found a dramatic decline in the CO2 sink between the mid-1990s and mid-2000s. A separate study published this year showed the ability of forests to soak up anthropogenic carbon dioxide - that caused by human activity - was weakening, because the changing length of the seasons alters the time when trees switch from being a sink of carbon to a source.
Soils could also be giving up their carbon stores: evidence emerged in 2005 that a vast expanse of western Siberia was undergoing an unprecedented thaw. The region, the largest frozen peat bog in the world, had begun to melt for the first time since it formed 11,000 years ago. Scientists believe the bog could begin to release billions of tonnes of methane locked up in the soils, a greenhouse gas 20 times more potent than carbon dioxide. The World Meteorological Organisation recently reported the largest annual rise of methane levels in the atmosphere for a decade. Some experts argue that the grave nature of recent studies, combined with the unexpected boom in carbon emissions, demands an urgent reassessment of the situation.
In an article published this month in the journal Climatic Change, Peter Sheehan, an economist at Victoria University, Australia, says the scale of recent emissions means the carbon cuts suggested by the IPCC to stabilise levels in the atmosphere "cannot be taken as a reliable guide for immediate policy determination". The cuts, he says, will need to be bigger and in more places. Earlier this year, Jim Hansen, senior climate scientist with Nasa, published a paper that said the world's carbon targets needed to be urgently revised because of the risk of feedbacks in the climate system. He used reconstructions of the Earth's past climate to show that a target of 350ppm, significantly below where we are today, is needed to "preserve a planet similar to that on which civilisation developed and to which life on Earth is adapted". Hansen has suggested a joint review by Britain's Royal Society and the US National Academy of Sciences of all research findings since the IPCC report.
Rajendra Pachauri, who chairs the IPCC, argues that suggestions the IPCC report is out of date is "not a valid position at all". He said: "What the IPCC produces is not based on two years of literature, but 30 or 40 years of literature. We're not dealing with short-term weather changes, we're talking about major changes in our climate system. I refuse to accept that a few papers are in any way going to influence the long-term projections the IPCC has come up with." At Defra, Watson said: "Even without the new information there was enough to make most policy makers think that urgent action was absolutely essential. The new information only strengthens that and pushes it even harder. It was already very urgent to start with. It's now become very, very urgent."