Famed Italian tenor Enrico Caruso with soprano Claudia Muzio in New York during his 15th year with the Metropolitan Opera and two years before his death
Ilargi: Today’s intro is a more philosophical introspection, from Bruce. On a day of meaningless rate cuts, that may well be the best approach, to do a little thinking outside of the masses' boxes and get some substance. The more meaningful nonsense will come soon and fast enough.
"Everybody complains about politicians. Everybody says they suck. Well, where do people think these politicians come from? They don't fall out of the sky. They don't pass through a membrane from another reality. They come from American parents and American families, American homes, American schools, American churches, American businesses and American universities, and they are elected by American citizens."
Bruce: A co-worker of mine is forever saying "of course".The government will screw this up - of course. Our section is understaffed again - of course. Of course this won't be done on time.Of course. "Of course" is a kind of cynicism, of course.It sounds wise and worldly, and that's the intent in using the phrase, but it's cynical. It says, not that there's no choice in the matter, but that no choice will be made when one was needed.
We like to complain about politicians, and about anyone who has the power to make decisions that affect our lives. Yet as Carlin observed, we create and support politicians through our institutions and at the ballot box. Our democracies - and I'm thinking of America, Canada, the European Union, and anywhere else that observes the ritual of pulling levers or marking X on a piece of paper - only function because a core fan-base thinks that their particular candidate will at least be less deplorable than the people running against him or her.
In our democracies we vote, when we vote at all, in favour of a name on a ballot or screen that is associated with a set of ideas and proposals that are called a platform - a sort of expedient world-view deemed appropriate by the candidate and his or her advisors. We can't pick and choose individual issues in those platforms.We select the name that represents the platform we can best live with, in our own lives. If our candidate wins, we delight in having our particular issues dealt with in the way we see as "obvious" and "necessary", and put up with the rest of the platform without thinking about it much - but since it's "our man" or "our woman" in office, we're sure they will deal with those things in a similarly resolute and inspired manner.
But I wonder about these allegiances. Why do we advocate and adhere to a worldview designed and expressed by someone else?What is it we believe about the way the world works that lets us rest satisfied, while someone else runs our world?You and I don't have our hands on the levers of power - we don't directly preserve the good and change the bad -so how does it happen that we endorse someone else acting as our proxy? I mean this in the widest sense.Not simply elected politicians - we the people (one of the great phrases and concepts in the history of the world) may at least take some measure to decide what personalities occupy those offices - but also those appointed by the elected. By what means do we trust them?
As a private citizen who was, until the present crisis, oblivious to the machinery of the financial system, I assumed that the persons set in those controlling offices knew what was best, not only in applying my contribution to the tax pool, but with that of the wider population and of industry. I assumed that the greatest good of the greatest number was being seen to, even if I was not aware of the means by which this was being done. When children used to attend a class called "Civics" in school, this was the governing assumption - that our system works: see how well, in our science, our industry, our arts, and in the dignity of hearth and home.
This has now vanished.
The trust is broken. Broken because the basis of that trust has been shown to be false. The image from the 1950's of a wife in a pretty print dress who tends to her breadwinner's every need is found ludicrous and predatory. A suburban home with white bread and television is a picture of imprisonment. The son who rises to soldierhood to die in some foreigner's land is not democracy's hero but a victim of a bad education and poor civilian prospects.
What of us now?The substance of those civics lessons that children used to receive no longer pertain.The fabric of the society that taught those optimistic lessons is torn apart. The American Way - and not merely the American Way, but the way of all industrial societies - is shown to be one of impunity, indifference to suffering, callousness toward the victims of business decisions, and obsessions with contemporary fashion and of lucrative trends.
Just the worst outcome of all the current cash injections and bailouts to banks and factories would be that they succeed brilliantly in restoring the status quo. That they allow the comfortably numb to stay that way. That they allow the true believer in capitalist industrialism to go on believing with their very essence that they are the pinnacle of human civilization. That our fathers were right all along, and that we should proceed on their course again.
Would that we do endure a decade of retreat and reconsideration. And that out of that we emerge a more patient, more tolerant, and wiser people.
There is a great deal of unmapped country within us which would have to be taken into account in an explanation of our gusts and storms.
New $3 Trillion Bailout Is Coming to the Masses
Pollster Frank Luntz asked a large audience at a conference in Washington last week to raise their hands if they had received a government bailout. While they chuckled and rested their hands on their laps, Luntz made an important observation. Bailout money is snowing down in an unprecedented blizzard, and if the moves fail to stimulate the economy, there will be a lot of angry voters Perhaps the same realization moved President-elect Barack Obama’s economic advisers to begin considering a bailout for the masses If Luntz asks the same question a few months from now, everyone may well lift their hand.
Bloomberg News last week reported that the chairman- designate of the National Economic Council, Lawrence Summers, had been conferring with conservative icon and Columbia Business School Dean Glenn Hubbard about a housing plan Hubbard designed with Columbia colleague Christopher Mayer. Obama’s economic advisers appear to have embraced the proposal, which is already "on a fast track at the Treasury," according to the story. The Hubbard-Mayer plan calls for the government to revive the moribund housing market by providing just about everybody with access to a 30-year fixed-rate mortgage with a 4.5 percent interest rate. That’s almost a full percentage point lower than the average national rate of 5.47 percent currently.
Buyers could borrow as much as 95 percent of the value of the home they purchase. The plan might extend to those with existing mortgages, allowing them to refinance and get the same terms. When either type of deal is complete, the lender will place the loan with Fannie Mae or Freddie Mac. Anyone refinancing with positive equity in their home would be relatively easy to accommodate. For those with negative equity -- meaning the dollar amount of their mortgage exceeds the value of their house -- Hubbard and Mayer recommend that homeowners and lenders split the loss evenly and start over with a clean mortgage reset to reflect the property’s current market value.
With some forecasts for fourth-quarter gross domestic product growth inching toward negative 8 percent at an annualized rate, drastic policy measures are becoming increasingly palatable. This mortgage plan is radical, and might just be powerful enough to help turn this troubled economy around. The bottom line: if you have a mortgage, this plan would put extra money in your pocket Imagine, for example, that you have a $500,000 mortgage with a 30-year fixed-rate loan carrying an interest rate of 6.1 percent, the average rate for a fixed 30-year mortgage issued this year. Lowering the interest rate to 4.5 percent would reduce monthly payments by about $500 monthly. Someone with a mortgage of $150,000 would save about $150 a month.
These monthly payments changes are different from tax rebates because they would last for many years. For that reason, consumers would be fairly likely to increase their spending. After all, if your monthly housing expenses just dropped by $400, then adding a new car payment of $300 a month might seem a lot less frightening, even in these difficult times. These subsidized mortgages should increase the number of home buyers and help push property values back up. There are a lot of problems in the economy, but they all began in the housing sector and it seems likely that staunching the bleeding there is a prerequisite for achieving financial stability. Make no mistake, this remedy will be costly.
Last week’s report suggests that the Obama team may be wary of allowing everyone access to this plan, since it costs so much -- $3 trillion by one recent estimate. One constraint being discussed is to disallow refinancing, limiting the program to home buyers. The restriction will be impossible to impose, however. All that you would need to do to qualify for the 4.5 percent rate would be to find a "bailout buddy" and agree to purchase each others’ homes with the new low-rate loan. You could then either swap the homes back, or agree to rent the homes to each other for the same fee.
Also, the program will have the largest possible effect on home prices, a key target of the policy, only if borrowers expect it to last a long time. After all, if the person you sell your house to in the future has to borrow at a high interest rate to finance the purchase, then he will offer a lower price. That realization should affect the price you are willing to pay today. Thus, the cost will be steep for two reasons. It will be tough to limit the new mortgage to home buyers, and the program will have to be sustained for a long time. In the past, steep costs would have killed such a bill. But in today’s environment, it has almost become a political necessity to give voters their bailout too. Ladies and gentlemen, grab your bailout buddy, help is on the way.
Fed Readies for Balance Sheet Tool as Rate Nears Zero
The Federal Reserve may today reduce its main interest rate to the lowest level on record and prepare for one of the boldest experiments in its 94-year history: using its balance sheet as the key tool for monetary policy. The Fed’s Open Market Committee will probably cut the benchmark rate in half, to 0.5 percent, according to the median of 84 forecasts in a Bloomberg News survey. The central bank may also signal plans to channel credit to businesses and consumers by further enlarging its $2.26 trillion of assets.
Chairman Ben S. Bernanke plans new steps to combat the credit crunch and prevent the worst recession in a quarter century from turning into a depression. The danger is the Fed’s credibility could be hurt if policy makers don’t clearly communicate a new strategy of manipulating the supply of money, at a time when FOMC members have diverging views on the subject. "We expect the FOMC to leave the policy outlook open- ended," said Louis Crandall, chief economist at Wrightson ICAP LLC, the world’s largest broker of trades between banks, in Jersey City, New Jersey. "The FOMC may have no choice but to muddle along for a while longer" because "there is no sign that a consensus on a new approach has begun to emerge," he said.
Investor speculation that the Fed will ease monetary policy today pushed yields on 10-year Treasury notes to the lowest since 1954. The dollar traded near a two-month low against the euro and was close to its weakest level in 13 years versus the yen. The last time the Fed detached money creation from setting interest rates was in 1979, when former Chairman Paul Volcker oversaw a violent upward move in borrowing costs. Dubbed the "Saturday Night Massacre," the effort was aimed at reining in inflation, which exceeded 13 percent that year. Bernanke, a scholar of the Great Depression, indicated in a Dec. 1 speech that policy makers will need to focus on "the second arrow in the Federal Reserve’s quiver -- the provision of liquidity," including options such as purchasing Treasuries to inject more cash into the economy.
A formal commitment to expand the balance sheet would constitute "the most extraordinary policy approach we have seen" so far, said Brian Sack, a former economist at the Fed’s Monetary Affairs Division, who is now senior economist at Macroeconomic Advisers LLC in Washington. The FOMC, which began meeting in Washington yesterday, is expected to release its statement around 2:15 p.m. Originally scheduled as a one-day meeting, the Fed extended its gathering to two days to discuss options that go beyond lowering rates. "This is really a great communications challenge," said William Ford, a former Atlanta Fed chief who’s now at Middle Tennessee State University in Murfreesboro. "It is going to take some educational effort to elaborate on how these policy options would work" because "people don’t know how to interpret what they are talking about."
The FOMC, which first started targeting the federal funds rate in the late 1980s, has lowered its benchmark by 4.25 percentage points since September last year. The last time it cut the rate to 1 percent, in 2003, the U.S. had already pulled out of a recession. This time, the central bank sees at least another half-year of economic contraction. It’s unclear how specific the Fed will be in today’s statement in outlining options after exhausting rate cuts. Bernanke has repeatedly invoked emergency powers not used to since the 1930s and expanded the Fed’s credit to the economy by $1.4 trillion. "The main focus of the Fed’s effort will shift to credit policies aimed at reducing credit spreads and improving the flow of funds in financial markets," said Mark Gertler, a New York University economics professor who has collaborated with Bernanke on research.
Fed policy makers disagree over the primary cause of the credit freeze. Central bank plans to buy $200 billion in consumer and small business loans and $600 billion in mortgage-backed securities suggest they consider rates remain high on home loans and credit cards because banks are unwilling to lend. Yet banks may instead be reacting to a decline in the credit quality of borrowers, Richmond Fed President Jeffrey Lacker said in a Nov. 19 speech. Tumbling property values and stock prices have hammered consumers’ finances. The net worth of U.S. households fell by $2.81 trillion to $56.5 trillion in the third quarter, the biggest decline since records began in 1952, according to the Fed’s Flow of Funds report.
"My reading of current conditions is that bank lending is constrained more now by the supply of creditworthy borrowers than by the supply of bank capital," Lacker said in his speech at the Cato Institute in Washington. Yield premiums on asset-backed securities surged as forecasters predicted a worsening recession and the unemployment rate increased to the highest level since 1993. Yields on AAA credit-card bonds maturing in three years rose to a record 5.75 percentage points more than the one-month London interbank offered rate this month, JPMorgan Chase & Co. data show. "The little bit of stability we have had is because there is an impression the Fed has almost unlimited resources and has adopted a tactic of intervention," said Ethan Harris, co-head of U.S. economic research at Barclays Capital Inc. in New York.
After rate cuts: The Fed's new ball game
After what is likely to be the last in a long series of interest rate cuts Tuesday, the Federal Reserve is expected to continue its new, perhaps more effective monetary strategy: printing lots of money. The Fed traditionally uses its rate-cutting tool to encourage lending and boost the economy. But despite a staggering 4.25 percentage points of cuts since September 2007, the economy has not improved - in fact, it has gotten worse, drifting in to a recession last December.
Economists expect the Fed to produce one more cut to its benchmark funds rate at the conclusion of its Federal Open Market Committee meeting Tuesday, trimming the rate to 0.5%, the lowest level on record. Whether one last rate cut will help stimulate economic growth remains to be seen. At any rate, the Fed will likely continue to use its new favorite tool, quantitative easing, "Fed-speak" for pouring new money into the economy.
In addition to lowering rates, the Fed has increased its lending to financial institutions and foreign central banks throughout the year to ease the credit crunch. But when the financial markets exploded into crisis-mode in mid-September, the Fed's reserve of Treasurys to support its lending began to run low. As a result, the central bank began firing up the printing presses, financing drastically increased lending to banks, purchases of corporate debt and bailouts of troubled institutions like AIG (AIG, Fortune 500).
As a result, the Federal Reserve's balance sheet has exploded since mid-September, more than doubling to $2.3 trillion from less than $1 trillion before Lehman Brothers' collapse ignited the lending crisis. The huge increase in Fed lending has helped to ease credit, encouraging private institutions to lend on their own. Perhaps the best example of this trend can be seen in the commercial paper market, which is short-term corporate debt that companies sell to investors. That key market dried up after Lehman's bankruptcy, but the Fed was able to restore it to health by purchasing more than $300 billion of paper. Private investors have followed, outpacing the Fed's weekly purchases for three weeks in a row.
The Fed may look to quantitative easing as a way of boosting the housing market. By buying up 10-year Treasurys in large volume - essentially the government buying up its own long-term debt - the Fed could help to lower mortgage rates for prospective homebuyers. Thirty-year fixed rate mortgages, which have historically moved in step with the 10-year note, currently hover around 5.5% despite 10-year Treasury yields of about 2.5%. Before the credit crunch, the rates were more typically within a range of 1.5 to 2 percentage points from one another. Economists say printing more money to help lower mortgage rates may get at the crux of the problem facing the economy.
"The combination of low home prices and low mortgage rates will make home affordability so much higher," said Bernard Baumohl, chief economist for the Economic Outlook Group. "Ultimately, housing is the epicenter that's holding back the banks and the economy from growing." Buying up droves of Treasurys may also help encourage banks to lend, as government yields dip even lower into already historic lows. Gaining little return on those investments, banks may be forced to return to their traditional money-maker, issuing loans.
But there is a dark side to quantitative easing: inflation. The government has backed all of this new debt by selling Treasurys, which have been the golden asset of the credit crisis. They have been the only liquid security of late, reaching historic highs as their yields have hit all-time lows. But there will come a time when the stock market bounces back and investors will no longer be satisfied with such low returns on their investments. "Everybody and their brother knows this has to come down some time," said Kim Rupert, fixed income analyst with Action Economics. "It's tough to continue to buy Treasurys at these unsustainable levels." That would mean huge amounts of government debt with little demand left to buy it, resulting in a devaluing of the dollar.
"The end result of all of this could be the next major problem: the crisis of confidence in the dollar," said Baumohl. "At some point, foreign investors are not going to come to the table to buy U.S. debt, leading to a dollar decline." The dollar has held up very well throughout the credit crisis despite very low interest rates. But with countries like China and Middle Eastern countries with export-based economies facing a crisis of their own, those huge purchasers of U.S. government debt may start to ask for more return on their investment before they look elsewhere.
"That won't happen until about 2010," Baumohl said. "Right now, people are just so nervous about the credit markets, they'll continue to buy Treasurys even with rates at ridiculously low levels." Treasurys continued to rise Monday as industrial production slid again, a sign that the economy will not rebound from the recession any time soon. The benchmark 10-year Treasury was up 19/32 to 110 27/32 and its yield dipped to 2.51% from 2.57% from late Friday. Bond prices and yields move in opposite directions. The 30-year rose 2 5/32 to 130 9/32 and its yield dipped to 2.95% from 3.05%, dropping below 3% for the first time in its history.
The 2-year note rose 1/32 to 100 31/32 and its yield dipped to 0.75% from 0.77%. The yield on the 3-month note was 0.02%, and has been hovering around 0% for days. Yields near the zero mark on short-term bills are an indication that investors are completely risk-averse, putting safety at a priority above profit. The Treasury Department said its auction of $27 billion of 6-month notes Monday was well-received, with $73 billion in open interest. The median yield for the notes was 0.17%, and the yield traded at 0.2% later in the afternoon.
Meanwhile, lending rates between banks continued to sustain record low levels. The overnight Libor rate held 0.12%, and the 3-month Libor rate fell to 1.87% from 1.92% late Thursday, according to Bloomberg.com. Libor, the London Interbank Offered Rate, is a daily average of what 16 different banks charge other banks to lend money in London, and is used to calculate adjustable-rate mortgages. More than $350 trillion in assets are tied to Libor.
The "TED spread" narrowed to 1.85 percentage points from 1.89 percentage points Thursday. The TED spread measures the difference between the 3-month Libor and the 3-month Treasury bill, and is a key indicator of risk. The higher the spread, the more unwilling investors are to take risks.Another indicator, the Libor-OIS spread, narrowed to 1.55 percentage points from 1.62 percentage points. The Libor-OIS spread measures how much cash is available for lending between banks, and is used for determining lending rates. The bigger the spread, the less cash is available for lending.
Housing Starts in U.S. Fell Record 18.9% to 625,000 Pace
U.S. builders broke ground in November on the fewest new homes since record-keeping began, signaling the housing slump will extend into a fourth year. Construction starts on housing fell 18.9 percent last month to an annual rate of 625,000 that was the lowest since the government started compiling statistics in 1959, the Commerce Department said today in Washington. The annual rate was lower than all 70 estimates in a Bloomberg survey of economists. Dwindling sales and multiplying foreclosures are forcing builders to hold off starting new homes. Decreases in construction spending continue to drag on the economy, increasing the odds of a prolonged recession.
"Builders are not only correcting for overbuilding but are also competing with a flood of foreclosed homes in the existing home market," Michelle Meyer, an economist at Barclays Capital Inc. in New York, said before the report. "It’s going to be hard for builders to increase construction in many parts of the country because of the huge overhang." The cost of living in the U.S. fell 1.7 percent last month, the most since record-keeping began in 1947, as the price of gasoline and other energy costs plunged, the Labor Department said. Economists had forecast starts would drop to a 736,000 annual pace from a previously estimated October rate of 791,000, according to the median forecast in the Bloomberg survey. Estimates ranged from 650,000 to 810,000. October starts were revised lower to 771,000 in today’s report. Compared with November 2007, starts were down 47 percent.
Building permits, an indicator of future residential projects, declined 15.6 percent to a 616,000 pace, also the lowest on record. Permits were forecast to drop to a 700,000 pace for November, from 730,000 a month earlier, according to the Bloomberg survey. Construction of single-family homes dropped 16.9 percent to a record-low 441,000 rate, today’s report showed. Work on multifamily homes, such as townhouses and apartment buildings, fell 23.3 percent from the prior month to an annual rate of 184,000. Housing starts declined in all regions of the country, led by a drop of 34.6 percent in the Northeast. Construction starts fell 23.1 percent in the Midwest, 16.8 percent in the West and 15.6 percent in the South.
The National Association of Home Builders/Wells Fargo index of builder confidence held at a record-low reading of 9 for December, the Washington-based association said yesterday. "The crisis continues," NAHB chairman Sandy Dunn, a builder from Point Pleasant, West Virginia, said in a statement. "While builders are doing everything we can in the way of price and non-price incentives to move new homes off the books, buyers are afraid to move forward, and in any case there is almost no way to compete with the cut-rate product that is continually flooding the market from mounting foreclosures."
U.S. foreclosure filings in November were 28 percent higher than a year earlier and a brewing "storm" of new defaults and job losses may force 1 million homeowners from their properties next year, RealtyTrac Inc. said Dec. 11. President-elect Barack Obama has said his economic team is working on plans to address the housing crisis. The worsening economic slump suggests the government may need to enact a stimulus package of $600 billion over a two-year period, Laura Tyson, an economic adviser to Obama, said yesterday in an interview on Bloomberg Television.
US considers $40 billion car industry funding
The US government is considering handing its ailing domestic car industry up to $40 billion (£26 billion) in funding as it tries to ascertain the exact extent of the companies' financing needs. The amount – almost three times the $14 billion the US Congress was considering handing to General Motors and Chrysler last week – is surprisingly high given the degree of divided opinion among US politicians and the general public as to whether to save the companies or let them file for Chapter 11 bankruptcy protection.
Both GM and Chrysler have said they do not have enough money to see them through to the end of this year, and require $4 billion and $7 billion respectively to get them through to January. Rival Ford asked for a bridging loan of $9 billion, but does not need the money immediately and is unlikely to receive any government money in the short-term. It is understood that President George W. Bush and his aides would rather give GM and Chrysler a fighting chance of survival, than give them a small amount of money now only for them to return and seek help from President-elect Barack Obama, when he takes office. As a result, White House and Treasury officials spent the weekend and much of Monday working with the two companies to try to assess not only how much money they need, but in what form it would best be delivered.
"An abrupt bankruptcy for autos could be devastating for the economy," said President Bush aboard Air Force One during his trip to Iraq and Afghanistan. "We're now in the process of working with the stakeholders on a way forward. We're not quite ready to announce that yet." As well as speaking to the companies themselves, discussions are thought to have taken place with the United Auto Workers union and the duo's bondholders, who could prove vital to any solution. Although President Bush and Treasury Secretary Hank Paulson are willing to use the $700 billion bank bail-out fund, it is thought other alternatives are being assessed, including the provision of debtor-in-possession (DIP) financing.
Bank of America analyst Jeffrey Rosenberg argues that DIP financing "helps to forestall….a systemic risk outcome by allowing companies to continue to operate and in this case to continue to make payments to their suppliers." But the problems in the US car industry are not restricted to domestic manufacturers, with Japan's Toyota announcing it had suspended construction of a new plant in Mississippi indefinitely until the market improves. The new factory, which will make Prius hybrids, was due to open in late 2010.
Goldman Sachs Reports Wider-Than-Estimated $2.12 Billion Loss
Goldman Sachs Group Inc. reported a fourth-quarter loss of $2.12 billion, the first since the company went public in 1999, as asset values and investment-banking fees declined. The loss of $4.97 a share in the three months ended Nov. 28 compared with net income of $3.22 billion, or $7.01, in the same period a year earlier, the New York-based company said today in a statement. The average estimate of 18 analysts surveyed by Bloomberg was for a loss of $3.73 per share.
Chief Executive Officer Lloyd Blankfein and six deputies gave up bonuses this year after the worst financial crisis since the Great Depression forced Goldman Sachs to convert to a bank- holding company and accept $10 billion from the U.S. government. The firm that set a Wall Street profit record in 2007 cut 10 percent of its employees last month as its stock plummeted 69 percent this year. "They're a survivor and they continue to pick up market share, but it's going to be volatile and you have to be able to stomach some risk," said William Fitzpatrick, an equity analyst at Optique Capital Management in Milwaukee, which oversees $1 billion and owns Goldman Sachs shares. Revenue is "going to be challenged for at least a 12- to 18-month period," he said.
Goldman Sachs and smaller rival Morgan Stanley, the only two of the biggest five U.S. securities firms to survive, changed into banks after investors lost confidence in companies that rely on debt-market funding. Merrill Lynch & Co., the third-biggest U.S. securities firm, agreed to sell itself to Bank of America Corp. in September just as Lehman Brothers Holdings Inc., the fourth-biggest, went bankrupt. Bear Stearns Cos., the smallest of the five, sold itself to JPMorgan Chase & Co. in March. Morgan Stanley will post fourth-quarter results tomorrow.
Warren Buffett's Berkshire Hathaway Inc. in September bought $5 billion of preferred stock in Goldman Sachs, which raised an additional $5.75 billion by selling common shares for $123 apiece to investors. The infusions failed to restore investors' confidence, and the firm received $10 billion from the U.S. government in October as part of a $700 billion financial- industry rescue plan. Goldman Sachs closed yesterday at $66.46 in New York Stock Exchange composite trading.
Glenn Schorr, an analyst UBS AG in New York, estimated in a Dec. 2 note to investors that Goldman Sachs would post a loss of $5.50 a share in the fourth quarter. "They've performed better than their peers, as only recently have they begun to post some losses," said David Killian, a portfolio manager at Valley Forge Advisors LLC in King of Prussia, Pennsylvania, which oversees $700 million and owns Goldman Sachs shares. "The volatility of the returns is an important component, and the more volatile the less people are willing to pay for it because they can't predict it."
Band Aid for the banking industry: "Bleed the World"
"At Christmas time we should always spare a thought for those less fortunate than us. After 20 years of bleeding the world, the global financial community has fallen on hard times. These people desperately need our thoughts, prayers and lots of our money. If you have any investments or savings left, or any money left over at the end of the month please, please give generously."
AIG Sells $39.3 billion in Mortgage-Backed Securities to Fed Vehicle for $19.8 billion
American International Group Inc. sold residential mortgage-backed securities with a face value of $39.3 billion to a government-funded facility as the U.S. seeks to limit losses at companies that did business with the insurer. AIG will receive about $19.8 billion for the assets, which were held by the insurer’s securities-lending program, the New York-based firm said today in a statement. The facility was mostly funded by the Federal Reserve Bank of New York, which may collect the majority of profits if it sells assets for more than the purchase price, according to a regulatory filing. The insurer paid $1 billion to the fund, said AIG spokesman Nicholas Ashooh.
The Fed has committed as much as $152.5 billion to rescue AIG from insolvency and minimize "disruption to the financial markets." AIG stumbled when it lent securities to investors and used the cash it got back as collateral to buy mortgage-backed securities that plunged in value. When the investors asked for the collateral back, AIG wasn’t immediately able to pay. "The creation and launch of this financing entity will eliminate the liquidity issues associated with AIG’s U.S. securities-lending program," Chief Executive Officer Edward Liddy said in the statement.
The securities-lending program has been "terminated," the statement said. Today’s deal replaces a $37.8 billion credit facility announced by the Fed Oct. 8 to help AIG meet its collateral requirements. Competing insurers Chubb Corp. and MetLife Inc. have also curtailed their own securities lending programs. The government rescue package includes a $60 billion loan, a $40 billion investment, as much as $30 billion to purchase assets underlying credit-default swaps sold by the insurer, and the money for securities lending.
AIG posted four straight quarterly losses totaling about $43 billion on bad bets on the housing market, including credit-default swaps protecting fixed-income investors against losses. The insurer, which agreed to turn over an 80 percent stake in exchange for the government rescue, has declined 97 percent this year in New York Stock Exchange composite trading. AIG slipped 6 cents today to $1.74.
Trichet Sees Rate-Cut Limit, Signals ECB May Pause
European Central Bank President Jean- Claude Trichet said there's a limit to how far the bank can cut interest rates and signaled policy makers may pause in January. "Do we have a feeling there is a limit to the decrease in rates? At this stage certainly yes," Trichet told journalists in Frankfurt late yesterday. The comments were embargoed until today.
Asked whether the ECB will refrain from a further rate reduction next month, Trichet said it wants to "concentrate at this stage on getting what we already decided to be really operational." With risk-averse banks still refusing to lend to each other after monetary policy was loosened at an historic pace, Trichet's ECB is more reluctant than the Federal Reserve and the Bank of England to fight the financial crisis with more rate cuts. The Fed may lower its benchmark rate to the lowest on record later today, and Bank of England Governor Mervyn King indicated U.K. policy makers are likely to keep reducing rates.
"The message from Trichet is that there is some caution at the ECB about cutting interest rates too far," said Klaus Baader, chief European economist at Merrill Lynch & Co. in London. "The ECB is going to focus more on making sure previous rate cuts are passed on to money markets, so we don't see them cutting as soon as January. There will be more cuts later." The ECB has lowered its benchmark rate by 175 basis points since October to 2.5 percent, the most aggressive reduction in its 10-year history. Europe's manufacturing and services industries contracted in December at the fastest pace in at least a decade, data showed today, indicating the economy is falling deeper into recession.
Investors are betting the slump will force the ECB to slice at least another 25 basis points off its key rate at its next policy meeting on Jan. 15, Eonia forward contracts show. Before Trichet's comments were published today, a 50-point cut had been fully priced in for January. The euro rose and the yield on the two-year note, the most sensitive to interest-rate expectations, pared gains. "We have to beware of being trapped at nominal rates that would be much too low," Trichet said. "It seems to me that it is certainly something we have in mind and we will have to examine that and reflect on that. But as you know, we never pre- commit."
"The ECB is taking an isolationist stance to differentiate itself from the Fed and the BOE," said Julian Callow, chief European economist at Barclays Capital in London, who believes the bank will pause next month and then cut its key rate to 1.25 percent by May. "In a way it's free riding on the U.S. fiscal stimulus plan, hoping it will help the global economy," said Callow. "However, with the Fed embarking on quantitative easing, it will push up the euro, which would be another massive blow to Europe's economy."
The Fed may today halve its main interest rate to 0.5 percent and signal plans to channel credit to businesses and consumers by further enlarging its $2.26 trillion of assets. The policy, known as quantitative easing, was adopted by the Bank of Japan for five years through March 2006 to fight deflation. While Trichet refused to rule out such measures given the "extraordinary" circumstances, he said it would "not be appropriate" at the moment for the ECB to start buying government bonds.
Instead he urged banks to lend to each other again and said the ECB is examining whether to cut its deposit rate further to discourage financial institutions from parking excess cash with it overnight. Banks deposited 178.4 billion euros ($244 billion) with the ECB yesterday. In the year to Sept. 15, deposits with the ECB averaged just 534 million euros a day. The euro interbank offered rate, or Euribor, that banks say they charge each other for three-month loans fell 4 basis points to 3.20 percent today, European Banking Federation data showed. While the lowest since August 2006, that's still 70 basis points more than the ECB's benchmark. The gap averaged 15 basis points in the seven years to August 2007, before the credit crisis began.
Since lowering the benchmark rate on Dec. 4 by 75 basis points, the biggest-ever single reduction, some ECB officials have indicated they're reluctant to cut borrowing costs much further. Executive Board member Juergen Stark said on Dec. 10 that the scope for further moves is "very limited" and Bundesbank President Axel Weber said the next day he "would like to avoid" the ECB's key rate falling below 2 percent. By contrast, Portugal's Vitor Constancio said last week that policy makers still have a "margin of maneuver" on rates to fight the "risk of a significant recession." Trichet said it's important to ensure that the ECB's 175 basis points of monetary easing to date "is effective in terms of going through the various channels and into the real economy."
In the face of fragility
Few understand better than Jean-Claude Trichet, European Central Bank president, the scale and complexity of the global economic crisis. He chooses a simple metaphor, however, to explain why everything went so wrong in the financial system. It was "as if we had been keen on eliminating a number of airbags from the car". Yet "now that we have an accident, we are surprised to see that we have a lot of scars". In an interview with the Financial Times, in his office near the top of Frankfurt’s Eurotower, Mr Trichet is clear that global capitalism has been driven in a reckless fashion and that it is time for policymakers to re-read the highway code. Such events "are very, very grave. They call into question the resilience of the full body of global finance and of part of the global economy, and we cannot afford to have such occurrences regularly. We have to draw all the lessons ... without any taboos".
Mr Trichet’s words carry weight not only in Europe because, at least since Alan Greenspan’s departure as US Federal Reserve chairman, he has been a senior prefect among global policymakers. Now five years in the job, he drew the ECB to the attention of the world in August 2007 when it took the lead in pumping emergency liquidity into paralysed financial markets, leaving other central banks scrambling to follow. Since the collapse three months ago of Lehman Brothers, the US investment bank, the ECB has massively expanded its financial market life-support operations. A university-trained engineer and literary buff, whose favourites include Shakespeare’s sonnets as well as French poetry, Mr Trichet learnt the ropes of global financial crises more than 20 years ago. It is tempting to suggest that as a former French Treasury official and then Banque de France governor, the 65-year-old has seen it all before – except that the current crisis is of dimensions certainly not seen in the ECB’s 10-year history.
But his prescription for putting the wheels back on the financial system is arguably out of kilter with views prevailing elsewhere, especially in Washington and London where instruction manuals are being torn up in an attempt to temper a sharp economic downswing. The ECB president – looking weary at the end of a year travelling the globe to co-ordinate rescue actions – argues forcibly that there are limits to policymakers’ actions and that the correct response depends crucially on an accurate insight into the workings of different economies. The ECB remains on accident alert. Mr Trichet points to the six black telephones on the conference table in his office, poised for teleconferences of the ECB’s 21-strong governing council at any hour (at least one has been held when it was past midnight in some eurozone countries). Just 90 minutes notice is required to summon a meeting, he boasts. "The full continent would be there. That’s very impressive because this would mean all members ... from Ljubljana to Helsinki and from Lisbon to Dublin."
Europe’s cultural and structural peculiarities require calibrated policy responses to rapidly deteriorating economic circumstances. This is clearest on fiscal policy stimulus packages. Whereas monetary policy is decided by the ECB in Frankfurt, tax and government spending policies are set in national capitals. To prevent monetary and fiscal policies clashing, the architects of Europe’s monetary union – which included Mr Trichet – drew up a "stability and growth" pact, laying down rules on the size of public sector deficits and debt levels. That pact, Mr Trichet insists, is a "quid pro quo for the fact that we do not have a federal budget and a federal government" and should continue to be respected. "We would destroy confidence if we blew up the stability and growth pact".
Mr Trichet will not discuss individual countries but appears to respect Germany’s refusal to pull out all the fiscal stops . With its relatively strong public finances, Europe’s largest economy is best placed to take advantage of the room for manoeuvre allowed under the stability pact. "I do not want to comment on any particular country, because my duty is to look at the whole continent of 320m fellow citizens," he says. "But I fully accept that there are differences in the capacity of households in various cultures to accept a deterioration in the situation." He cites so-called "Ricardian effects" – named after David Ricardo, the early 19th century economist – in which consumers fear that government spending today will mean higher tax bills in the future, so they cut their own outlays. "One might lose more by loss of confidence than one might gain by additional spending."
Rapidly escalating risk premiums on eurozone government bonds are also signalling market alarm over fiscal profligacy, Mr Trichet suggests. "You have the financial spreads, you have the potential Ricardian effects to take into account. This confirms that it’s good to respect the rules of the pact as they are, utilising, of course, the room for manoeuvre that they enshrine." The ECB president also highlights the role played in the eurozone by "automatic stabilisers" – whereby government spending rises and revenues fall in a downswing without governments taking any action. "An order of magnitude could be that for the same decrease of gross domestic product, you would have perhaps twice as much influence of automatic stabilisers as a percentage of GDP in the euro area as compared with the US. A large level of public spending as a proportion of GDP is not something that we necessarily have to be very proud of but, again, it’s some kind of an ‘amortiser’ in periods that are very difficult."
What, then, does Mr Trichet make of the UK’s fiscal interventions – where public sector borrowing is expected to hit 8 per cent of GDP next year – and the new US administration’s spending plans? The ECB chief is too diplomatic to criticise any government. But he argues that the world is "paying a price for the absence during a long period of time of appropriate balances in the various economies the world over ... What we are being told is – and again it’s a message for all industrialised countries in my understanding – that it is not a normal position, that it is a dangerous position to be domestically and externally significantly in imbalance." US policymakers recognise, Mr Trichet argues, that "there are limits ... if you think that you have no limits, then you are taught that there are limits by the Ricardian effects, by the financial markets themselves".
After the collapse of the dotcom bubble, Mr Trichet says, there was "a degree of excessive pessimism". Central banks were under pressure to cut interest rates to very low levels. "I am not criticising anybody and I know what pressure the ECB was resisting at the time." At the beginning of 2004, he recalls, "three heads of state and government of large countries were calling publicly on the ECB to decrease interest rates. I suppose, with the benefit of hindsight, it would appear extraordinary, taking into account what happened afterwards". The years that followed saw investors seeking higher yields, which together with low risk premiums and low levels of volatility encouraged an asset bubble – sowing the seeds of the current crisis. Mr Trichet's comment underlines European policymakers’ wariness about Mr Greenspan’s legacy. The lessons seem to have rubbed off on to ECB policymakers. In the past two months, the ECB has cut its main policy interest rate by a massive 175 basis points to 2.5 per cent – but other central banks have cut faster, and Mr Trichet indicates that the ECB is far from taking the exceptional steps under consideration, for instance at the Fed, to boost growth. Asked if the ECB would consider buying up government debt, he replies: "We’ll always look at the situation on the basis of our own analysis, taking everything into account. Today`, we will certainly not consider that it will be appropriate at all."
Still, for all his stress on the limitations that policymakers face, Mr Trichet is bold in his agenda for avoiding a future crash. Policymakers have to accept economic "ups and downs", but they have "an overwhelming duty?...toeliminate, as completely as possible, all the inbuilt elements in global finance that are amplifying the booms and the busts". That means looking at risk management in the banking system, at accounting rules and at the surveillance of the world’s systemically important economies. "The fragility not only of global finance but of the global economy itself is something we should reflect on. There are some key intermediate inputs that are produced in only three factories in the world. This is not reliable. We have this just-in-time system, with minimum inventories, which in case of a shock might make the full body of the real economy more immediately vulnerable," he warns. Similarly, "in the financial system we have eliminated a number of cushions and shock absorbers that we had here and there".
Invoking past decades when the free-market west faced a communist east, he observes that other countries "were devising other ideas, which failed, and it’s very good that they failed. However, the trust which was put in the resilience of the market economy is at stake now". Mr Trichet is vehement: "We cannot afford in future to put the concept of the market economy at risk as we did." After the collapse of Lehman Brothers in September, the European Central Bank dramatically increased its emergency liquidity operations, raising fears that the banking system would become too dependent on its support. But the ECB has been making healthy profits on the measures, writes Ralph Atkins.
Analysts’ calculations suggest the Frankfurt-based institution has earned at least €200m ($268m, £179m) in extra interest revenue this year as a result of its expanded operations – more than enough to cover the cost of paying its nearly 1,400 staff. The ECB has generated profits by charging interest on the liquidity it has lent to banks – currently it is offering unlimited amounts at a fixed interest rate on a weekly basis or for periods up to six months. In conjunction with the US Federal Reserve, it has also pumped dollar liquidity into eurozone markets. Mr Trichet says that those who talk of boosting growth through "quantitative easing" – flooding markets with liquidity – should note that the ECB’s weekly balance sheet has expanded by as much as 55 per cent compared with a year ago. The increase "is impressive", he remarks.
Natacha Valla, a Goldman Sachs economist based in Paris, has estimated the boost to ECB profits by comparing the volumes of liquidity provided with the amounts that it would normally have supplied. From this, she deducted the amount of interest paid by the ECB on funds deposited overnight at the ECB, which since the collapse of Lehman have regularly exceeded €200 billion. She describes her estimate of additional profits in the €200m-€300m range as "very conservative". In comparison, ECB total staff costs in 2007 were about €170m, according to the bank’s latest annual report. The ECB does not set out to make a profit on its operations; last year and in 2006 it reported a zero overall profit, after transferring funds into reserves. Ms Valla notes that since the Lehman collapse, the massively larger sums parked overnight in the ECB’s "deposit facility" have resulted in the ECB paying out more to banks, reducing its profits. But the system still looks a money-spinner. Analysts suspect that much of the money parked by banks overnight at the ECB – rather than lent to others – was borrowed from the ECB in the first place.
China’s economy hits the wall
There was a distinct whiff of triumphalism in Beijing in the weeks after the collapse of Lehman Brothers. Chinese officials speculated aloud about whether it would be wise to lend the Americans the money they needed to bail out their sinking banks. There was tut-tutting about American profligacy. The famous prediction by Goldman Sachs that the Chinese economy would be larger than that of the US by 2027 was revisited – perhaps it would happen even sooner than that?
But two months into the global financial crisis, things look much grimmer for China. In fact the only recent examples of social unrest in one of the world’s main economies have come there, not in the west. Laid-off workers in factories in southern China have staged protests that had to be contained by riot police. There have also been strikes and violent protests by taxi drivers in some cities across the country. The notion that the Chinese economy has so much momentum that it has "decoupled" from the US looks like a myth. The economic statistics tell their own story. Last week the Chinese government announced that the country’s exports fell in November, compared with a year earlier, in the first such monthly drop for seven years. There are said to be 1m new graduates looking for work. It is generally held that the Chinese economy needs to grow at 8 per cent a year to absorb all the new workers coming on to the market. But new projections suggest that Chinese growth next year will be lower than that – possibly much lower.
Chinese workers cannot express their discontent through the ballot box, so messages to the country’s political leaders are relayed through strikes and riots. Social unrest in China’s industrial heartlands will cause real alarm in the governing circles in Beijing. The urban middle-classes also have reason to be unhappy: there have been severe stock-market and property crashes in China over the past year. The government – like its western counterparts – has already made it clear that it will respond to the new downturn with a massive fiscal stimulus package. But the next 12 months will still be very difficult. The west’s recession – and the associated drop in consumer spending – will worsen. This will have the direct affect of depressing demand for Chinese goods. And it will have the indirect effect of heightening tensions between the US and China.
China’s trade surplus hit a new record last week because imports are falling even faster than exports. The Obama administration is certain to want China to allow its currency to appreciate, to close the deficit. But the domestic pressures on China will point in the other direction – to allow the renminbi to fall in value in an effort to boost exports and keep more factories open. An atmosphere of economic crisis in both countries is unlikely to make the discussion any more civilised. Protectionism is already gaining ground in the US, with the proposed bail-out of the American car industry. Some of America’s senior trade experts are very worried that this is just the beginning. "Obama has wise economic advisers," says one, "but the instincts they are surrendering to are quite disturbing." Protectionism could take many forms. But if next year’s international talks on climate change run into trouble – as seems likely – pressure could grow for some sort of "carbon tariff" on Chinese goods.
Any rise in protectionism in America is liable to be swiftly emulated in the European Union, which is China’s largest market. At the moment, the Chinese government seems to feel it can afford to treat the Europeans with a degree of disdain. China recently cancelled a summit with the EU at a few days’ notice, to express displeasure at European leaders’ meetings with the Dalai Lama. But trade is one area where the Union has enormous powers and acts as a single bloc. At the moment the European Commission is still in the hands of economic liberals. But a new commission will be appointed in 2009 and things could change. There are already strong protectionist pressures in countries such as Italy and France.
Next year will clearly be very tough for China. But over the past 20 years predicting the demise of the Chinese economic miracle – or the Chinese Communist party – has proved to be a mug’s game. For years western analysts have pointed to fundamental weaknesses in the Chinese economy. In the 1990s, it was popular to predict that the Chinese banking system would collapse. (Perhaps we were looking at the wrong banking system?) Environmental problems, shortages of energy and water and demographic imbalances are other Chinese weaknesses that have long been pored over. But China has powered ever onwards. The country got through the political upheavals of 1989 and the Asian economic crisis of 1997, which also led to sharply slower growth and higher unemployment.
Still, the economic crisis of 2009 could pose the toughest tests that the Chinese government has faced since the student uprisings of 1989, whose 20th anniversary will fall next year. For it is now clear that, far from being immune to the global financial crisis, China is very vulnerable. Its economy may not be hit as hard as that of the US. But as a poorer country – with a less resilient political system – it could suffer worse. It would be a historic irony if the Chinese Communist party was thrown into crisis, not by the collapse of communism in 1989 – but by the convulsions of capitalism in 2009.
China’s Zhou Sees More Rate Cuts as Investment, Economy Weaken
China’s central bank Governor Zhou Xiaochuan said interest rates may fall again this month after exports declined, inflation slowed and a report today showed property investment cooled. "From now until the beginning of next year is full of interest-rate-cut pressure," Zhou said in Hong Kong, where the Financial Stability Forum is meeting. Consumer prices are "going down and sometimes even faster than we think," he said. China’s economy, the world’s fourth largest, may be heading for its slowest growth in two decades as the global financial crisis cuts demand. The government pledged Dec. 13 to boost liquidity after cutting interest rates last month by the most in 11 years to spur lending and consumption.
"They realize now that the risk is of 5 to 6 percent growth next year," said Dwyfor Evans, a strategist with State Street Global Markets in Hong Kong. "They will use interest rates, money supply, bank lending -- the full spectrum of monetary stimulus. It’s short, sharp, shock treatment." The CSI 300 Index of stocks fell 1.1 percent as of 1:29 p.m. in Shanghai on speculation that a weakening economy will cut company profits. The yuan traded at 6.8474 against the dollar from 6.8500 before the investment report. Spending on factories and real estate rose 26.8 percent in the first 11 months from a year earlier, down from a 27.2 percent gain through October, the statistics bureau said today. Industrial output grew the least since 1999 in November, exports fell for the first time in seven years and inflation was the weakest in almost two years, reports showed in the past week.
China’s slowdown is deepening before a 4 trillion yuan ($584 billion) stimulus package announced last month kicks in. The central bank has reduced the one-year lending rate to 5.58 percent from 7.47 percent in September and dropped quotas limiting lending by banks. The deepening global recession is taking a toll across Asia. South Korea’s growth will slow rapidly next year, the Ministry of Strategy and Finance said in Gwacheon today. China is targeting an 8 percent economic expansion to generate jobs and avoid social instability, China Banking Regulatory Commission Chairman Liu Mingkang said in Beijing on Dec. 13. Growth will probably be 5 percent or 6 percent next year, International Monetary Fund Managing Director Dominique Strauss- Kahn said in Madrid yesterday, Reuters reported. That would be down from 9 percent in the third quarter of this year and 11.9 percent in 2007.
Zhou said he couldn’t describe November’s data as "very bad," citing retail sales, which grew 20.8 percent. Spending growth for real-estate development cooled, rising 22.7 percent in the first 11 months from a year earlier after gaining 24.6 percent through October, today’s figures showed. The increase was 7.6 percent for November alone, the least in almost three years, estimated Xing Ziqiang, an economist at China International Capital Corp. in Beijing. Exports declined 2.2 percent in November, the first fall in seven years as recessions in the U.S., Europe and Japan reduced demand. Imports plunged 17.9 percent, pushing the trade surplus to a record $40.09 billion. China’s balance of payments will "determine the exchange rate," Zhou said today. The yuan’s biggest one-day drop against the dollar on Dec. 1 prompted speculation that the central bank would switch to a policy of depreciation to help exporters by keeping down prices in overseas markets.
"As demand from the U.S. and Europe weakens, a price cut doesn’t do much to help," Zhou added. "Some factories may think they will be able to sell more if they cut prices, but some don’t. We have a controlled, floatable system. We intervene, but market forces play a bigger role." The currency has climbed 21 percent against the dollar since a fixed-exchange rate ended in 2005. Gains have stalled since mid-July. China’s economic growth may slow to 5.5 percent in the first quarter and 4 percent in the second quarter, CFC Seymour Ltd. estimates. Goldman Sachs Group Inc. sees a rebound after a slide to 4.7 percent in the second quarter.
Alt-A Mortgages Deteriorating More Rapidly than Expected
Citing "a rapid deterioration of U.S. Alt-A RMBS performance," Fitch Ratings again took the hatchet to its previous assumptions for Alt-A mortgages on Monday morning, revising its surveillance methodology and updating loss projections for all U.S. Alt-A RMBS. Fitch said it now expects losses on all Alt-A collateral to far exceed the estimates of its ‘moderate stress’ scenario in its late ratings update earlier this year.
"Market developments, ongoing home-price declines and loan performance trends in the Alt-A sector over the prior six months have effectively eliminated the possibility of this stress scenario," said Fitch in a statement. The rating agency said it now expects average cumulative losses om 2005, 2006 and 2007 vintage Alt-A transactions to hit 2.72, 6.78 and 9.58 percent, respectively, up dramatically from expectations at the agency earlier this year.
Fitch cited a "rapid increase in 60+ day delinquencies experienced over the past six months," despite servicers’ collective efforts to hold off on actual foreclosure sales — likely implying that a halt to foreclosures is having little effect in resolving borrower delinquencies. Between May and October 2008, Fitch said that 60+ day delinquencies for the 2007 vintage increased from 8.80 percent to 14.65 percent; 2006 and 2005 vintages also experienced steep increases rising from 10.30 percent to 14.24 percent and 6.57 percent to 8.79 percent, respectively.
While delinquencies are continuing to pile up, cumulative losses are not — at least, not yet.. "The small increase in cumulative losses relative to the rising level of 60+ day delinquencies reflects, in part, the lengthening foreclosure/liquidation timeline being experienced throughout all vintages," analysts at the agency wrote. All of which means that it’s time to get ready for a whole new slew of downgrades to Alt-A in the coming few weeks. Fitch warned in its note Monday that it expects that it will downgrade many senior bonds to below investment grade — just in time for fourth quarter earnings.
A Second Mortgage Disaster On The Horizon?
When it comes to bailouts of American business, Barney Frank and the Congress may be just getting started. Nearly two trillion tax dollars have been shoveled into the hole that Wall Street dug and people wonder where the bottom is. It turns out the abyss is deeper than most people think because there is a second mortgage shock heading for the economy. In the executive suites of Wall Street and Washington, you're beginning to hear alarm about a new wave of mortgages with strange names that are about to become all too familiar. If you thought sub-primes were insanely reckless wait until you hear what's coming.
One of the best guides to the danger ahead is Whitney Tilson. He's an investment fund manager who has made such a name for himself recently that investors, who manage about $10 billion, gathered to hear him last week. Tilson saw, a year ago, that sub-prime mortgages were just the start. "We had the greatest asset bubble in history and now that bubble is bursting. The single biggest piece of the bubble is the U.S. mortgage market and we're probably about halfway through the unwinding and bursting of the bubble," Tilson explains. "It may seem like all the carnage out there, we must be almost finished. But there's still a lot of pain to come in terms of write-downs and losses that have yet to be recognized."
In 2007, Tilson teamed up with Amherst Securities, an investment firm that specializes in mortgages. Amherst had done some financial detective work, analyzing the millions of mortgages that were bundled into those mortgage-backed securities that Wall Street was peddling. It found that the sub-primes, loans to the least credit-worthy borrowers, were defaulting. But Amherst also ran the numbers on what were supposed to be higher quality mortgages. "It was data we'd never seen before and that's what made us realize, 'Holy cow, things are gonna be much worse than anyone anticipates,'" Tilson says.
The trouble now is that the insanity didn't end with sub-primes. There were two other kinds of exotic mortgages that became popular, called "Alt-A" and "option ARM." The option ARMs, in particular, lured borrowers in with low initial interest rates - so-called teaser rates - sometimes as low as one percent. But after two, three or five years those rates "reset." They went up. And so did the monthly payment. A mortgage of $800 dollars a month could easily jump to $1,500. Now the Alt-A and option ARM loans made back in the heyday are starting to reset, causing the mortgage payments to go up and homeowners to default.
"The defaults right now are incredibly high. At unprecedented levels. And there’s no evidence that the default rate is tapering off. Those defaults almost inevitably are leading to foreclosures, and homes being auctioned, and home prices continuing to fall," Tilson explains. "What you seem to be saying is that there is a very predictable time bomb effect here?" Pelley asks. "Exactly. I mean, you can look back at what was written in '05 and '07. You can look at the reset dates. You can look at the current default rates, and it's really very clear and predictable what's gonna happen here," Tilson says.
Just look at a projection from the investment bank of Credit Suisse: there are the billions of dollars in sub-prime mortgages that reset last year and this year. But what hasn't hit yet are Alt-A and option ARM resets, when homeowners will pay higher interest rates in the next three years. We're at the beginning of a second wave. "How big is the potential damage from the Alt As compared to what we just saw in the sub-primes?" Pelley asks. "Well, the sub-prime is, was approaching $1 trillion, the Alt-A is about $1 trillion. And then you have option ARMs on top of that. That's probably another $500 billion to $600 billion on top of that," Tilson says.
Asked how many of these option ARMs he imagines are going to fail, Tilson says, "Well north of 50 percent. My gut would be 70 percent of these option ARMs will default." "How do you know that?" Pelley asks. "Well we know it based on current default rates. And this is before the reset. So people are defaulting even on the little three percent teaser interest-only rates they're being asked to pay today," Tilson says. That second wave is coming ashore at a place you might call the "Repo Riviera" - Miami Dade County. Oscar Munoz used to sell real estate; now his company clears out foreclosed homes. "Business is just going through the roof for us. Fortunately for us, unfortunately for the poor families who are going through this," Munoz explains.
"I wonder do you ever come to houses where the people are still here?" Pelley asks. "Absolutely," Munoz says. "That's really a sad situation. I'd rather not meet the people." Asked why not, Munoz says, "It’s not easy to come in and move a family out. It's just our job to do it for the bank. It's just the nature of what's going in the market right now." Munoz says his company alone gets about 20 to 30 assignments per day. "And we're one of the few companies right now who are hiring. We have to hire people because the demand is so high," he tells Pelley. People who've been evicted tend to leave stuff behind. The next house is usually much smaller. Banks hire Munoz to move the possessions out where, by law, they remain for 24 hours. Often the neighbors pick through the remains.
Once the homes are empty the hard part starts - trying to find buyers in a free-fall market. Miami real estate broker Peter Zalewski talks like a man with a lot of real estate to move. "We have 110,000 properties for sale in South Florida today, 55,000 foreclosures, 19,000 bank owned properties. Sixty-eight percent of the available inventory is in some form of distress. They need someone to clean it up." Asked what the name of his company is, Zalewski says, "It's called Condo Vultures Realty." What does that mean? "That in times of distress, and in times of downturn, there's opportunity. And you know, vultures clean up the mess. A lot of people seem to think they kill, but they don't actually kill, they clean," he says.
The killing, in Miami, was done by the developers back when it seemed that the party would never end. They sold hyper-inflated condos at what amounted to real estate orgies-sales parties for invited guests who were armed with option ARM and Alt-A loans. "There were red ropes outside. They had hired cameramen, and they had hired photographers to almost set the scene of a paparazzi," Zalewski remembers. "They were hiring fake paparazzi? To make the customers feel like they were special?" Pelley asks. "You were selling a lifestyle," Zalewski says.
Asked what roles these exotic mortgages played, Zalewski says, "They were essential. They were necessary. Without the Alt A or option ARM mortgage, this boom never would've occurred." It never would have occurred because without the Alt As and the option ARMs, many buyers never would have qualified for a loan. The banks and brokers were getting their money up front in fees, so the more they wrote, the more they made. "They stopped checking whether the income was even real. They turned to low and no-doc loans, so-called 'liar's loans' and jokingly referred to as 'ninja loans.' No income, no job, no assets. And they were still willing to lend," Tilson says. "But help me out here. How does that make sense for the lender? It would seem to be reckless, in the extreme," Pelley remarks. "It was," Tilson agrees. "But the key assumption underlying, the willingness to do this was that home prices would keep going up forever. And in fact, home prices nationwide had never declined since the Great Depression."
On the way up, everyone wanted in. No one expected to feel any pain. People like acupuncturist Rula Giosmas became real estate speculators. Giosmas says she bought about six properties in this last five-year period as investments. She says she put 20 percent down on each. Now they're all financed with option ARM loans. Asked what she understood about the loans, Giosmas says, "Well, unfortunately, I didn't ask too many questions. I mean in the old days, I would shop around. But because of the frenzy, and I was so busy looking to buy other properties, I didn't really focus on shopping around for mortgage brokers." "But if you're investing in real estate, you're buying multiple properties, you should be asking a lot of questions," Pelley remarks. "Why didn't you ask?" "I was busy. I was really busy looking at property all the time, all day long," she replies.
She also acknowledges that she didn't read the paperwork. Now she’s losing money on every property. "You know that there are people watching this interview who are saying, 'You know, she was just foolish. She was greedy and foolish. She was buying small apartment buildings and wasn't paying enough attention to how they were financed,'" Pelley points out. "My full-time job is I'm an acupuncturist. So, this was just a side thing," she says. Giosmas says she was misled and she hopes to renegotiate her loans. But many other buyers have simply walked away from their properties. One Miami luxury building was a sellout, but when 60 Minutes visited, a quarter of the condos were in foreclosure. Zalewski says one of those condos was originally purchased in October 2006 for $2.4 million. Now he says the asking price from the lender is $939,000. And there are tough years to come because, just like the sub-primes, the Alt-A and option ARM mortgages were bundled into Wall Street securities and sold to investors.
Sean Egan, who runs a credit rating firm that analyzes corporate debt, says he expects 2009 to be miserable and 2010 also miserable and even worse. Fortune Magazine cited Egan as one of six Wall Street pros who predicted the fall of the financial giants. "This next wave of defaults, which everyone agrees is inevitably going to happen, how central is that to what happens to the rest of the economy?" Pelley asks. "It's core. It's core, because housing is such an important part. We're not going to get the housing industry back on track until we clear out this garbage that's in there," Egan explains.
"That hasn't cleared out yet. We haven't seen the bottom," Pelley remarks. "It's getting worse," Egan says. "There are some statistics from the National Association of Realtors, and they track the supply of housing units on the market. And that's grown from 2.2 million units about three years ago, up to 4.5 million units earlier this year. So you have the massive supply out there of units that need to be sold." "What with the housing supply increasing that much, what does it mean?" Pelley asks. "It means that this problem, the economic difficulties, are not going to be resolved in a short period of time.
It's not gonna take six months, it's not gonna 12 months, we're looking at probably about three, four, five years, before this overhang, this supply overhang is worked through," Egan says. In the next four years, eight million American families are expected to lose their homes. But even after the residential meltdown, Whitney Tilson says blows to the financial system will keep coming. "The same craziness that occurred in the mortgage market occurred in the commercial real estate markets. And that's taking a little longer to show. But there are gonna be big losses there. Credit cars, auto loans. You name it. So, we're still, you know, we're maybe halfway through the mortgage bubble. But we may only be in the third inning of the overall bursting of this asset bubble," Tilson says.
"Does that mean that the stock market is gonna continue plunging as we've seen the last several months?" Pelley asks. "Actually we're the most bullish we've been in 10 years of managing money. And the reason is because the stock market, for the first time I can say this, in years, has finally figured out how bad things are going to be. And the stock market is forward looking. And with U.S. stocks down nearly 50 percent from their highs, we're actually finding bargains galore. We think corporate America's on sale," Tilson says. The stock market will still have a lot of figuring to do with more troubling news on the horizon. The mortgage bankers association says one out of 10 Americans is now behind on their mortgage. That's the most since they started keeping records in 1979.
The Bernard Madoff Ponzi scheme is the greatest financial shock so far in a year full of them. We still have a couple of weeks to go, but barring Warren Buffett being caught in Vegas thrusting Berkshire Hathaway stock at strippers, it is hard to imagine anything worse. I don't say this lightly. How can Madoff be worse than Lehman Brothers or AIG or the travails of Detroit's Big Three? It's because what he did was so simple. And he duped so many smart, conservative people for so long. And he did it in plain sight. Look at the list of those who lost money. Swiss private banks. Jewish family foundations. Retirees in Palm Beach. Not exactly the Fast Eddies of finance. But therein lay the brilliance of Madoff's scheme.
He didn't promise the usual Ponzi manna from heaven--double or triple your money with Bernie Madoff's surefire, get-rich quick scheme! No, he promised and delivered 10% returns. So consistent were his returns in good times or bad, an investment in Madoff came to be called the "Jewish Bond." His investment strategy was a "black-box" model, one to which no one but him had access. And yet when the returns were good, no one bothered to ask how he was making them. Madoff also moved easily in the familiar power networks of New York. He was chairman of the co-op board at his fancy Upper East Side building. He was chairman of the board of Yeshiva University's Business School. A member of exclusive country clubs in the Hamptons and Palm Beach. Strange as it may seem to people beyond this claustrophobic social world, these are not positions assigned lightly.
Madoff had earned the trust of individuals forged in the fires of New York finance, law and government, supposedly some of the toughest, smartest, savviest people in the world. He fooled them all over many years, and his reputation among them probably protected him from scrutiny. Perhaps it was because of his social standing that, ultimately, it had to be members of his own family who turned him in. It was his two sons, Mark and Andrew, who contacted authorities on the evening of Dec.10, after their father admitted to the fraud. Both worked for their father's brokerage business but had no role in the asset management business, which Bernard ran secretively himself. But again, who is the one to trust in this unfolding Shakespearean drama of betrayal and family strife?
The details are already rich and in some ways hilarious. Madoff's auditor was a tiny firm in Rockland County, which consisted of three employees: a 78-year-old living in Florida, a secretary and a 47-year-old accountant operating out of an office the size of a small bedroom. When skeptics warned the Securities and Exchange Commission about Madoff, they were repeatedly brushed off. The SEC investigated Madoff in 2005 and 2007 but came up with nothing, which tells you much about the quality of SEC investigations in these heady hedge fund years. And now we are to believe that Madoff's sons acted out of principle by shopping their father to the Feds.
Is it possible, that once Madoff saw the end was nigh, he began orchestrating his own demise? That he decided the timing? It wouldn't surprise me in the least if the lawyers sorting through this debacle find that in the days leading up to this, Madoff's remaining wealth headed out to safe havens, untouchable either by his investors or the authorities--but perhaps one day accessible to his family. It's just speculation, but Madoff is clearly a man who knows how to work a system.
Madoff Crisis Hits Europe Hard
Billion-dollar writedowns seem to be on the horizon as some of Europe's largest banks reveal their entanglement in Madoff's mess. Europe's banking sector is ending 2008 just as it started the year -- with the announcement of potential billion-dollar writedowns. Yet instead of exposure to subprime or securitized assets, this new round of prospective losses relates to European banks' links to the alleged $50 billion (€36.5 billion) fraud of hedge fund manager Bernard Madoff. Details about Madoff's activities are slowly emerging, but some of Europe's largest financial companies revealed their exposure on Dec. 15 to address investors' mounting concerns. That includes Spain's Banco Santander .. the largest bank by market capitalization in the 15-member euro zone -- which said it had €2.3 billion ($3.1 billion) of exposure through a Geneva hedge fund. Iberian rival Banco Bilbao Vizcaya Argentaria also announced €300 million ($405 million) in potential losses, while France's billionP Paribas confirmed its exposure could top €350 million ($473 million).
Media reports on Dec. 15 said Britain's HSBC -- the largest bank overall in Europe -- may have to write down $1 billion in losses, although a spokesperson declined to comment. Royal Bank of Scotland, which is 60 percent owned by British taxpayers, similarly announced £400 million ($607 million) in potential losses, and France's Natixis reported exposure of €450 ($611 million). Further Consolidation? All told, European potential losses to the alleged fraud could exceed $11 billion. That comes on top of mark-to-market losses of $1.2 trillion (as of October 2008) that the Continent's financial companies already have announced over the course of the protracted financial crisis. The Dow Jones Euro Stoxx Banks index has fallen 63.5 percent this year, and experts reckon Madoff-related writedowns could well lead to further consolidation in Europe's contracting financial services sector. "We're expecting additional writedowns in the fourth quarter; the numbers will be fairly significant," says Ralph Silva, research director at financial services consultancy Tower Group. "Most banks will want to do it all in one go. They need to bury this [exposure] as quickly as possible."
European bourses on Dec. 15 offered a mixed response to the flurry of bank announcements. By early afternoon trading, shares in billionP Paribas and HSBC had fallen 7.98 percent and 1.50 percent respectively. Others, though, performed better: France's Société Générale, with less than a €10 million ($13.5 million) exposure, and Britain's Man Group, with potential losses of $360 million, rose 0.84 percent and 3.15 percent respectively. Some of Europe's largest banks will have to eat billion-dollar writedowns in their fourth-quarter results, but analysts say it will be smaller financial institutions that could suffer the most from Madoff's alleged fraud. That includes several private Swiss banks, including Union Bancaire Privée and Benbassat, which reportedly could face multibillion-dollar writedowns. Both banks declined to comment, but Swiss newspaper Le Temps quoted sources saying UBP may lose $850 million and Benbassat's exposure could top $935 million. "The smaller banks without deep pockets will probably suffer more," says Tower Group's Silva. "Customers are looking to the safety of larger brands, so any further writedowns, combined with a slowing of new business, doesn't bode well."
For Europe's larger banks, the potential of multibillion-dollar writedowns certainly isn't welcomed, but they also face the daunting prospect of trying to recoup the money they invested with Madoff. According to Simon Gleeson, a partner at law firm Clifford Chance, that won't be easy. First of all, it remains unclear whether there's any money to recover. Until investigators figure out where the investments have gone, which analysts say could take months, banks won't know how much they can recoup. "For legal recourses to be useful, there needs to be something to get back," Gleeson notes. If and when that's established, lawyers then must wade through the complexities of deciding which institutions are repaid first. Gleeson says institutions with direct debt exposure to Madoff's funds will get first shot at any recoverable assets.
Banks with indirect links -- such as those, like billionP Paribas, that provided lending to others to invest in Madoff's instruments -- will be given lower priority for potential financial recovery. London analysts with stockbrokers Keefe, Bruyette & Woods estimate $7.8 billion of Europe's total $11 billion exposure is through indirect investments. "There's no reason to believe European bank creditors will do any worse than their US counterparts," Gleeson explains. That may help some institutions eventually recover their investments, but analysts say it'll take time for investigators to unwind Madoff's dealings. After already writing down billions of dollars in assets so far in 2008, this latest scandal certainly won't help Europe's beleaguered financial services sector. But battle-weary investors seemed to take the news in stride.
Oh What A Tangled Web We Weave.....
There are some, shall we say, "interesting" new twists and turns to the alleged Madoff swindle. First is the sheer enormity of it. Anyone who believes that one man managed to doctor $50 billion worth of money away from clients over the space of a decade or more, and nobody else was in the know or complicit in the fraud needs a mental examination.
Let's think about this folks. There were account statements sent to customers, there were forms filed with the SEC and other regulators, there were tax returns, there were internal books of account kept. All of this had to balance and show that everything was on the "up and up" during the entire time. Does anyone actually believe that these thousands of documents were correlated, produced and distributed by exactly one individual and nobody else anywhere up or down the line knew about it, was complicit in it, or assisted? Neither do I.
Who might be on the list of people that "might have known"? Well, we can start with the SEC, can't we, since Barron's wrote an article on May 7th of 2001 entitled "Don't Ask, Don't Tell." There's little doubt that once something hits the mainstream press its "secret", right? Now let's focus on a few other things. Chief among them is an apparent family tie between the Madoff's and a former Assistant Director of the SEC from 1996 to 2006.
True? I don't know. But it sure as hell is suspicious, isn't it? $50 billion is not a small amount of money by anyone's measure. But before one cries too big of a river for those who lost it all in what appears to be the biggest Ponzi Scheme of all time, one should note that a number of people interviewed said they figured Madoff was "cheating" since he was a market maker and had returns they couldn't explain - they just didn't think he was cheating them! A knowing scam? You decide.
The true scam here isn't Madoff though. Its that this sort of attitude - bed, bribe, lie, browbeat and cajole - has become all of what Wall Street is about over the last ten years. See, we had "investment banks" who "paid to play" with their bond ratings - ratings that were modeled by a computer that was told to assume "house prices will never go down." Never? We had other models that "assumed" various ratios (such as debt to income) for no-doc loans, where people didn't even bother stating an income - and others who simply took the "stated" income and believed it - even though HUD itself did a study that showed that a plurality of so-called "stated" income loans overstated actual income by as much as 50%! Fraudulent on its face? You decide.
We had our current Treasury Secretary who appeared before the SEC and Congress in 2000 to lobby for the removal of leverage limits, was told (quite literally) to go to hell - that was he was asking for was unsafe - but he had the audacity to come back four years later with the same request and ramrodded it through. The result? Bear Stearns, Lehman Brothers, AIG, Fannie and Freddie - all "boomed" with leverage more than double the previous legally-mandated limit. Is Paulson responsible? You decide. We have sitting Congresspeople who got "preferred rates" on loans from Countrywide Financial with cumulative benefits in the tens of thousands of dollars while they were voting to create (or not) additional regulations on the lending industry. Crooked? You decide.
We have a Federal Reserve who's previous chairman created a speculative bubble in the Internet space and when it popped, he knew this should and must lead to the default of the bad debt taken on. But instead of allowing that, he (along with Congress) intentionally blew an even bigger bubble in housing and the American Consumer. Our current Fed Chairman was a member of the Federal Reserve at the time and saw this happen, but made no comment about it. Congress was repeatedly warned that what was happening was unsustainable and did nothing. Idiotic at best, criminally negligent at worst? You decide.
Is all this an accident? Or is it racketeering? Simply put, is there a predicate felony in here somewhere, and two or more people conspiring to swindle others? If so, RICO may apply. Or will it? Mr. Obama is now officially President-elect, the electors having sat and voted, and will be inaugurated on January 20th (Yes, I know, Congress must "accept" the results, but the fact is that the actual vote - of the electors - has now happened.)
To Mr. Obama - are you going to sit still for this swindle? In your home state, where I lived for 13 years, corruption was a way of public life. The jokes about dead people voting in Chicago weren't just the stuff people chuckled about over a drink in the bar - there really were people who had passed away that consistently cast ballots in elections, never mind the old saw about Chicago machine politics: vote early and often. America is tired of the crap President Obama. We're sick of being lied to, swindled and robbed. We understand (even if we would like to deny it) that the so-called "economic growth" of the last ten years has been a fraud - our wages have barely budged, our cost of living has gone up, and we've been drowning in an ever-increasing amount of debt.
Oh sure, we still believe in Santa Claus when it comes wrapped in a flag with a 10 gallon hat and "Uncle Sam" emblazoned across his chest; we think we can have free medical care, free social security and free energy. At least when we're dreaming. What America needs right now President Obama is the truth. The God's Honest Truth. We can't have things for free. We can't spend more than we make. Houses can't sell for more than 3x incomes and be sustainable. Prices must come down. We can't keep charging up the nation's (or our personal) credit cards. We can't have both good-paying jobs in the US and $30 DVD players. Pick one but don't bitch when the other disappears. We can't tax or spend our way out of this mess. The bad debt must be defaulted, and this will mean bankruptcies among both people and companies (including banks) - lots of them.
This is inevitable. We can't kick the can down the road any longer. The mathematics do not lie and can no longer be ignored. The longer we continue to deny and kick the can the worse the destruction will be in our economy, employment and capital markets. The swindlers must go to jail. It is the only deterrent that works. You, President Obama, have a choice. You can either play the same game that President Bush did, listening to the same hopelessly-corrupt and compromised "advisers" and doing what they put forward, which incidentally got us in this mess in the first place or you can think on your own, do the math on your own, and then do the right thing.
You get only one shot at this; your first term is four years and frankly, sir, you don't have it. You've got about six months to demonstrate that this nation is going to stop all of the stupidity that led us to this special place in Hell before your halo effect from the election wears off, and if you have not done so by then the damage will be irreversible. Me? I'm planning for the worst, because while you may be from the Land of Lincoln, I don't believe you have what it takes. Prove me wrong sir, and make me proud of our nation and its President. If you dare.
Global Car Industry Fearful for Detroit
For years, the overseas operations of Ford and General Motors helped buoy Detroit when times were difficult in the United States. But there are growing concerns that the automakers’ problems in the United States will weigh down their more successful units in Europe, Asia and Latin America — even with a short-term lifeline that the Bush administration has signaled it will provide to G.M. and Chrysler, which sells almost exclusively in the United States.
Ferdinand Dudenhöffer, director of the Center for Automotive Research in Gelsenkirchen, Germany, warned that the indirect effect of a potential G.M. collapse for American parts makers would be severe. He added that German manufacturers in the United States, like Mercedes and Bayerische Motoren Werke, the maker of BMW cars, would have to rethink not just their American supply chains but their global ones as well. "There would be no winners, only losers," Mr. Dudenhöffer said. "This would create a huge mess around the world."
Both G.M. and the Ford Motor Company were profitable in Europe last year and in the first half of 2008. But neither of their European operations is large enough to survive on its own, said Graeme Maxton, an economist who has long tracked the car industry. "They’d need a parent of some sort," Mr. Maxton said. Other automakers may be reluctant to assume that role, given the slack sales of European giants like Renault, Fiat and Daimler. The tight credit markets would also inhibit any large deals. "Two drowning men clinging together don’t make a good swimmer," Mr. Maxton added.
Already, Mr. Dudenhöffer said, the image of Opel, G.M.’s German subsidiary, is suffering among German consumers because of bankruptcy speculation, and suppliers could become nervous if the talk persists. Because of this, many analysts say they are skeptical that Opel can survive as an independent company if G.M. seeks bankruptcy protection. A more workable solution might be to combine G.M.’s entire overseas business, they said, which would produce roughly three million to four million cars annually. The parallel downward moves in the United States and international automotive markets are a turnabout from the usual pattern in which strength in one market offsets weakness in another. And markets outside the United States have generally been much more stable, in part because governments keep gasoline prices steadier by imposing hefty fuel taxes.
"Normally, North America and Europe don’t move in tandem," said Louis E. Lataif, a former president of Ford in Europe and now dean of the School of Management at Boston University. In fact, he said, one reason Chrysler is in even worse shape is because its overseas business is limited. Chrysler had a German base when it was owned by Daimler from 1998 to 2007, but its operations are now largely confined to North America. Over the years, Ford has tended to be stronger in Europe while G.M. has been more successful in China, said Peter Morici, a professor at the School of Business at University of Maryland. And in recent years both companies have enjoyed hefty profits in Latin America, especially Brazil.
"Until now, overseas operations have not been drains on cash," said Rod Lache, a Deutsche Bank analyst in New York. "But with sales now down 35 percent-plus in Brazil and off 30 to 35 percent in Western Europe, every market in the world looks like it will burn cash." While it has been largely obscured in the current debate in Washington over aid to the ailing industry, Detroit and Europe are closely intertwined. Ford and G.M. employ a combined 120,000 workers across Europe and together sold roughly four million cars there last year.
Nearly a quarter of the 9.37 million cars G.M. sold worldwide in 2007 were purchased by European customers.
European executives at G.M. have appealed to Germany’s chancellor, Angela Merkel, for more than $1 billion in loan guarantees, while the Swedish government said on Thursday that it would provide $3.5 billion in aid for Volvo Car and Saab, as well as suppliers. Volvo Car is owned by Ford, and G.M. controls Saab. The Spanish province of Aragón, which is home to G.M.’s largest European plant, in Zaragoza, has also agreed to provide up to $200 million in credit guarantees. In late November, the head of G.M. in Europe, Carl-Peter Forster, who has long compared his efforts to revitalize the carmaker’s European business to those of a long-distance runner, told engineers at a meeting at Opel’s headquarters that now the situation resembled running a marathon up a mountain.
He acknowledged in an interview that parts suppliers were nervous. "They ask, ‘Can you guys survive?’ " he said. "We can. We do have cash in hand, and that’s also why we’ve asked governments for help. We need the credit guarantees to sustain the relationship with suppliers." John Fleming, chief executive of Ford in Europe, said he was concerned about a ripple effect if G.M. failed. "In the current financial situation," he said, "you’d have to worry about the implications on the supplier base." Both companies have deep roots on this side of the Atlantic: Ford’s British business dates to the era of Henry Ford, and G.M. acquired Opel in the 1920s. Most of their success there is in the small-car market. More than 60 percent of their sales come from the Focus and Fiesta at Ford, and the Corsa and Astra at G.M. By contrast, Detroit has long depended on light trucks and sport utility vehicles to generate most of its profits in the United States.
Ford, in fact, plans to reintroduce the Fiesta in the United States in 2010 to satisfy demand for smaller, more fuel-efficient cars. But actually making money on those small cars has proved more difficult than moving them off the lot, especially for G.M. Its market share has shrunk to about 9.5 percent from roughly 12 percent, and G.M. remains under pressure to cut overhead. With 55,000 workers spread across 20 plants, G.M.’s work force in Europe is now down 40 percent from a decade ago. Though Ford lost billions trying to crack the luxury market with brands like Jaguar, which it sold to Tata Motors of India this year, and Volvo Car, industry experts say it has done a better job of reducing capacity, slimming payrolls and selling global winners like the Fiesta over the last five years.
Mr. Fleming suggested that overseas units benefited the North American parent in profit as well as better products, like the fuel-efficient Fiesta, which Ford could adapt to North America quickly because it already existed in Europe. He also pointed to his success in turning around Ford in Europe as a template for what both automakers could do in the United States if they survive through the current crisis. "We didn’t have the right products, we didn’t have the right capacity," Mr. Fleming said of the early years in the decade, when Ford lost billions in Europe. "We had the same issues as the U.S. industry does now. But we were able to accelerate development of the right products and get capacity in line with demand."
Why Toyota wants GM to be saved
Detroit's Big Three aren't the only automotive companies that want to see the government step in with some much needed financial help. Overseas automakers, most notably Toyota Motor, all endorse some form of federal aid to keep General Motors, Chrysler LLC and possibly Ford Motor out of bankruptcy. The Senate killed an effort to get the automakers a stopgap loan last week and now the Bush administration has said it is looking at providing the automakers help from the $700 billion approved to bailout banks and Wall Street firms. "We support measures to help the industry," said Toyota Motor spokeswoman Mira Sleilati. "We just want a strong, competitive healthy industry."
This may seem surprising at first, especially when you consider that much of the opposition to the auto bailout was from senators from Southern states home to auto plants operated by Asian auto companies, such as Alabama and South Carolina. But the Asian automakers insist they never lobbied against such help for the Big Three. And this makes sense once you take a closer look at the dynamics of the auto industry and how intertwined the fates of all the companies are. Here's why Toyota, Honda Motor (HMC) and other Asian auto manufacturers clearly believe they are all better off with GM and Chrysler surviving than if they go out of business.
The overseas automakers, who between them produce more than 3 million vehicles a year at U.S. plants, all worry their production would be hurt if one of the U.S. automakers went under. That's because a Big Three failure would likely lead to widespread bankruptcies in the auto parts supplier industry. Erich Merkle, lead auto analyst with the consulting firm Crowe Horwath LLP, said there is much overlap between the automakers' suppliers. Since most parts in an automobile have only a single supplier producing them, the disruptions in production will be severe and prolonged.
"It could take months for a Toyota to work through that and resume normal production," he said. Merkle said the current network of auto suppliers, manufacturers and dealerships have worked well for the overseas automakers, who have posted steady gains in their U.S. market share during the past few years. Besides sharing suppliers, many dealers sell both U.S. and overseas brands. So the failure of a U.S. automaker could hurt the overseas manufacturers' dealer network and their sales as well, Merkle said. "There would be a severe disturbance in the force," he quipped.
A collapse of one of the Big Three would also probably cause an even more severe hit to the U.S. economy. That would further eat into demand for U.S. auto sales, which hit a 26-year low in November. "The U.S. economy would be in shambles," Merkle said. "The robust U.S. economy that Toyota and the others depend on would suddenly not be as lucrative." The overseas automakers agree that the last thing they need is for the U.S. economy to slow further. The U.S. is the largest market for Toyota, Honda and Nissan (NSANY). All are expected to report lower U.S. sales this year for the first time ever.
"We want to get the economy back," said Michael Stanton, CEO of the Association of International Automobile Manufacturers, which represents most of the Asian automakers with plants in the U.S. "Everyone is hurting at this level of sales. Everybody is either cutting back or shutting down." The latest cutbacks came Monday when Toyota announced it was putting plans to open a new plant in Mississippi on hold indefinitely, even though it is about 90% complete. The plant was set to start building the first domestically produced Prius in 2011. While the overseas automakers would be certain to eventually pick up more U.S. market share if a U.S. automaker stopped doing business, Merkle said the need to sell off the inventory of the failed automaker at fire sale prices would depress all prices in the industry in the short-term.
The final concern for the overseas automakers is a longer-term problem. If a U.S. automaker fails, that could open the door for a Chinese or Indian automaker to buy up the assets of the failed automaker and create a new low-cost competitor in the U.S. "You could open the door for foreign companies to buy distressed assets at rock bottom prices," he said. He pointed to India's Tata and China's Geely, as two automakers in the developing world that are already on record as being interested in expanding into western markets like the United States. "Tata and Geely would be incredibly open to brownfield sites," he said, referring to the term used to describe companies that buy discarded industrial facilities. Toyota and Honda have already felt the effects of competition from other upstarts firsthand in the U.S.
Korean manufacturers Hyundai and Kia have eaten into the sales of Toyota's and Honda's small, inexpensive vehicles, but that growth has taken decades. Merkle said it might take a year or more for a new competitor to get off the ground. But by grabbing U.S. automakers' assets, vehicle designs and dealerships, an incoming Indian or Chinese manufacturer could quickly become a low-cost threat much quicker than the Koreans. The established automakers like Toyota and Honda are also unlikely to look to buy the distressed assets themselves because they have never used acquisitions or purchases of other companies' assets as a method of growing.
Instead, they have always built their own facilities from the ground up in order to expand. Merkle said that is unlikely to change, even if the more productive facilities of U.S. automakers were put up for sale by a bankruptcy court, Merkle said. While companies such as Tata or Geely are likely to eventually enter the U.S. anyway, Merkle said the vacuum caused by the failure of GM or Chrysler could jumpstart those efforts and bring them to the market years earlier than expected.
517,000 Ontario jobs at risk
Ontario would lose 517,000 jobs within five years if the Big Three automakers went out of business, according to a new provincial report obtained by the Star. The review, prepared for the Ministry of Economic Development and to be released today, warns the collapse of General Motors, Ford and Chrysler would send lasting shock waves through the economy.
If auto output by U.S.-based manufacturers in Canada were cut in half, at least 157,000 jobs would be lost right away, 141,000 of them in Ontario. By 2014, job losses would rise to 296,000 nationally, including 269,000 here. If production were to cease completely, 323,000 jobs would be lost immediately in Canada, including 281,800 in this province, rising to 582,000 nationally and 517,000 in Ontario by 2014. The Ontario Manufacturing Council, an arm's-length provincial government panel, commissioned the 11-page report, which was prepared by the Centre for Spatial Economics. The report paints a gloomy picture if governments at Queen's Park, in Ottawa, and in Washington do not bail out the automakers.
"The depreciation of the dollar, lower interest rates, and lower production costs eventually help the economy to partially recover (over the following five years, 2015 to 2019) but the loss of the Detroit Three leaves a permanent dent in Canada's economy in terms of jobs and output," the report says. "For any Canadians who feel that the auto industry is expendable to our economy, this report is a wake-up call," Economic Development Minister Michael Bryant said in an interview yesterday. "This report suggests that even under a scenario where half the auto sector is lost, our economy (in Ontario) basically craters and brings the whole rest of the (Canadian) economy with it," Bryant said.
The damage would extend well beyond the auto and related parts industries to housing and a broad range of consumer spending, said Jayson Myers, an economist who is president of Canadian Manufacturers and Exporters. Myers is a co-chair of the manufacturing council with Jim Stanford, economist for the Canadian Auto Workers union. "We were surprised how big the impact is. ... It shows the importance of ensuring we maintain production here." The impact on citizens would be huge, Bryant predicted. "If the auto industry is somehow allowed to part (from) our economy, it's the equivalent of a nuclear winter with lasting effects ... and would require enormous cuts to public services plus massive deficits every year."
North American automobile demand is already down to 11 million vehicles from a previous 19 million. "Let's hope that doesn't last long," said Myers. "I'm pretty certain we will see demand rebound, but certainly it won't rebound to 19 million units." Because automakers have been offering plenty of sales incentives and rebates in the past few years, which eat into future sales, "it's not going to be easy" to get demand up given the economic crunch facing consumers, Myers said. Nor could Japanese-based automakers like Toyota and Honda, which already build cars and trucks in Ontario, be expected to fill the void left by GM, Ford and Chrysler.
"The economic impacts estimated by this analysis are likely to understate the true economic impact for several reasons, despite the possibility that foreign vehicle producers could expand production in Canada," the report states. First, "a permanent contraction of the motor vehicle industry would negatively impact the U.S. and, indeed, the global economy, reducing the demand for Canadian exports from all industries." That would depress prices of commodities such as oil and minerals, hurting resource-rich provinces like Alberta and Saskatchewan. Second, the bankruptcy of any of the Big Three automakers might have serious implications for their pension funds and retirees' incomes.
Third, the study suggests "more than 80 per cent of the parts industry would vanish in the event of the failure of all three Detroit companies," which would temporarily disrupt foreign automakers' production in North America. A subsequent housing slump would cast a pall over construction jobs as well as hurt the retail, insurance, real estate and financial services sectors, the report said. Bryant said it underscores the necessity of keeping the Big Three in business. "We have to mitigate the impact as much as possible." The study comes as Ottawa and Queen's Park are preparing a $3.4 billion (Cdn.) emergency aid package if Washington comes through with a $14 billion (U.S.) rescue.
The U.S. Senate last week rejected a $14 billion bailout, but President George W. Bush is expected to resurrect it as early as this week. In Canada, both levels of government are still determining how much money Ottawa and Queen's Park would each contribute. Both Prime Minister Stephen Harper and Premier Dalton McGuinty have been in constant contact and Ottawa is talking with the White House to track the status of the U.S. bailout, Bryant said. In the wake of Harper's offer of help for automakers, Alberta Premier Ed Stelmach yesterday urged assistance for his province as well. Stelmach asked Ottawa to match the $2 billion Alberta is spending on carbon capture and storage technology to fight climate change, saying it would generate tax revenue and create manufacturing jobs across the country.
Supertankers store 50m barrels of oil
Oil companies and traders are storing at least 50m barrels of oil in supertankers in a clear sign of supply outstripping demand as the global economy slows. The surge in floating storage, – enough to meet France’s oil imports for a month and the biggest since late 2001–, is likely to push the Opec oil cartel, which is due to meet on Wednesday in Oran, Algeria, to make a deeper production cut to reduce stocks. Storing oil in tankers is unusual as it is significantly more expensive than inland. Abdullah al-Badri, Opec’s secretary general, said on Monday: "Stocks are very high. We have to act. We see a very sizeable reduction [in production]." Chakib Khelil, Opec president, said: "Everybody is supporting a cut."
Oil prices rose briefly above $50 a barrel, recovering from a four-year low of $40.50 earlier this month. Oil later traded $1.30 down at $44.95 barrel on concerns that Opec’s cuts would not be enough to prevent further stock building. Several Opec officials have suggested a 2m barrels-a-day cut, the biggest in recent history, and were also hoping to persuade Russia – the world’s largest oil producer outside the cartel – to make a reduction. But with Russia’s oil output already declining because of a lack of investment, any commitment is likely to be seen as a political gesture rather than an actual reduction. Whatever the size of Opec’s cut, the floating storage surge is a clear sign the cartel is losing its battle to cut supplies more quickly than demand falls.
Jens Martin Jensens, managing director at Bermuda-based Frontline, the world’s largest operator of supertankers, said that as many as 25 supertankers – each holding about 2m barrels – were being used as floating storage worldwide. Other traders suggested a similar number, pointing to companies such as BP and Royal Dutch Shell and traders such as Vitol and Koch as the holders of the oil. Opec ministers said in November they intended to reduce developed countries’ oil stocks from the equivalent of 56 days of demand to 52. But the surge in floating storage indicates that tanks are brimming, in spite of Opec’s having announced 2m b/d in cuts. Indeed, inventories have risen to almost 57 days’ demand. The International Energy Agency, the western countries’ oil watchdog, said the surge was the "result of abundant prompt supplies having a hard time finding customers".
Energy projects put on hold in response to lower prices
From the plains of North Dakota to the deep waters of Brazil, dozens of major oil and natural gas projects have been put on hold or canceled in recent weeks as companies scramble to adjust to the collapse in energy markets. In the short run, falling oil prices are leading to welcome relief for consumers across the globe, particularly in the United States, and even in countries where taxes represent a large share of the cost of gasoline and other fuels. But the project delays are likely to reduce future energy supplies - and analysts say they may set the stage for another rapid spike in oil prices once the global economy recovers.
Oil markets have just gone through their sharpest-ever spikes and their steepest drops on record, all within a few months this year. Now, with a global recession at hand and oil consumption falling, the market's extreme volatility is making it harder for energy executives to plan ahead. As a result, exploration spending, which had risen to a record this year, is being sharply reduced. The list of projects delayed is growing by the week. Wells are being shut down across the United States, new refineries have been postponed in Saudi Arabia, Kuwait and India, and ambitious offshore drilling plans are being reconsidered off the coast of Africa.
Moreover, investment in alternative energy sources like wind power and biofuels that had flourished in recent years could dry up if prices stay low for the next few years, analysts said. Banks have become reluctant lenders, especially to renewable energy projects that may prove unprofitable in an era of low oil and gas prices. The precipitous drop in oil prices since the summer, coming on the heels of a vertiginous seven-year rise, was a reminder that oil, like any commodity, is a cyclical business. When demand drops and prices fall, companies curb their investments, leading to lower supplies. When demand recovers, prices rise again, starting a new cycle. As familiar as the pattern may be, the changes this time are taking place at record speed. In June, some analysts were forecasting oil at $200 a barrel; now with prices under $50, no one knows how low they might fall.
"It's a classic - if extraordinarily dramatic - cycle," said Daniel Yergin, chairman of Cambridge Energy Research Associates and author of "The Prize," a history of the oil business. "Prices have come down so far and so fast, it's become a shock to the supply system." The delays could curb future global fuel supplies by the equivalent of 4 million barrels a day within the next five years, according to Peter Jackson, an analyst at Cambridge Energy Research Associates, Yergin's company. That is equal to 5 percent of current oil supplies. One reason projects are being shut down so fast is that costs throughout the industry, which had surged in recent years, are still elevated despite the drop in oil prices. Many companies are waiting for those costs to come down before deciding whether to go forward with new projects. "The global market has been turned upside down since the summer," the International Energy Agency, a leading energy forecaster, said in a recent report. In today's uncertain environment, a slowdown in spending is inevitable, according to energy executives who are devising their budgets for next year.
Last year, spending on exploration and production amounted to $329 billion, according to PFC Energy, a consulting firm. That figure is certain to fall. "We're in remission right now," said Marvin Odum, the vice president for exploration and production for Royal Dutch Shell in the Americas. But once the economy picks up, he said, "the energy challenge will come back with a vengeance." Oil demand growth has weakened throughout the industrial world. The International Energy Agency projects that worldwide demand will actually fall this year, for the first time since 1983. So much surplus oil is sloshing around the world right now that some companies, including Shell, are using oil tankers for storage. Prices could fall as low as $25 a barrel, according to Merrill Lynch, if the demand slowdown extends to China next year, which looks increasingly likely. Different companies have different price thresholds for going forward with drilling projects. But across the industry, a price drop this drastic has "a dampening effect," said Odum, the Shell executive. "The big uncertainty is how long this economic environment is going to last," he said.
The biggest cutbacks so far have been in Canada's heavy oil projects, where some of the world's highest-cost production is concentrated. Some operators there need oil prices above $90 a barrel to turn a profit. StatoilHydro, a large Norwegian company, recently pulled out of a $12 billion project in Canada because of falling prices. Similarly, Shell, Nexen, and Petro-Canada have all canceled or postponed new ventures in the province of Alberta in recent weeks. The drop in prices could crimp investments even in places where production costs are low. The Saudi monarch, King Abdullah, recently said he considered $75 a barrel to be a "fair price." Saudi Arabia, which has invested tens of billions of dollars in recent years to increase its production, recently announced that two new refinery projects, with ConocoPhillips and the French company Total, were being put on hold until costs fall. In Kuwait, the government recently shelved a $15 billion project to build the country's fourth refinery because of concerns about slowing growth in oil demand.
The list goes on: South Africa's national oil company, PetroSA, on Thursday dropped plans to build a plant that would have converted coal to liquid fuel. The British-Russian giant TNK-BP reduced its capital-spending budget for next year by $1 billion, 25 percent less than this year. In North Dakota, oil drillers are scaling back exploration of the Bakken Shale, a geological formation that was recently seen as promising but that is more expensive to produce that traditional fields. "People are dropping rigs up there in a pretty significant way already," Mark Papa, the chief executive of EOG Resources, a small natural gas producer, recently told an energy conference. Another U.S. producer, Callon Petroleum, suspended a major deep water project in the Gulf of Mexico, called Entrada, just weeks before completion because of what it described as a "serious decline in project economics."
According to research analysts at the brokerage firm Raymond James, U.S. drilling could drop by 41 percent next year as companies scale back. "We expect operators to significantly cut their activity in the coming weeks due to the holiday season, and many of these rigs will not come back to work," the report said. As scores of small wells get shut down, analysts at Bernstein Research have calculated that oil production in North America could decline by 1.3 million barrels a day through 2010, or 17 percent, to 6.14 million barrels a day. This decline, rather than cuts by members of the Organization of Petroleum Exporting Countries, "will be the catalyst needed for oil prices to rebound," Neil McMahon, an analyst at Bernstein Research, said during a conference call this month.
The drop in energy consumption could afford some breathing room for producers who had been straining in recent years to match fast-rising demand. But analysts warn that the world can ill afford a lengthy drop in investment in energy supplies. To meet the growth in global population and the rising affluence expected over the next few decades, the world will need to invest $12 trillion to increase its oil and natural gas supplies, according to the International Energy Agency. "If we cut back dramatically on investments, we could end up in a situation where supply growth goes flat when the economy starts to recover," said Jackson, the analyst. "The steeper the decline, the steeper the response."
Job cuts adding to growing number of housing defaults
Unemployment is now the cause of almost half of all foreclosures on conventional mortgages, raising concerns that mounting joblessness will stall any housing recovery and could cause more foreclosures next year. The increase in unemployment as a cause is a significant shift from 2007, when foreclosures were primarily driven by the large number of homeowners who had taken on risky loans. Many were first-time home buyers or those who bought during the housing boom that ended in 2006.
Now, layoffs and the recession are playing the pivotal role in driving mortgage defaults. The 4.3 million people collecting unemployment is the most since 1974, the Labor Department says. During the first half of the year, about 46% of the 90-day delinquencies on conventional, conforming loans were because of a loss of income, vs. 36% in 2006, according to mortgage giant Freddie Mac. Job losses exacerbate the situation for homeowners with risky mortgages. "A subprime buyer is already more fragile, so when unemployment rises, foreclosures go up," says Freddie Mac spokesman Brad German.
Mounting joblessness is also affecting homeowners who may have traditional, 30-year conventional loans but are living paycheck to paycheck. They tend to be more urban, lower- and middle-class blue-collar workers, says Rick Sharga of RealtyTrac. "It's not going to be pretty," Sharga says. "You're going to see whole different regions of the country suffer." Rising unemployment could undermine chances of a housing rebound for months to come. Potential home buyers are less likely to borrow for a home because of uncertainty about job security. That could keep inventories high as unsold homes stay on the market for months — dragging down home prices.
Another complication: Banks are less likely to lend when unemployment is high. "Many people have adjustable-rate mortgages that they were planning on refinancing," says Elena Rivkin Franz, a real estate lawyer in the San Francisco area. "Unfortunately, if you don't have a steady stream of income, you can't get a refinance, or at least an affordable one." A recent study by the National Coalition for the Homeless found homelessness rising. It's often hard for displaced workers to find new jobs. When they do, the new jobs on average pay about 13% less than the previous jobs, the coalition says.
Primary care doctors struggling to survive
The morning's last patient, a disabled woman on Medicare, trails her doctor into her office and confides that she doesn't have money for lunch. Tanyech Walford pulls out her billfold and hands her $3. It's money the doctor really doesn't have. "I tell patients I'm broke, and they just chuckle," she said. "They don't believe me." Walford's fashionable medical suite in a sleek black-paneled building in Beverly Hills was hiding a grittier reality: She spent much of her lunch hour that day in her office opening mail -- hoping to find payment checks to help fill the gap between her expenses and her revenue. She hadn't drawn a paycheck for herself since February. On top of that, her practice has cost her $40,000 in personal savings and left her with $15,000 in credit card debt. Walford, 39, also owes $80,000 in medical school loans. She shops at Ross and other discount retailers, and rarely eats out or takes time off. "I'm totally stressed out," Walford said. "How can I take care of my patients when I'm that stressed?"
Walford is not alone in her struggle. Relatively low earnings, rising overhead and overwhelming patient loads are sending veteran primary care physicians into early retirement and driving medical students into better-paying specialties, creating what the New England Journal of Medicine recently called a crisis. Primary care doctors "should be able to leave work thinking not of their income, or of unanswered phone calls, or of test results that they might have overlooked," Boston physician and associate journal editor Thomas H. Lee wrote in the Nov. 12 issue. "They should go home thinking, 'This is what I was meant to do.' " But after five years, Walford couldn't hang on any longer. She closed her office nine days ago. "It's sad," said Walford, who has shoulder-length wavy black hair, a cherubic smile and a slight lilt that betrays her Jamaican roots. "I worked really hard. It's a tragedy."
The loss of a single physician thrusts hundreds of patients into medical limbo. But the effect is far broader. Experts say the pool of primary care physicians is insufficient to meet the needs of an aging population. Already, shortages make it difficult to see physicians in swaths of northern and rural California, as well as neighborhoods in South Central Los Angeles and other urban cores. Much of the problem lies in an endangered business model: the one- or two-physician general practice. Such practices are particularly difficult for primary care physicians to maintain because of their relatively slim and declining margins. In her best year, Walford grossed about $360,000, more than enough to cover her overhead and take home a tidy income. That stands in sharp contrast to this year, when her practice slid into the red.
Small general practices afford doctors autonomy to practice medicine as they see fit and can produce strong doctor-patient bonds. But these physicians have little or no clout to leverage better payments with insurers; they have no economy of scale, which makes overhead more burdensome. "It's very difficult, even in rich neighborhoods like Beverly Hills, to set up a solo practice," said Richard Scheffler, an economist at UC Berkeley. "The doctor has to pay rent, a nurse, have a bookkeeper, billing systems, computers. All of those fixed costs are very, very hard for a solo practitioner to have and survive." Dr. Jerry Connell kept his family practice going in Santa Rosa for 29 years. But he closed it in October because his income had slipped to $50,000 a year, even though he had 2,600 patients. "I could make more with my Social Security and investments than I could by staying in practice," said Connell, 66. He didn't bother looking for a buyer because "no one in Sonoma County has been able to find a replacement in five years." Connell sold his equipment, but not to doctors. A biofuels company bought his scales and microscope. A veterinarian bought his laboratory equipment. And a tattoo salon bought his autoclave to sterilize needles.
The economic slowdown is making matters worse. Physician revenues nationwide are falling as patients who have lost jobs or homes stop paying their bills and skip appointments. "As people are tightening their belts, they are deferring things they think are a luxury or not absolutely necessary," said Long Beach physician Jeffrey Luther, president of the California Assn. of Family Physicians. "We see people putting off physicals and mammograms and blood tests because they just don't have the cash." Walford's patients began canceling in droves several months ago. Even those who need to monitor chronic conditions like heart disease and diabetes stopped coming in. Of those who did come, many asked to be billed -- even for co-payments as small as $10 -- and then never paid. "I love medicine," she said. "But they don't tell you this stuff in medical school. They tell you there's a shortage of doctors."
Walford's 1,950-square-foot office, down the hall from the Armenian Consulate, was in a professional building on La Cienega Boulevard. Framed modern art and historic photographs lined the walls. Oriental rugs were scattered over blond wood floors, and table lamps cast a cozy glow. The office had four examination rooms and two waiting rooms -- one in the front and one in the back, for overflow. A couple of years ago, the space might have made sense. Walford was seeing 30 patients a day. In recent months, her patient load dropped to about 15; on bad days, 12. Walford was forced to cut her staff from three medical assistants to one. In the end, the two of them did it all -- answering telephones, scheduling appointments and filing charts. A naturalized citizen who emigrated from Jamaica as a girl, Walford grew up in Hyattsville, Md. She was inspired by a missionary doctor she heard speak while at the University of Maryland. The first member of her family to finish college, she attended medical school at the University of Virginia. A residency at Harbor-UCLA hospital brought her west. Many of her patients were very attached to her. Some, like Catherine Ingram, cried when they learned Walford was leaving. A retired nurse, Ingram, 65, had been coming to Walford for four years. "I was just getting used to her . . . trusting her," Ingram said. "She's wonderful."
In one of her last days in her practice, Walford saw Vincent and Eloise Hall, Malibu residents who own an auto parts distribution business in Compton. She checked Eloise's blood pressure, noted that she had lost 5 pounds and reminded her that she was due for a mammogram. After giving Vincent, 74, a flu shot, Walford noticed that his blood pressure was up. As they went through the medications he is on, she learned that he had stopped taking his blood pressure pills. She reminded him of their importance and lectured him about getting more exercise. Said Eloise Hall, 80: "She reminds me of our daughter. "Angela Russ couldn't get a doctor to see her until she found Walford. The 54-year-old airline customer service representative has insurance, but other physicians demanded that she pay her annual $600 deductible upfront. Walford gave her a pay-as-you-go option. "I love her," Russ said.
Beverly Hills medical offices, near the prestigious Cedars-Sinai Medical Center, command some of the highest rents in the nation. Walford's suite ran $7,900 a month. It cost her an additional $6,700 or so for payroll, workers' compensation, taxes, medical and liability insurance, utilities, continuing medical education fees and other expenses. But in the last few months, many patients failed to pay their bills. In September, she sent invoices to Medicare, Medi-Cal, private insurers and patients for $70,000. With negotiated discounts and government fee schedules, Walford, as a rule of thumb, expected to collect two-thirds of her billings, or about $45,000, that month. Instead, she got $14,000 -- less than her overhead. Walford fell behind on her rent. But she didn't bother dunning her patients. "I can send patients to collections until the cows come home," she said. "I will never see that money."
Many primary care physicians boost their income by offering Botox injections and other cosmetic procedures for cash. Walford couldn't afford the training. Others have abandoned poor and working-class patients altogether, opening so-called concierge practices that require clients to pay an annual retainer of $1,500 or more and to submit their own insurance claims. Her patients would not have supported that sort of practice. With debt mounting each month, Walford was forced to explore other options. She set her sights on large, stable practices near where she grew up. She sought a job -- one with a steady paycheck -- that would allow her to take vacations without worrying about who would cover for her. She longed to concentrate on patients rather than on billing and collections. And she wanted to live in a place where she could afford to buy a home in a couple of years.
Early next month, Walford will join 200 physicians in a multi-office practice affiliated with Johns Hopkins Medical Center in Prince George's County, Md. Her base salary will be $115,000, plus bonuses based on the complexity and quality of care she delivers. Benefits include vacations, health insurance, a pension plan and paid continuing medical education. Walford couldn't find anyone to buy her practice and is still searching for someone to take over her lease. Dr. Peiman Berdjis, a friend with an office nearby on Wilshire, agreed to take the charts of the 2,000 patients she had seen over the years. Her patients can start seeing Berdjis or find another doctor. Walford said she sold her equipment for "pennies on the dollar" and gave her furniture to a couple who lost their home in the Sylmar wildfire. She stayed up until 4 one morning putting stamps on farewell letters to her patients. "This is a relief," Walford said from her cellphone as she drove east toward her new practice. "I've been spent emotionally, financially, physically, and now I need to have someone else worry about the finances."